Despite a recent recovery in crude, low oil prices still pose a large problem for many energy stocks.
However, not all oil businesses suffer when crude prices crash. In fact, refinery stocks such as Marathon Petroleum (NYSE:MPC) and Phillips 66 (NYSE:PSX) actually benefit from falling oil prices. Learn why these two refiners in particular have distinct competitive advantages -- including diversified business models with strong midstream assets and master limited partnerships -- that make for excellent hedges against low oil prices, and make them worthy of consideration for your long-term petroleum portfolio.
Marathon Petroleum: location, location, location ... and MPLX
Refining margins usually rise when oil prices fall because input costs decline faster than refined product prices, but Marathon also has two key advantages over many of its competitors. First, its refineries are strategically located to take advantage of cheaper crude oil feedstocks from Canada, as well as the Bakken and Eagle Ford shale formations.
This access to cheaper crude has consistently helped keep Marathon among the most profitable refiners in America.
However, what really excites me about Marathon's prospects for growth is its midstream MLP MPLX (NYSE:MPLX). Marathon owns nearly 70% of the MLP, as well as 100% of the general partner and incentive distribution rights, or IDRs.
Because a deceny chunk of Marathon's EBITDA is derived from assets that could be dropped down to MPLX, Marathon could sell these assets to its MLP to raise significant growth capital but would still benefit from the vast majority of the cash flow these assets generate -- courtesy of fast distribution and IDR fee growth from MPLX.
In fact, Marathon's management is making investment in its midstream assets a top priority, with 35% of 2015's capital expenditure budget going toward growing this operating segment via such projects as the Sandpiper and Southern Access Extension pipelines. Marathon intends to invest $1.4 billion into these projects over the next few years, and has earmarked them as future potential MPLX drop-down targets.
Marathon also has an excellent track record of returning cash to shareholders through strong dividend growth and buybacks that have helped it to crush the market in recent years. I am confident this aggressive push into midstream -- when combined with potential improved refining margins due to low oil prices -- should greatly increase the odds of Marathon continuing to outperform the market going forward.
Phillips 66: a growing diversified empire with shareholder-friendly management
Phillips 66 is my other top choice for refining stocks for two main reasons other than the benefit of low oil prices on refining margins. First, its business model is highly diversified, which helps to smooth out operating cash flow over time and allow for stable and steady dividend growth.
For example, in addition to its 14 refineries, it has a 50% equity stake in Chevron Phillips Chemical, a large global petrochemical operation. Most excitingly for growth investors is the fact that Phillips 66 is involved with two midstream MLPs: DCP Midstream Partners -- of which it owns 50% of the general partner and IDR rights -- and Phillips 66 Partners -- of which it owns 100% of the general partner and IDR rights, as well as 69% of the limited units.
Management forecasts that EBITDA generated from its midstream segment will grow by almost 50% per year through 2018.
However, strong growth means little unless management is willing to return cash to shareholders. Fortunately, Phillips 66 has had an extremely shareholder-friendly cash return policy since its 2012 spinoff.
As this chart shows, Phillips 66's dividend growth rate has been much better than the S&P 500's in recent years, which with its aggressive share buyback policy has helped produce market-trouncing returns. Better yet, management plans to continue this generous policy, with quite a bit remaining under its existing $7 billion buyback authorization -- enough to reduce the share count by an additional 4%.
Takeaway: quality refiner stocks can help hedge oil investors against low oil prices
Short-term oil prices are notoriously hard to predict, but oil investors can hedge their portfolios by diversifying into high-quality refiners such as Marathon Petroleum and Phillips 66. A low oil price environment not only boosts margins at their refining segments, but their planned aggressive investment into midstream distribution networks, along with their shareholder-friendly buyback and dividend programs, should help increase the probability of market-beating total returns for years to come.