As the market fights through all recent volatility, particular within the energy space, many an investor no doubt feels the need to scream in terror and sell everything as shares drop as much as 30%, 40%, 50%, or even more from their highs. While investment theses change and selling some members of the energy sector may be warranted, Phillips 66 (NYSE:PSX) may be the exception. Here's why.
Diversified business model allows for stability
Despite the volatility of many commodity businesses, Phillips 66's diversified assets provide stability in a sector fraught with uncertainty right now. Phillips 66 has major businesses in three industry segments -- midstream, refining and marketing, and chemical -- that make it different from other stand-alone midstream, refining, and chemical companies.
Phillips 66's integration of these business segments offers customers and investors incredible value. The integration and overall business expertise allow the company to create value downstream and allocate capital efficiently, which, in turn, allows for a higher or expanding multiple because its higher quality business model versus many of its stand-alone competitors. In addition, each of the business segments generates FCF yields of 5%-25%, making them incredibly valuable on a stand-alone basis.
Management is shareholder-friendly and competent
Management has been extremely shareholder-friendly, having returned $7.7 billion to shareholders in the form of dividends ($1.7 billion) and share repurchases ($6 billion) since 2013. Overall, management has repurchased 15% of the shares outstanding since 2012. It's also been able to generate returns on invested capital of over 16% the past three years, which shows its ability to allocate capital effectively.
Management has increased the dividend from $0.45 to $2.18 per share over the past three years. It's also staying focused in this depressed commodity environment, as it reinvests in high-return opportunities. I expect management to continue to be shareholder friendly and increase shareholder value over the long term.
Strong cash flow and undervalued shares
Phillips 66 had cash flow from operations of $5.9 billion in 2015. And management expects maintenance capital expenditures for 2016 to be around $1.3 billion . That gives us a back-of-the-envelope net free cash flow of about $4.6 billion, if cash flow from operations comes in anywhere around the 2015 (which I do believe will happen). Let's be conservative, though, and use the 2009-2014 average FCF figure of $2.7 billion for our calculation. The average FCF figure gives investors a company trading at a P/FCF of 16.63, and it's likely to be a low-line figure as the company continues to grow, even in a depressed commodity environment.
The 2013 spinoff of master limited partnership Phillip 66 Partners (NYSE:PSXP) has created exceptional value for Phillips 66 shareholders. Phillips 66 still has a 73% limited-partner and 2% general-partner stake, whose value could grow to $10 billion to $15 billion by 2018 . This stake currently amounts to $18 to $27 per share for Phillips 66 shareholders (or 22.5% to 33.75% of the recent market price).
With cash of $3.02 billion and debt of $7.79 billion, the company continues to operate with a strong balance sheet. At a 17% net debt-to-capital ratio, it should be able to maintain current operations and grow organically through a down cycle in commodities.
Tying it all together
There's no doubt that Phillips 66 is a capital-intensive business exposed to commodity prices. However, the company's diversified business model and capable management team have generated exceptional shareholder value in the past. I expect this trend to continue as the company compounds investor returns over the long run.
While the decline in oil prices has put a slight dent in the earnings power at Phillips 66 in the short term, it hasn't led to any structural changes to the company. If fact, I would argue that that it's positioned itself well to grow in this low-priced commodity environment. After all, we're talking about a business that's been in existence for more than a hundred years and has gone through significant ups and downs in the commodity cycle before. I believe that this well-diversified company will be able to emerge from this downward price cycle in an excellent position to profit, as it has done so many times before.
Phillips 66 appears to be a long-term buy-and-hold investment in an industry going through uncertain times.