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Here's Why You Should Hold on to Phillips 66 (PSX) Stock Now

Zacks Equity Research

Phillips 66 PSX is well poised to grow on the back of midstream growth projects. However, rising operating costs remain a concern for now.

The Houston, TX-based refining and midstream company — with a market cap of $35.7 billion — has an expected earnings growth of 5.2% for the next five years. Phillips 66 beat earnings estimates in the last four quarters, with average positive surprise of 23.5%. Its 2020 earnings per share estimates of $2.28 have witnessed four upward and two downward revisions in the past 30 days.

Phillips 66 Price and EPS Surprise

Phillips 66 Price and EPS Surprise

Phillips 66 price-eps-surprise | Phillips 66 Quote

Let’s delve deeper to find out why this Zacks Rank #3 (Hold) stock is worth retaining in your portfolio at the moment.

A Look at the Positives

Phillips 66 is the leading player in each of its operations like refining, chemicals and midstream in terms of size, efficiency and strength. The company is on track to enhance its potential in every business segment by streamlining the portfolio of assets and investing in significant developments.

The midstream business is in high demand in the United States as there is a huge need for fresh pipeline and infrastructure properties in the flourishing shales owing to the existing takeaway capacity constraints. To capitalize on this, the company allocated a significant portion of capital budget for midstream operations, which will lead to higher margin and solid growth. Precisely, Phillips 66, whose oil and gas pipeline network is expected to reach 24,000 miles by 2020, is an industry leader in the midstream business.

The company is adding two 150,000 barrels per day (bpd) fractionators for expanding the Sweeny Hub. The additional fractionators, backed by long-term commitments, are expected to commence operations in the fourth quarter. Following the expansion project completion, Sweeny Hub will have a massive 400,000-bpd fractionation capacity, which will help it deliver strong growth. The company is also incorporating 7.5 million barrels of storage capacity at Clemens Caverns in the Sweeny Hub.

Phillips 66 is strongly committed to return cash to shareholders through both dividend payments and share repurchases. It pays a quarterly dividend of 90 cents per share ($3.60 on an annualized basis), which will continue even amid the current market uncertainty caused by the coronavirus pandemic. Notably, it has paused the share buyback program from Mar 18 and expects to resume it later. Since inception, the company has returned more than $25.7 billion to shareholders.

The International Maritime Organization, through IMO 2020 regulations, has planned to reduce the sulphur content in marine fuels, which increases the demand for distillate fuels. Phillips 66, with updated refining assets, is well positioned to adapt to the change in regulations.

What’s Deterring the Stock?

There are a few factors that are holding back the stock from reaching true potential.

Adjusted pre-tax loss of $401 million from the company’s refining operations widened from the year-ago loss of $219 million. This underperformance was attributed to reduced volumes and weak margins. The segment’s realized refining margins on a worldwide basis fell to $7.11 per barrel from the year-ago quarter’s $7.23. Moreover, the same in Atlantic Basin/Europe and West Coast fell to $2.38 and $4.80 per barrel from the year-ago level of $7.76 and $6.25, respectively.

Phillips 66’s operating expenses rose 4% through 2019 to $5,074 million. Moreover, in the first quarter, total costs rose year over year due to higher operating expenses. This can affect its profit levels in the coming quarters.

Although Phillips 66 is strongly committed to constantly return capital to shareholders through dividend payments, the stock has mostly paid lower dividends than the industry in the past year.

While the phase-one trade agreement has solved a few concerns for the United States, there are many more to be addressed, which raises the possibility of an escalation of trade war. Moreover, the global coronavirus outbreak has crippled energy demand growth. The threat to overall economic growth might hurt the company’s refining businesses. 

As of Mar 31, 2020, cash and cash equivalents were $1.2 billion, reflecting a sequential decline from $1.6 billion. Total debt rose to $13 billion from $11.8 billion in fourth-quarter 2019. Moreover, the interest coverage ratio of 4.02 compares unfavorably with the industry’s 11.8. Its declining times interest earned ratio has raised questions on the refiner’s ability to pay off the current portion of long-term debt load. Given the weakness in energy demand due to coronavirus-induced lockdowns, the company’s earnings will remain under pressure, which might pose difficulty for Phillips 66 in paying down the debt burden.

To Sum Up

Despite significant prospects, rising operating costs and weak energy demand are affecting the company. Nevertheless, we believe that systematic and strategic plan of action will drive its long-term growth.

Stocks to Consider

Some better-ranked players in the energy space include Chesapeake Energy Corporation CHK, CNX Resources Corporation CNX and Comstock Resources, Inc. CRK, each holding a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Chesapeake Energy delivered an average positive earnings surprise of 42.8% in the last four quarters.

CNX Resources beat earnings estimates thrice and met once in the last four quarters, with average positive surprise of 111.5%.

Comstock Resources’ 2020 sales are expected to gain 32.7% year over year.

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