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Coverage Initiation: Phillips 66 (PSX)
Phillips 66 (PSX) was incorporated in November 2011 as a wholly owned subsidiary of ConocoPhillips (COP) in preparation for its eventual spin off from that company. In April of 2012 Phillips 66 was separated from ConocoPhillips; ConocoPhillips did not retain any ownership interest in Phillips 66. Essentially, Phillips 66 is made up of ConocoPhillips’ former Downstream business, including its refining, marketing and transportation operations; its natural gas gathering, processing, transmission and marketing operations (primarily conducted through a 50% equity investment in DCP Midstream, LLC); and petrochemical operations (conducted through an equity investment in Chevron Phillips Chemical Company LLC).
The history of Phillips 66 is clearly tightly tied to that of its former parent. ConocoPhillips traces its roots back to the early 1900s and includes the formation and growth of several iconic U.S. brands, several of which Phillips 66 now owns. The spin-off transaction was a way for ConocoPhillips to better focus on its core business of pulling oil and natural gas out of the ground. Phillips 66, meanwhile, is made up of a solid core of assets and partnerships that are both highly profitable and provide ample potential for growth. Moreover, ConocoPhillips did not saddle the spun-off entity with a material debt load, leaving Phillips 66 with both the potential for growth and the financial flexibility to achieve it.
Phillips 66’s operations fall into three main business units, the Refining and Marketing division, the Midstream group, and its Chemicals operation. The Refining and Marketing segment is by far the largest of the three, accounting for over 95% of revenues in the first quarter of 2012. This division purchases, refines, markets and transports crude oil and petroleum products, in the United States, Europe and Asia. Its domestic crude oil processing capacity is approximately 1.8 million barrels per day. Adding in its foreign operations brings that number to net crude oil processing capacity of 2.2 million barrels per day globally. It owns or has an interest in 11 refineries in the United States and four internationally, though it only operates two of the latter facilities. (This segment also engages in power generation activities, lubricants and other specialty products businesses, though none of these are the main focus.)
The public face of this division, and the company as a whole, is the retail arm. Its refined products are sold at around 10,000 outlets in the United States and Europe, primarily under the Phillips 66, Conoco and 76 brands in the United States and JET in Europe. Nearly all the outlets in the United States are marketer-owned or –supplied. The international operations include both company-owned and dealer-owned sites. In addition to these operations, the company owns and leases transportation assets that it uses to deliver crude oil, refined products, natural gas and natural gas liquids, including pipelines and terminals, marine and inland vessels, railcars and trucks.
Phillips 66’s Midstream business primarily consists of a 50% equity investment in DCP Midstream, LLC, a joint venture with Spectra Energy (SE). DCP Midstream is a large and well diversified natural gas gathering and processing entity in the United States, with assets located in the Rocky Mountains, Midcontinent, Permian, East Texas/North Louisiana, South Texas, Central Texas, Gulf Coast, Niobrara, Eagle Ford, Barnett and Granite Wash regions. Its assets include 62,000 miles of pipelines, 61 gas processing plants, and 12 natural gas liquid fractionators. Phillips 66 directly owns and operates interests in three natural gas liquids fractionators and gathering systems and a 25% interest in the Rockies Express natural gas pipeline.
The company’s Chemicals business is primarily comprised of a 50% equity investment in Chevron Phillips Chemical Company LLC, a joint venture with Dow 30 stalwart Chevron (CVX – Free Value Line Research Report on Chevron). This business has facilities in the U.S. Gulf Coast region and investments in the Middle East, that offer access to both feedstocks and the Asian markets. It is one of the world’s top producers of olefins and polyolefins, and a leading supplier of aromatics and styrenics.
Phillips 66’s operations are virtually all tied to crude oil and natural gas. As such, fluctuations in crude oil, natural gas liquids, and natural gas prices have a material impact on both the top and bottom lines. Safe and timely transportation of refined and unrefined products is also an important issue, though historically not a material one. However, as a simplistic example, gas can only be sold if it is delivered to the gas stations baring the company’s brands.
The company’s operations also expose it to material regulatory oversight, both domestically and abroad. Failure to adhere to industry standards or to adjust its operations for new laws could have a material impact on the company. Moreover, regulatory changes could require substantial outlays just to maintain compliance, including those related to environmental issues.
The health of the domestic and global economy are also issues to watch, as demand for its end products are tightly related to the financial strength of the areas in which they are sold. Competitors can also have an impact on pricing since the company’s products are, largely, commodities. So capacity and supply issues are worth considering when looking at Phillips 66.
Investors interested in a large, well-financed downstream energy play would do well to monitor Value Line’s regular quarterly reports on Phillips 66, while also keeping an eye out for our coverage of late breaking news.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.