Phillips 66 Midstream Operations Strong, Debts On The Rise

On Jun 20, we issued an updated research report on downstream energy player Phillips 66 (NYSE:PSX) . We appreciate the company’s decision to allocate funds for higher margin chemicals and midstream businesses. However, high dependence on debt financing could hurt the company.

Phillips 66 currently carries a Zacks Rank #3 (Hold), which implies that the stock will perform in line with the broader U.S. equity market over the next one to three months.

The company expects more value from its chemicals & midstream businesses than extensive refining operations. Owing to the rising need for fresh oil and gas pipelines and infrastructure properties in the shale plays, midstream services are much in demand in the central U.S. Moreover, improving petrochemical demand should call for more chemical business in the U.S.

Also, Phillips 66 has an impressive capital deployment record. The company regularly rewards shareholders with dividend hikes. In fact, since its spinoff, the company has raised dividends every year. This reflects the company’s solid financial strength and steady returns from operating units. Most importantly, the company is likely to witness nearly 48% year-over-year earnings growth in 2017.

Moreover, we appreciate the company’s decision to invest $1.3 billion out of the total 2017 capital budget of $2.3 billion in growth projects. It is to be noted that over the last four years, Phillips 66’s operating cost and sales, general & administrative expenses were considerably high with no signs of reduction. For the first time during first-quarter 2017, the company managed to cut down costs to a great extent. If this can be maintained, the refiner will garner significant cash flow over the coming days.

However, since the beginning of 2012, there has been exponential growth in long-term debt, reflecting Phillips 66’s weak balance sheet. As of the end of Mar 2017, the company’s balance sheet had only $1.5 billion in cash balance, while total debt of $10.2 billion is significantly higher.

It is to be noted that oil price is trading much below the level attained during mid-2014. Weak commodity prices could compel upstream players to reduce their exploration and production activities. This might translate into lower demand for new pipeline infrastructures and hurt Phillips 66’s midstream business.

On top of that, the one-year pricing chart shows that Phillips 66 has underperformed the Zacks categorized Oil Refining & Marketing industry. During the said time frame, the company has gained almost 0.1%, as compared to the broader industry’s 10.6% rise.

Stocks to Consider

Better-ranked players in the energy sector include Canadian Natural Resources Limited (TO:CNQ) , McDermott International Inc. (NYSE:MDR) and W&T Offshore Inc. (NYSE:WTI) . Canadian Natural and McDermott sport a Zacks Rank #1 (Strong Buy), while W&T Offshore carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

We expect year-over-year earnings growth of almost 725% in 2017 for Canadian Natural.

McDermott beat the Zacks Consensus Estimate in each of the trailing four quarters, the average positive surprise being 387.50%.

W&T Offshore had an average positive earnings surprise of 69.21% for the last four quarters.

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