Phillips 66 (PSX) is the most diverse of the major refining companies, but you wouldn’t know it based on the way the stock trades. Specifically, the market has assigned PSX a valuation similar to other refiners, and the stock trades in lock step. However, the company’s chemicals and midstream businesses warrant a different valuation multiple, and the stock price shouldn’t be quite as highly correlated with other refiners. We believe PSX offers a decreasingly volatile but growing earnings stream and deserves a higher stock price based on its attractive free cash flows that are used to profitably grow the business and reward shareholders with stock buybacks and increasing dividends.
The following table from the company’s latest Investor Update shows the earnings (before interest, taxes, depreciation and amortization) of Phillips 66 over the last five years as well as the company’s expectations for 2018.
Fast growing midstream and chemicals businesses will generate a significant portion of EBITDA growth, but refining and marketing & sales will also contribute. Refining and marketing & sales are the main business activities of most refining companies, but Phillip’s 66 is unique in the large (and growing) portion of earnings from other businesses (i.e. midstream and chemicals).
This next table shows the typical EV/EBITDA valuation multiple assigned to the various business activities in which PSX is involved (EV is enterprise value, and it’s basically a summation of a company’s total debt and equity value with some minor adjustments). The PSX valuation is higher than its refining peers, but the market is still not giving the company enough credit for the size and growth potential of its chemicals and midstream businesses. Midstream businesses receive a significantly higher multiple due largely to the very stable earnings they generate from long term fee agreements.
If PSX were to receive full credit for its various business segments then its stock would trade about 12% higher based on its current business mix and 20% higher based on its expected 2018 business mix. However, even without this business mix multiple expansion, the stock has significant upside from the large expected EBITDA growth between now and 2018. And unlike its refiner peers, this growth will be generated largely by midstream and chemicals (as well as some growth contributions from refining and marketing & sales). For added perspective, if PSX achieves its expectation of around $2.3 billion of midstream EBITDA in 2018 then the midstream business is worth around $34 billion as a stand-alone company (we used a 14.5x multiple), not far below what the entire company is worth now.
PSX will spend heavily to generate the midstream and chemicals growth, but the company generates more than enough cash to fund the growth and to also reward shareholders with share buybacks and increasing dividends. The following charts show the mix of capital spending as well as the breakdown of cash returned to shareholders.
If PSX meets its growth expectations and generates $9.3 billion of EBITDA in 2018 then the company is worth significantly more than its current stock price suggests. Further, the stock has even more upside if the market starts giving it credit for its midstream and chemicals businesses instead of just lumping it in with other large (less diversified) refiners.