needs no introduction. His stock-picking ability over the past
several decades is without equal.
#-ad_banner-#Many investors tend to focus on his mega-cap
stocks, such as
, or one of his rare tech holdings,
-- but there are, of course, other great investments to be found
in his portfolio.
One stock that he owns that doesn't get much attention is
Phillips 66 (NYSE:
Buffett's Berkshire Hathaway (NYSE:
owns just under 5% of the company
. (Last summer, my colleagues here at StreetAuthority
found that PSX is a favorite
of both Buffett and
T. Boone Pickens
Spun off from
in 2012, Phillips 66 is one of the largest oil refiners and
marketers in the U.S. It has a strong return on equity at 15%,
its valuation is compelling, and it pays a solid dividend.
At the Ira Sohn Investment Conference this month, Zach
Schreiber, CEO of hedge fund PointState Capital, made
a case for taking a long position in refining
. Schreiber expects the price of West Texas Intermediate (
) crude oil to fall in the next few years -- and fall hard.
That's because U.S. oil production is growing faster than
demand. However, the U.S. can't export it, given the ban on crude
oil exports. Thus, it'll have to be refined. That's a big win for
Phillips 66. In addition, the U.S. government has no plans to
reduce the amount of oil it imports from other countries.
Phillips is a fairly diversified downstream oil and gas
company, with refining, marketing, chemicals and midstream
businesses. All segments saw sequential earnings growth last
quarter, except refining. Refining was weak due to lower volumes
as a result of planned plant maintenance.
Going forward, Phillips 66's focus will be on higher-margin
businesses, namely chemical and midstream operations. The greater
shift toward chemicals and midstream should not only boost
overall margins but also help reduce its exposure to the more
volatile refining business. The ultimate goal is to lower its
earnings from refining to about a third of total earnings from a
The company plans to spend some $16 billion over the next few
years on new projects, with 70% of that total going toward
chemicals and midstream operations. It is looking to expand
chemical capacity by 35% in that time.
Phillips 66 is also a dividend and buyback machine. Its
current dividend yield is 2.4%, but that payout amounts to only
22% of earnings -- meaning that Phillips 66 has plenty of
flexibility to boost its dividend. In comparison, both
Valero Energy (NYSE:
Marathon Petroleum (NYSE:
pay a dividend yield of only 1.8%.
Since being spun off from ConocoPhillips in 2012, Phillips 66
has reduced its shares outstanding by 10%. During the first
quarter of 2014, the company bought back $1.6 billion in stock.
It still has $1.8 billion available under its share buyback plan.
That's good enough to reduce its shares outstanding by 4%.
PSX trades at a forward price-to-earnings (P/E) ratio of 10
based on next year's earnings estimates. That is a premium to its
refining peers, including Valero Energy and Marathon Petroleum at
8.5 and 8.4, respectively. But this is easily justified given its
diversified business model. And with its transition toward higher
margin businesses, this premium valuation should persist.
Risks to Consider:
Any unplanned downtime at its refining locations generally
has a meaningful impact on earnings. As well, crude
can have a big impact on Phillips 66's profitability. The other
potential risk is that the U.S. could relax its export policy on
crude oil exports, which would mean less oil for Phillips 66 to
Action to Take -->
Buy Phillips 66 for 20%-plus upside to $100, based on the
assumption that Phillips 66 should trade at a P/E of 12.5 on
expected 2015 earnings of $8.09 a share.
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