Buffett’s Favorite Refiner Spared Squeeze
The largest U.S. refiners that are not also oil producers are Phillips 66 (NYSE: PSX), Valero Energy (NYSE: VLO), Marathon Petroleum (NYSE: MPC) and Tesoro (NYSE: TSO). But one of these stocks is not like the others. While the latter three have been down double-digits in 2016 since very early in the year, Phillips 66 has fared significantly better:
We have covered in detail the reasons for the refining sector’s troubles this year. The primary culprit is the rise in oil prices, which eroded refining margins. When oil prices are falling, fuel prices tend to fall more slowly, inflating margins. This is why refiners handily outperformed oil producers in 2015. But the opposite happens when oil prices are rising, so refiners have underperformed in 2016.
Why has Phillips 66 fared so much better than its peers? Let’s start by looking at some of the important financial metrics for each of the four largest pure-play U.S. refiners:
- EV – Enterprise value in billions of U.S. dollars as of Sept. 2
- EBITDA – Earnings before interest, tax, depreciation and amortization, in billions for the trailing 12 months (TTM)
- FCF – Levered free cash flow in billions
- Debt – Net debt at the end of the most recent fiscal quarter
- Yld – Annualized yield based on the most recent quarterly dividend
Phillips 66 is in fact cheaper than two of its three comparables on the basis of EV/EBITDA, even after the large year-to-date declines suffered by those refiners. On the other hand, it’s the only one of the four to have negative free cash flow over the past year (primarily a result of major capital expenditures).
But these metrics can’t explain the large discrepancy in performance. Perhaps another explanation is the “Warren Buffett effect.”
Buffett’s Berkshire Hathaway (NYSE: BRK.B) began purchasing shares of Phillips 66 in 2012. In 2013, it exchanged some $1.4 billion in PSX stock for the refiner’s pipeline polymers business but kept buying more shares. Berkshire Hathaway has steadily increased its PSX stake over the past year. During the second quarter of 2016, Berkshire purchased an additional 3.23 million shares, making PSX the 6th largest holding in its investment portfolio, with a market value of $6.3 billion. It now owns more than 15% of Phillips 66.
At Berkshire Hathaway’s annual shareholder meeting in April, Buffett was asked whether Berkshire’s energy investments, including Phillips 66, stemmed from a long-term view on oil prices. Not at all, he responded: “We’re thinking about other things when we make those decisions.”
What might those thoughts be? Recall that in 2010, Berkshire Hathaway bought the Burlington Northern Santa Fe (BNSF) railroad. This was early in shale oil boom, and what ensued was explosive growth in rail shipments of crude oil produced in places like North Dakota to refineries around the U.S. One of BNSF’s most important customers is Phillips 66, which has refineries at multiple locations along BNSF lines. Incidentally, one of those happens to be the Phillips 66 refinery in Billings, Montana, where I worked a decade ago.
Could Berkshire Hathaway’s growing stake in Phillips 66 explain the company’s outperformance relative to its peers? Possibly. Berkshire has been accumulating PSX below $80 a share. The current price of PSX is $78.87, so barring a strategy shift or additional appreciation the buying is likely to continue.
What’s the end game for Berkshire Hathaway? Some speculate that the company may be positioning for a buyout of PSX, using the playbook from its acquisition of BNSF in 2010. By the time that deal was announced, Berkshire had accumulated a 23% stake in the company. The acquisition provided a premium of about a 30% to the market price.
I have personally owned Phillips 66 shares from the time I worked for the refiner’s former parent, ConocoPhillips (NYSE: COP). But is PSX worth adding to your portfolio given Buffett’s interest? Consider subscribing to The Energy Strategist as we continue to monitor this developing situation.