A Refining Stock That Tames The Energy Roller Coaster
The energy recovery remains on track, but don’t put away the Dramamine just yet. Oil and gas prices continue to subject investors to dizzying ups and downs.
For advice on how to cope with daily volatility in the energy patch, let’s turn to our in-house energy guru Robert Rapier. In his capacity as head honcho of The Energy Strategist, Robert explains his overall investment philosophy:
“As an investor, I learned long ago that it’s tough to time the markets. I learned to be a deliberate and patient investor. I place my bets and then wait until either my thesis bears fruit or the fundamental outlook changes.”
Robert’s deliberative attitude mirrors that of “super investor” Warren Buffett. The Oracle of Omaha focuses on quality companies with fortress balance sheets and patiently waits for them to ride out the market’s temporary ups and downs. That’s why his Berkshire Hathaway (NYSE: BRK-A) owns a large stake in refiner Phillips 66 (NYSE: PSX).
Below, I explain why PSX helps investors put the brakes to the energy roller coaster. First, I’ll let Robert Rapier quickly explain the textbook economics of the energy business:
“Fluctuations in crude oil prices have different impacts upon oil producers (upstream), pipeline companies (midstream), and refiners (downstream). Savvy investors can find opportunities whether crude oil prices are rising or falling…
Downstream is where refining to finished products occurs. This segment frequently trades out of sync with the upstream segment. Falling oil prices are bad for upstream, but good for refining margins — and vice versa.”
Wall Street’s amnesia…
Investors are so relieved that the oil and gas price recession is finally over, they’re making risky bets on overvalued but inherently weak companies that are still struggling to recover from the oil and gas bust. Amnesia is dangerous to your portfolio.
During the oil boom in the early days of the economic recovery, oil prices reached an astonishing high of $110 a barrel in mid-summer 2014. Energy companies of all stripes recklessly borrowed money to expand production, which seemed like a good idea at the time. Banks were only too happy to dole out the loans.
The shale production revolution in North America turned the U.S. into the world’s largest producer of oil. America actually dethroned Saudi Arabia as the king of oil producers, a landmark that we thought we’d never see in our lifetimes.
Then the bottom fell out due to overproduction and energy prices embarked on a protracted decline. Oil prices plunged to as low as the mid-$20s in February 2016, sending many indebted operators into bankruptcy. Now, oil prices are hovering at around $50 a barrel, the threshold that energy companies need to break even.
Natural gas prices are rebounding from their long slump as well. Natural gas spot prices in 2016 averaged $2.49 per million British thermal units (MMBtu), the lowest annual average price since 1999. The price now stands at about $3.18 MMBtu.
When investors think of energy, crude oil typically comes to mind. However, natural gas provides about 30% of the total energy consumed in the U.S. Demand for clean-burning natural gas is growing exponentially and gas may surpass oil as the world’s most important energy source. Industry experts predict that more than $100 billion may be invested in natural gas during the next decade, which makes natural gas the sleeping giant of commodities.
But the energy recovery remains bumpy and triggers for another correction abound everywhere around the globe. In addition to the supply and demand equation, geopolitical risk looms large. As world leaders behave like toddlers playing with loaded handguns, anything can happen.
Put your money in companies, not sectors…
Through it all, Warren Buffett, the world’s greatest value investor, knows that refiner Phillips 66 is resistant to these uncertainties. Buffett likes to say that he invests in companies, not whole sectors.
Diversification combined with low costs is the key to PSX’s strength. With a market cap of $39.3 billion, Phillips operates through four segments: midstream, chemicals, refining, and marketing and specialties. This diversification enables PSX to withstand unfavorable conditions in any one market.
Phillips has working interests in several large oil, gas, and natural gas liquid pipelines. PSX’s mainline pipelines are well situated to exploit fast-growing shale plays. Consequently, while crack margins are under pressure from rising input costs, PSX’s midstream segment is poised for a prosperous year.
Phillips also reaps high margins from its value-added chemicals activities, which benefit from economic growth and are less susceptible to oil and gas price swings.
PSX’s total debt-to-equity ratio (in the most recent quarter) is only 42.7, one of the lowest in the energy patch. PSX’s trailing 12-month price-to-earnings ratio (P/E) of 25.8 is lower than the trailing P/E of 29.3 for its industry.
As PSX launches several new large-scale projects this year, the outlook for this refiner is bullish. The average analyst expectation is that PSX will rack up year-over-year earnings growth of 40.4% in the next quarter, 44% in the current year, and 54.7% next year.
Analysts who cover the stock have on average set a one-year price target of $89, which would represent a gain of more than 17% from current price levels. The dividend yield stands at a hefty 3.27%, making Phillips an enticing total return package. Beat energy volatility at its own game, with Buffett’s favorite energy play.
Got a question or comment? Send me an email: firstname.lastname@example.org. Letters from readers have been pouring in all week, on a wide variety of topics. I’ll tackle the latest batch in tomorrow’s newsletter. — John Persinos
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