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Why Buffett Is the Largest Institutional Owner of Phillips 66

The company's diversified business portfolio includes refining, midstream, chemicals, and marketing and specialty operations.

Phillips 66 (PSX) is a downstream energy company; its diversified business portfolio includes refining, midstream, chemicals, and marketing and specialty operations, explains Bill Selesky, analyst with Argus Research.

This diversification has proven valuable in different commodity price environments over the years, and, despite current weak refining margins, we believe the company’s cash flow is less volatile than that of most pure-play refiners.

We also have a positive view of management’s plans to allocate more capital to its high-return chemicals and midstream businesses, which are well positioned to benefit from secular growth in North American hydrocarbon production.

PSX has consistently returned excess cash to shareholders in the form of both dividends and share buybacks. It raised its quarterly dividend by 11% in July 2017, and recently announced a $3 billion buyback authorization.

We are raising our 2017 EPS estimate to $4.38 from $4.16 based on our expectations for modest margin improvement and increased stock buybacks over the remainder of the year. The 2017 consensus estimate is $4.43.

We are also boosting our 2018 estimate to $5.88 from $5.67, which assumes higher volumes and stronger pricing next year. The 2018 consensus estimate is $5.88.

Phillips holds a majority stake in its MLP, Phillips 66 Partners LP. The MLP has created a low-cost alternative financing vehicle for Phillips 66, allowing the company to grow its midstream business more quickly than would otherwise have been the case due to the tax-advantaged structure of the MLP.

PSX will also have the opportunity to drop down additional midstream assets into the MLP, such as its stake in Bayou Bridge pipeline. Management expects $8-$10 billion in cash proceeds to Phillips 66 from Phillips 66 Partners LP through 2018.

Warren Buffett’s Berkshire Hathaway (BRK.A) currently has a 15.77% ownership stake in the stock. The company initiated its position in August 2015.

Mr. Buffett noted that Berkshire was not buying Phillips 66 either as a refiner or as an integrated oil company, but rather because “we like the company and … and… the management very much.” Berkshire Hathaway is the company’s largest institutional.

We believe that many energy sector investors continue to overlook Phillips 66 due to recent weak performance in the Refining segment, which continues to face margin pressure.

However, we expect the shares to benefit from stronger margins and earnings going forward, driven by improving industry fundamentals, as well as from the company’s focus on dividend increases and stock buybacks. We are reaffirming our Buy rating on Phillips 66 and raising our price target to $108 from $96.

Bill Selesky is senior analyst at Argus Research.

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