PSX Stock: This Is Why Warren Buffett Is Buying Phillips 66

PSX StockWarren Buffett Is Bullish on PSX Stock

Phillips 66 (NYSE:PSX) stock is our favorite way to invest in the oil industry…and now even Warren Buffett agrees with us.

In a Securities and Exchange Commission (SEC) filing published last August, Buffett revealed he had been secretly accumulating Phillips 66 stock since the second quarter of this year. Over the past few months, he has continued building out his position. Including the recently purchased shares, his investment now totals $5.0 billion. (Source: “Berkshire filing reveals more Phillips 66 purchases as stock dipped,” CNBC, March 2, 2016.)

Phillips 66, though, is an odd bet. The company is a commodity business operating in chemicals, oil refining, and marketing operations. These are industries that don’t necessarily lend themselves to outsized returns.

So what could Buffett possibly see in this company? Here are three reasons Buffett is buying Phillips 66.

1. Outsized Margins

You’re getting screwed.

Drivers have enjoyed the recent break at the gas pump. But even when energy prices are dropping, the industry finds a way to take advantage of customers.

Over the past two years, oil prices have plunged 65%. Drivers, though, have yet to see the full benefit. The average price of gasoline across the country has dropped only 37% over the same period.

The difference has gone straight into the pockets of refiners. Drivers have responded to cheap oil by driving more, making it harder for refineries to keep up with demand. This has allowed processors to demand higher prices for their end product, even if the oil itself is cheaper.

Good news for refiners. Companies like Phillips are making money hand over fist. Last year, the company’s operating income came in at $4.3 billion, up 41% from the previous year.

2. Outsized Catalysts

Phillips 66 is mostly a boring refining company, which means it receives a boring valuation from investors. Today, the company’s enterprise value (the total value of debt and equity) trades at about six times its earnings before interest, taxes, depreciation, and amortization. This is about in-line with peers.

EV Multiples

Source: Phillips 66 Investor Presentation

However, Phillips 66 owns an extensive portfolio of “mid-stream” properties. This is industry lingo for the facilities that actually move and store energy products. Because they generate dependable dividends, investors are willing to pay a big premium for these assets.

To profit from the spread, Phillips 66 has been spinning off its midstream assets into a separate entity. Each time the company sells off a property, investors make a giant profit. If management is able to unlock the full value of these assets, it could be a huge catalyst for PSX stock.

And most of this cash is funneled straight to shareholders, which leads us to reason #3 that Warren Buffett is buying Phillips 66 stock.

3. Outsized Dividends

PSX stock has become a cash cow. Since the company was spun out of ConocoPhillips in 2012, management has increased the dividend paid by 180% and bought back 15% of its outstanding shares. Today, PSX shares yield a tidy 2.7%.

This distribution will likely increase, however. Given the limited expansion opportunities in the industry, Phillips 66 is returning most of its growing profits back to shareholders. Management also has more than $2.6 billion in buybacks authorization remaining.

The bottom line: Phillips 66 offers growing profits, numerous catalysts, and a healthy dividend. No wonder Warren Buffett is backing up the truck on PSX stock.