Phillips 66 quarterly report, Q3 FY2016

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Phillips 66 — Q3 2016 Form 10-Q

Business context and reporting period

Phillips 66 is an energy manufacturing and logistics company with Midstream, Chemicals, Refining, and Marketing and Specialties (M&S) businesses. This unaudited report covers the quarter and nine months ended September 30, 2016, compared with the corresponding 2015 periods. Management cautions that interim results are not necessarily indicative of full-year results.

Financial results and position

  • Q3 earnings: Net income attributable to Phillips 66 was $511 million, or $0.96 per diluted share, versus $1.578 billion, or $2.90 per diluted share, in Q3 2015. Sales and operating revenues were $21.624 billion, down from $25.792 billion.
  • Nine-month results: Net income attributable to Phillips 66 was $1.392 billion, or $2.61 per diluted share, versus $3.577 billion, or $6.52 per diluted share, in 2015. Sales and operating revenues were $60.882 billion, versus $77.082 billion.
  • Cash flow and uses: Operating cash flow was $883 million in Q3 and $2.296 billion for the nine months, compared with $4.216 billion in the prior-year nine-month period. Nine-month capital expenditures and investments were $2.031 billion; common dividends were $954 million and share repurchases were $812 million.
  • Liquidity and debt: Cash was $2.337 billion at September 30, down from $3.074 billion at year-end 2015. Total debt was $8.858 billion, with a 27% debt-to-capital ratio. Management reported approximately $5.4 billion of available capacity under credit facilities. The company’s $5 billion revolving facility was undrawn; Phillips 66 Partners had $50 million outstanding on its facility.
  • Dividends: The quarterly dividend was $0.63 per share, up from $0.56 in Q3 2015. A further $0.63 dividend was declared in October, payable December 1, 2016.

Material changes versus prior comparable periods

  • Q3 earnings declined 68%, primarily from lower Refining margins and lower Chemicals margins. Nine-month earnings fell 61%, also reflecting the absence of a $242 million deferred gain recognized in 2015 from the Immingham plant sale.
  • Refining earnings fell to $177 million in Q3 from $1.003 billion. Worldwide realized refining margin was $7.23 per barrel versus $13.96; utilization was higher at 97% versus 96%.
  • Chemicals earnings were $101 million versus $252 million. A CPChem equity-affiliate impairment reduced Phillips 66’s equity earnings by $89 million after tax in Q3 and year to date; lower olefins and polyolefins margins also weighed on results.
  • M&S earnings declined to $267 million from $338 million, mainly due to lower Q3 marketing margins. Midstream earnings were $75 million versus $101 million; improved DCP Midstream results partly offset weaker NGL results and higher transportation costs.
  • Nine-month operating cash flow decreased from $4.216 billion to $2.296 billion, principally because of lower refining margins and lower equity-affiliate distributions. Those distributions were $387 million versus $1.463 billion, including a $696 million special CPChem distribution in 2015.
  • Whitegate Refinery and related marketing assets were sold in September; the filing reports an immaterial gain. Its LIFO inventory liquidation reduced net income by $62 million, included in the disposition gain.

Outlook, management commentary, and risks

  • Management forecast approximately $3 billion of total capital spending for 2016 and gave a preliminary 2017 estimate of approximately $3 billion, subject to Board approval. The final 2017 budget was expected in December 2016.
  • Management said cash, operating cash flow, and access to external funding were expected to meet near- and long-term funding needs. It also noted that cash flows are highly dependent on volatile refining and marketing margins, NGL prices, Chemicals margins, and equity-affiliate distribution decisions.
  • DAPL and ETCOP construction financing draws were suspended pending permitting resolution, requiring renewed sponsor-loan draws. Phillips 66’s share of outstanding sponsor loans was $84 million. DAPL was awaiting a Missouri River easement; commercial operations were then expected in Q1 2017.
  • Environmental accruals were $484 million at September 30, 2016, and management expected substantial expenditures over the next 30 years. The filing identifies uncertainty around environmental remediation, tax and legal matters, regulation, commodity prices, project permitting and execution, and joint-venture decisions. Management said known contingencies were not expected to have a material adverse impact based on information then available.
  • Other exposures include a $140 million guarantee of MSLP debt, a $554 million maximum residual-value guarantee on the Houston headquarters lease, and railcar and aircraft lease residual-value guarantees. The filing notes that low crude-oil railcar values could result in a future charge; railcar exposure was estimated at approximately $330 million.
  • In October, Phillips 66 and Phillips 66 Partners extended their revolving-credit facility terms to October 2021; Partners also increased its facility capacity to $750 million. Partners issued $1.125 billion of senior notes and acquired pipeline and terminal assets from Phillips 66 for approximately $1.3 billion after quarter-end.

Important facts for investors to verify

  1. Whether refining and Chemicals margins recover, and how sustained high refinery utilization affects product inventories and crack spreads.
  2. Whether operating cash flow can support the dividend, capital program, debt maturities, and repurchases if margins and affiliate distributions remain weak.
  3. Progress on DAPL permitting and construction, the timing of commercial operations, and any further sponsor-loan funding needs.
  4. The realized financial impact of the CPChem affiliate impairment and the Whitegate disposition, including the disclosed LIFO inventory effects.
  5. Potential changes in environmental, legal, tax, lease-guarantee, and railcar residual-value exposures.
  6. Final 2017 capital budget and the financial effects of Phillips 66 Partners’ post-quarter asset transfer and debt issuance.