Phillips 66 (PSX) — Q1 2016 Earnings Call Transcript

Good morning, and welcome to Phillips 66 first quarter earnings conference call. With me today are Chairman and CEO, Greg Garland; President, Tim Taylor; and Executive Vice President and Chief Financial Officer, Kevin Mitchell. The presentation material we’ll be using during the call can be found on the Investor Relations section of the Phillips 66 website along with supplemental financial and operating information. Slide 2 contains our Safe Harbor statement. It’s a reminder that we will be making forward-looking statements during the presentation and our question-and-answer session. Actual results may differ materially from today’s comments. Factors that could cause our actual results to differ are included here as well as in our filings with the SEC. With that said, I will turn the call over to Greg Garland for some opening remarks.

Thanks, Rosy. Good morning everyone. Thank you for joining us. We had a good operating quarter running well across all of our businesses. However, weaker margins had a significant impact on our earnings this quarter. In refining, distillate crack spreads were the lowest since 2010. In chemicals, benchmark industry olefin chain margins were down from last quarter, and midstream was impacted by lower NGL prices. We experienced solid results from our marketing and specialties business. Total adjusted earnings were $360 million, and excluding working capital changes, we generated $722 million from cash from operations. We remain focused on operating excellence and completing our growth projects in midstream and chemicals, where we see great value and opportunity long term. We are maintaining a disciplined approach to capital allocation and believe that our strong balance sheet is a competitive advantage that positions us well to execute our plans through the commodity price cycles. During the quarter, we reinvested $750 million back into the business and distributed $687 million to shareholders in the form of dividends and share repurchases. Since May of 2012, we’ve returned $11.8 billion to shareholders through dividends and/or repurchase or exchange of 115 million shares. We continue to target a sixty-forty split between reinvestment in our business and distributions back to our shareholders and we have targeted another dividend increase this year of at least 10%. We made good progress on our major growth projects in midstream; we received all the permits necessary for the Dakota Access Pipeline to start laying pipe in May, and we would expect on-schedule completion by year-end. In the Gulf Coast, the Beaumont terminal expansion is going well. The terminal currently has 7.1 million barrels of storage capacity. We have 3.2 million barrels of new capacity under construction. Longer term, this facility can expand to 16 million barrels of storage capacity; also, development of the first phase for the Sweeny Hub is nearing completion. The LPG export terminal is 80% complete, on time, and on budget. The completion of the terminal will represent a major step in the development of a world-class energy complex within integrated refining, chemical, and midstream assets. PSXP remains an important part of our midstream growth strategy; the fee-based assets within its portfolio continue to perform well. PSXP increases its limited partner distributions by 5% this quarter and remains on track to achieve its steady growth objective of a five-year 30% distribution compound annual growth rate through 2018. DCP midstream is reducing its gas breakeven for self-help initiatives and expects to achieve breakeven at NGL prices below $0.35 per gallon this year. We are reducing costs, cutting capital substantially, and converting commodity exposed contracts to fee-based to improve financial strength and flexibility. In addition, the equity contributions from the owners last year strengthened the balance sheet, increased fee-based earnings, and positioned DCP for success in the future. We expect that DCP will be self-funded going forward. In chemicals, demand for consumer products remained strong; in response, CPChem continues to run at high rates across its system. Because CPChem’s primary production centers are in North America and in the Middle East underpinned by advantaged feedstocks, we believe CPChem’s asset base provides it with a competitive advantage. CPChem continues to advance the U.S. Gulf Coast petrochemicals project; it is now 75% complete with expected startup in mid-2017. Once running, CPChem’s global ethylene and polyethylene capacity would increase by approximately one-third. In refining, we see good gasoline supply and demand fundamentals for the remainder of the year, and we expect strong demand as we head into the summer driving season. Our focus on refining is operating excellence, maintaining our costs and capital discipline, increasing returns through selective investment. We invest in projects that are quick pay off, low cost, and high return. During the quarter, we advanced several of these refining projects. At the Wood River Refinery, we’re undergoing debottlenecking and are on schedule for completion in the third quarter. At Bayou, work on the FCC modernization is on schedule. At the Billings refinery, efforts are underway to increase the amount of heavy Canadian crude we can run to 100%. Each of these projects has a projected return on investment of about 30%. So with that, I will turn the call over to Kevin Mitchell to review the quarter results.

Thanks, Greg, good morning. Starting on Slide 4, first-quarter adjusted earnings were $360 million or $0.67 per share, reported net income was $385 million. Excluding working capital, cash from operations was $722 million. Capital spending for the quarter was $750 million, with approximately $450 million spent in midstream primarily on our growth projects. Distributions to shareholders in the first quarter totaled $687 million, including $296 million in dividends and $391 million in share repurchases. At the end of the first quarter, our debt-to-capital ratio was 27%, and after taking into account our ending cash balance, our net debt-to-capital ratio was 23%. Annualized adjusted return on capital employed was 5%, and our adjusted effective income tax rate was 33%. Slide 5 compares first-quarter 2016 and fourth-quarter 2015 adjusted earnings by segment. Quarter-over-quarter adjusted earnings were down $350 million, primarily driven by lower results in refining. Next we’ll cover each of the segments individually. I’ll start with Midstream on Slide 6. Transportation continues to generate stable earnings; the NGL business progressed construction on the Freeport LPG Export Terminal. Fractionator utilization was reduced due to turnarounds and the impact of ethane rejection on feedstock composition. Included in the transportation and NGL results is the contribution from Phillips 66 Partners. During the quarter, PSXP contributed earnings of $32 million to the Midstream segment. Distributions to Phillips 66 from our LP and GP interests increased 7% over the fourth quarter. DCP Midstream continues to work on its self-help initiatives to reduce costs, manage its portfolio, and restructure contracts. On Slide 7, Midstream’s first-quarter adjusted earnings were $40 million, down $2 million from the fourth quarter. Transportation adjusted earnings for the quarter were $72 million, down $6 million from the prior quarter, driven by lower equity earnings from Rockies Express Pipeline and Explorer Pipeline. NGL adjusted losses were $11 million for the first, a $9 million decrease from the prior quarter was largely driven by seasonal storage activity partially offset by lower tax expense. Adjusted losses for DCP Midstream were lower in the first quarter primarily due to improved liability and contract restructuring efforts, partially offset by the impact of lower commodity prices. In Chemicals, the Global Olefins & Polyolefins capacity utilization rate for the quarter was 93% and margins were lower; SA&S had improved equity earnings due to higher volumes at equity affiliates. As shown on Slide 9, first-quarter adjusted earnings for Chemicals were $156 million, down from $182 million in the fourth quarter. In Olefins & Polyolefins, the decrease of $36 million was largely due to lower margins driven by reduced polyethylene sales prices. This was partially offset by higher polyethylene sales volumes from lower controllable costs. Adjusted earnings for SA&S increased by $7 million on higher equity earnings from increased sales volumes due to the fourth-quarter turnaround activities at CPChem’s equity affiliates. In Refining, realized margins were $7.11 per barrel for the quarter, as market crack spreads decreased significantly from the prior quarter. Gasoline market cracks were down 14% from the fourth quarter, due in part to the impact of higher than normal industry gasoline production in the fourth quarter, as well as the impacts of butane blending and seasonally lower demand. Distillate market cracks were at a six-year low. Market capture decreased from 74% in the fourth quarter to 67% in the first quarter. Clean product yields fell to 82%, with gasoline yield at 43%. These yields reflect the impact of turnaround activity as well as accelerated maintenance on secondary units due to the low margin environment. Pretax turnaround costs were $115 million, $35 million lower than guidance due to deferral of some catalyst change activity. Slide 11 shows a regional view of the change in adjusted earnings compared to the previous quarter. The Refining segment had adjusted earnings of $86 million, down $290 million from last quarter. The reduction was largely due to lower market cracks. Atlantic Basin adjusted earnings decreased this quarter primarily due to lower volumes and inventory impacts. The Gulf Coast region saw lower margins and reduced volumes due to planned maintenance and unplanned downtime. In the Gulf Coast region, as well as the Central Corridor, we had unplanned downtime as we undertook discretionary maintenance in a low margin environment. In the Central Corridor, lower margins accounted for the majority of the reductions in adjusted earnings from the fourth quarter as market cracks were 24% lower. On the West Coast, market cracks were 26% lower; reduced margins were mostly offset by improvements in controllable cost and inventory impacts. Santa Maria continues to be affected by the Plains Pipeline outage. Next, we’ll cover market capture on Slide 12. Our worldwide realized margin was $7.11 per barrel versus the 3:2:1 market crack of $10.64 per barrel, resulting in an overall market capture of 67%. Market capture is impacted by the configuration of our refineries as it relates to our production relative to the market crack calculation. With 82% clean product yield for the quarter, we made less gasoline and slightly more distillate than premise in the 3:2:1 market crack. Losses due to secondary products decreased this quarter as the price differential between crude oil and lower value products such as coke and NGLs narrowed. Feedstock advantage was slightly higher than the fourth quarter, but crude differentials generally remained tight. The other category mainly includes costs associated with RINs, outgoing freight, product differentials, and inventory impacts. Let's move to marketing and specialties, where we posted a good quarter thanks to healthy U.S. margins and volumes. Slide 14 shows adjusted earnings for M&S in the first quarter of $205 million, down $22 million from the fourth quarter. In marketing and other, the $36 million decrease was largely due to lower biodiesel tax credits and lower margins in international marketing. This was partially offset by higher U.S. marketing margins. Specialty’s adjusted earnings increased to $43 million primarily due to improved base oil margins. On Slide 15, the corporate and other expense had after-tax net costs grow $127 million this quarter, an increase of $10 million from the fourth quarter. Net interest expense increased by $7 million primarily due to lower capitalized interests associated with the start-up of Sweeny Fractionator One, while corporate overhead and other expenses increased by $3 million due to the timing of legal and environmental charges. Slide 16 shows cash flow for the quarter. We began the year with a cash balance of $3.1 billion. Excluding working capital impacts, cash from operations was $722 million. Working capital changes reduced cash flow by $464 million. The cash benefit for the U.S. tax refund received in the quarter was more than offset by the customary first-quarter inventory build and the timing of marketing receipts and crude cargo payments. We funded $750 million of capital expenditures and investments, and we distributed nearly $700 million to shareholders in the form of dividends and share repurchases. We ended the quarter with 526 million shares outstanding. At the end of the quarter our cash balance was $1.7 billion. This concludes my review of the financial and operational results. Next, I’ll cover a few outlook items. In the second quarter, in Chemicals, we expect the global O&P utilization rate to be in the low 90s. In Refining, we expect the worldwide crude utilization rate to be in the mid-90s and for before-tax turnaround expenses to be approximately $100 million. We expect corporate and other costs to come in between $120 million and $125 million and company-wide we expect the effective income tax rate to be in the mid-30s. With that, we’ll now open the line for questions.

I don’t know if I could ask you about the impact of run cuts in the quarter because my understanding is that in the quarter you guys had deliberately taken some steps to basically run at lower rates, and obviously I am wondering if that was part of what fell behind the refining result in the quarter and my follow-up I guess is also refining related to the diesel overhang we see currently; obviously you guys are a little more exposed to that. I’d just love to get your perspective on how do you see, if you see that cleaning up and how do you see that putting out let’s say over the next about 3 to 6 months? And I will leave it there. Thank you.

So I'll start, and then Tim you can kind of give the overlook on this. So we ran really hard in January and March, and we slowed down in February, it is really the story. I think the interesting thing is we accelerated some maintenance activity, but a lot of it was on secondary units, and it didn't really affect the overall utilization as much as you might expect. But we did build some intermediate inventory during the quarter. So I think that's the major impact in terms of the operations, and Tim why don’t you hit on the outlook in terms of distillate?

Yes, Doug on the distillate side I think exports are the key to really clearing the length in North America, and we are seeing good demand in China, India, West Africa, and Latin America, and so I think that continues. That said, I think distillate for us continues to look to be the challenge for the market as we go forward, but I think it will clear; but it's really turning into more of a byproduct from a gasoline production standpoint. So I think as long as those export markets are open, that will continue to clear the U.S.

And then maybe just a quick follow-up, so you're planning to run your refineries back up into the mid-90s in the second, so I am just kind of curious if margins are still challenging in your distillate heavy yield, why would you continue to, are you just going to press into that or do you think there will be more voluntary run cuts as we go through the next three to six months? It doesn't sound like it.

Yes Doug, I think that we're seeing strong gasoline cracks. I mean they really recovered in March and now in April, the summer driving season that's going to drive the overall refinery utilization, certainly drives our thinking and then the distillate piece. The crack spread is really relatively stable where it is and has been, but I think that's the piece where we're looking to the exports to clear that. But I think the gasoline is pulling the refinery utilization across the industry.

Maybe just a follow-up on Doug’s distillate question, do you have any sense that maybe once we re-accelerate activity here in the U.S. from a drilling perspective, do you think that's a critical component of kind of cleaning up the disparity we're seeing between demand and maybe some of these building inventories on the distillate side?

It's part of a question, but I mean right now it's probably less than 2% of total distillate demand, but it's helpful; what is maybe 40,000 or 50,000 barrels a day is our estimate.

The second piece and maybe there is a question for Kevin, the buyback seemed to continue at a fairly robust rate, continuing the macro environment; I am just curious your thinking about ratability of the buyback program and kind of the seasonality of what we would expect on the cash flow?

Yes. So I'll take it and Kevin can step in. So I kind of think about this in several different buckets. The first bucket is really I don’t think the first quarter is reflective of our view of what 2016 is going to be. You have cracks have gone from $10 to $15; we have seen NGLs move from $0.37 to $0.47, $0.48. We're seeing good demand for transportation fuels; gasoline is seeing good demand for petrochemicals. We're seeing margins up a couple of cents and we think margins will continue to improve in the pet-chem change. So we think that ’16 is still kind of a $4 billion to $5 billion type cash generation year from us from operation. Second, I would say our view is that for high-quality MLPs, we think that the equity markets are open and that we would expect between some combination of debt and equity we would raise between $1 billion to $3 billion back into PSX this year. So this kind of moves you to $5 billion to $7 billion of cash, if you want to think about it that way we can afford a $3.9 billion capital program, $1 billion to dividends, and $1 billion to $2 billion of share repurchases given that. I will say just so we're looking at things going on and we're going through every line item in the capital budget both for ’16 and ’17. And we're assuring that our premises that we started with are still valid and that these projects are going to generate returns that are acceptable and meet our requirements. And so we'll be looking at that going forward into this year.

Just curious so Tim do you have any insight what is the current economic between branding directly the line naphtha into gasoline pool in the U.S. or that to export to either Europe or Asia for the petrochemical feedstock?

I am sorry Paul you cut out a little bit; could you repeat that the last part of your question?

No, I am just trying to say that, who is actually getting the more economic at this point, that you're keeping lesser in this country and branding directly to the gasoline pool or they are being exported overseas to be used for petrochemical feed?

Predominantly the exports are still the distillates on the gasoline side, I mean you’re seeing strong demand around the world and so…

No Tim I’m sorry, Tim, Tim, I am sorry I probably did not meet my question; I’m looking specifically for naphtha that whether it is more economic to directly brand it into the gasoline pool in the U.S. and then as octane to bring in the finished gasoline or that is better to kick them out in U.S. into the overseas to be used as a petrochemical feedstock; any insights from you guys given you're also a big petrochemical producer?

Yes, clearly naphtha demand has increased around the world but we still see the best value to go into the gasoline pool here, pull it with octane to blend it up but with the demand that we’re seeing in gasoline that’s still the preference that we have.

I see. And second question, and maybe this is for Kevin, do you have a number that you can share what is the Sweeny NGL Fractionator One, the contribution in the first quarter?

So Paul, we haven’t broken out at that level of detail; as you know we report at the sort of NGL sub-segment within our Midstream business at the PSXP level you can see there what they see on the Fractionator but that’s a different look to the Phillips 66 look so at this point that’s not a level of granularity that we have broken out at this time; obviously the Fractionator just started up at the end of last year, so still going through that start-up a little bit of incremental cost that you wouldn’t expect to be recurring, and volume is a little bit lower than capacity given the feedstock composition, but ultimately the full value is going to come when you see the export terminal up and running and get full contribution.

Tim, on tier 2, can you tell us that where you are in the process?

So we’re in the midst of really investing to deal with taking more sulfur out across our system, so we’ve a number of projects at our refineries that we're in the process of implementing to complete that but that has been a piece of our maintenance capital; our long-term maintenance capital, over the last several years and next year or so to complete that.

Can you tell me…

I will probably just say West Coast meets tier 3 standards, so it is the other refineries who are investing in, and those investments are included within the kind of $700 million of sustaining capital that we’ve outlined.

Right, Greg our Ozark West Coast is the, is how many of the other facility is already in compliance this year or that all of them will need to win until next year before you’re in compliance?

That will come in compliance at different times, giving the investment schedule through 2018 that we will hit Paul, so I think we’ve investments at most of the other refineries for tier 3, some more than others.

Okay, the final question, Greg, I hear you about how to balance the cash flow and expecting $1 billion to $2 billion of the NPL ex the cash contribution to the CCAR; to the degree if that didn’t materialize should we assume that you’re going to borrow money there to continue funding the temporary shortfall on the buy back or that the buyback will take a back seat?

Let me rephrase your question Paul: to the extent that we can’t access the market.

Thanks, good afternoon. Just a couple of questions, one LPG, one gasoline, on the LPG side you guys talked about sort of looking for additional contracts on the capacity that you still have open. But just curious is that capacity or is that market to export off your docks, is that still in that $0.13 a gallon sort of range; is that still the market price or is it something different?

Well you're right, I think that on a contract basis, we haven’t disclosed the terms specifically. And it's a range of things. I would say that the contract market long-term is higher than the spot market, it's maybe how I would like to answer that. So I think as you see these budgets come on, the contract piece would link that we’re seeing, or the short that we’re seeing on the demand side has moved that spot market down, but we’re still seeing good contract prices, and I think the customers that you talk to have a vision about long-term supply and that’s an important vision. So I think with all aspects you just have to look at the mix and decide which way you can go.

And did I hear your comments right that on the LPG demand-full size from the export side equation that right now is fairly pricing elastic because of the demand for light feedstock into global petrochemical capacity or is that—did I hear that wrong?

No, I was talking about we’re fairly neutral in the U.S. about what we chose to crack, and so the link in the LPG still needs to be exported. We’re still seeing good demand for PDH (propane dehydrogenation) propane feed units for cracker feeds around that. So it was really comments around the U.S. with its existing petrochemical operations; fairly stable and we’re posting different feedstock and every producer has their own preference to which feedstock they crack. And so that leaves you with there is excess LPG it still needs to be exported. You’re seeing propane, butane, and some of the C5, and now you’re starting to see some things happen on the ethane side as well.

Okay understood. On the gasoline side equation, so I understand that the projects that you guys have outstanding right now to potentially increase some of your gasoline yield. But if I’m looking at this coming summer versus last summer, I believe some of you also somewhat max out in gasoline production capacity. Can you produce or would you think that do you guys think you will produce more gasoline, finished gasoline this summer versus last summer?

I think we pretty much are running where we can. I would say on the industry side one thing is different this year is inventories are higher. So that may cap somewhat what you could see in terms of price response at the same time demand is up. So day sales in inventories actually haven’t grown as much as the gasoline absolute levels within case. So I think we still expect a fairly strong gasoline driving season and a good gasoline crack through the next couple of quarters.

Just want to reach out on the West Coast here. That’s a place where the results came in a little bit soft relative to our expectations. Is there anything unusual in the first quarter, it's actually the Plains pipeline outage or some turnaround activity that could have impacted those results? And then as we have some of these SEC to come back online over the next couple of months, do you think the West Coast environment stays relatively strong just because we’re going through a summer demand season? Or do you think we’re going to see some margin compression out there?

We had San Francisco down for turnaround first quarter and so that impacted results versus what we would have thought. We saw some impacts to the Plains pipeline to about some $10 million for the quarter. But we’re trying to mitigate that extent that we can. And then I think as the SEC comes back up, it's going to have an impact in California. The good news is demand is up quite a bit relative to the last couple of years. And so I think we still got good demand going for you there. But I do think that you’re not going to see the volatility in California that we’ve seen in the past year or two.

Thank you, Sally. We thank you for your interest in Phillips 66. If you have additional questions, Debby and I are available to take your call. Also, I want to remind the transcript for our call will be posted on our website shortly. Thank you.