Phillips 66 (PSX) — Q3 2016 Earnings Call Transcript

Thank you, Julie. Good morning, and welcome to the Phillips 66 third quarter earnings conference call. With me today are Greg Garland, Chairman and CEO; Tim Taylor, President; and Kevin Mitchell, Executive Vice President and CFO. The presentation material we will 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 two contains our Safe Harbor statement. It is 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 actual results to differ are included here as well as in our filings with the SEC. With that, I'll turn the call to Greg Garland for some opening remarks. Greg?

Thanks, Rosy. Good morning, everyone, thank you for joining us today. Third quarter results reflect the benefit of our diversified downstream portfolio and our continued strong operating performance in the challenging market. Our refining was again impacted by difficult market conditions, marketing and specialties and chemicals performed well and we delivered total adjusted earnings of $556 million or $1.05 per share. During the quarter market cracks further, crude differentials tightened and crude and NGL prices remain depressed. We operated safely, we ran our assets well and our industry-leading safety metrics for the year are the best we have ever achieved for holding our costs flat. We continue to execute on our disciplined capital allocation strategy. We recently lowered capital guidance to approximately $3 billion for 2016. We expect our 2017 capital budget to be below $3 billion. We are growing our higher value businesses and are focused on high-return value-enhancing projects. We are executing well on our projects under construction and we remain confident that our growth strategy will create value for our shareholders. We target a long-term 60/40 split between reinvestment and distributions. We expect the free cash flow generated from operations and proceeds from Phillips 66 partners, and capital market access to be sufficient to fund our growth program and distribution to our shareholders. We remain committed to our growing, secure, and competitive dividends as well as $1 billion to $2 billion per year of share repurchases. In midstream, lower energy prices and narrowed differentials have reduced the need for major infrastructure projects. We’re pivoted to investing in projects to build value around our extensive asset portfolio of refineries and logistics infrastructure. As we think about long-term global crude demand, we believe that US shale will be called upon to balance the market which will provide additional opportunities to create value in midstream. We are finishing construction on several of our major projects at Freeport, commissioning on a 150,000 barrel per day LPG export terminal is underway with our first cargoes expected to be shipped before year-end. Shipments will be a mix of term and spot cargoes. The Dakota Access pipeline is nearing completion. While the project awaits the issuance of an easement from the US Army Corps of Engineers to complete work beneath the Missouri River, construction continues on the remaining segment of the pipeline. DAPL and adjoining ETCOP pipeline which is complete and ready for commissioning are expected to provide the most economic option for moving Bakken crude to the Gulf Coast. Phillips 66 has a 25% interest in each of these joint ventures. In the Gulf Coast, the Beaumont Terminal expansion is ongoing. We have 3.2 million barrels of new storage capacity under construction, 2 million of which are expected to be in service by year-end. The Beaumont terminal continues to be a viable asset and we have plans to ultimately expand this facility to 16 million barrels. Phillips 66 partners remain an important part of our midstream growth strategy. So far this year the partnership has raised more than $2 billion in the capital market through debt and equity issuances which is used to grow through asset acquisition and the evolution of organic projects. Partners remains on track to achieve its growth objective. Over five years, we expect a 30% distribution compound annual growth rate through 2018. DCP midstream has made good progress on its strategic initiatives. DCP has reduced its cost structure, decreased its capital spending, and continues to convert commodity exposure contracts to a fee basis. We are pleased to see the improvements in our financial results and we expect that DCP will be self-funded going forward. In chemicals, global demand remains healthy. CPChem is advancing in US Gulf Coast petrochemical project which is about 85% complete. We expect the polyethylene business to start by mid-2017 and the ethane cracker in the second half of 2017. Once these new facilities are in operation, CPChem's global ethane and polyethylene capacity will increase by approximately one-third. As capital spending will be reduced following the completion of projects, we expect to see increased distributions with CPChem starting next year. In refining this quarter, we completed the sale of the Whitegate refinery in Ireland and advanced several returning hands-in projects. At the Wood River refinery, the bottleneck in yield improvement projects was completed this quarter and increased its capability for heavy oil processing. At the Billings refinery, we are increasing the amount of heavy Canadian crude we can run to 100%. And at Bayway work on the FCC modernization is progressing on schedule. During the quarter, we generated nearly $1.2 billion in cash from operations and from the Phillips 66 Partners equity offering. We have returned more than $500 million of capital to our shareholders through dividends and share repurchases in the third quarter. Since the formation, we have returned $12.8 billion to shareholders through dividends and the repurchase or exchange of 120 million shares. So with that I would like to turn the call over to Kevin Mitchell to review the quarter results.

Thanks, Greg. Good morning. Starting on slide four; third quarter net income was $511 million, we had several special items that netted to a loss of $45 million. In chemicals, we had an $89 million impairment of the CPChem equity affiliate. We also received a legal award in the third quarter that increased refining net income by $43 million. After removing these items, adjusted earnings were $556 million or $1.05 per share. Cash from operations for the quarter was $883 million and was reduced by a pension plan contribution of over $300 million. Excluding $339 million of working capital benefits, operating cash flow was $544 million. In addition, PSXT raised nearly $300 million from an equity offering during the third quarter. Capital spending for the quarter was $661 million with $365 million spent on growth, mostly in midstream. Distributions to shareholders in the third quarter totaled $508 million including $329 million in dividends and $179 million in share repurchases. At the end of the third quarter, our debt-to-capital ratio was 27% and after taking into account our ending cash balance, our net-debt-to-capital ratio was 21%. Year-to-date annualized adjusted return on capital employed was 7%. Our adjusted effective income tax rate for the third quarter was 30%. Slide five compares third quarter and second quarter adjusted earnings by segment. Quarter-over-quarter adjusted earnings were up by $57 million driven by improvements in midstream and marketing and specialties. Next we will cover each of the segments individually. I'll start with Midstream on slide six. After removing the non-controlling interest of $28 million, Midstream's third quarter adjusted earnings were $75 million, $36 million higher than in the second quarter. Transportation adjusted earnings for the quarter were $63 million, down $2 million from the prior quarter driven by higher operating costs associated with seasonal maintenance and low volumes due to refinery downtime. This was partially offset by higher equity earnings from the Rockies Express Pipeline which included the receipt of a $10 million settlement net to us. In NGL, adjusted earnings were $3 million for the quarter, this represented a $20 million increase from the prior quarter and was largely driven by higher earnings on seasonal trading and storage activity. Our share of adjusted earnings from DCP midstream was $9 million in the third quarter, an $18 million improvement compared to the previous quarter. This was primarily due to favorable contract restructuring efforts, lower costs, improved asset performance, and higher natural gas prices. Turning to chemicals on slide seven. Third quarter adjusted earnings for the segment were $190 million, the same as in the second quarter. In olefins and polyolefins, adjusted earnings decreased by $5 million from the prior quarter reflecting unplanned downtime. This was mostly offset by higher polyethylene chain margins. Global O&P utilization was 91%. Adjusted earnings for SA&S increased by $6 million on higher benzene margins. In Refining, we operated well with 97% crude utilization for the quarter. Clean product yield was constant at 84% with gasoline yield at 44% for the quarter. Pre-tax turnaround costs were $117 million in line with guidance. Realized margin was $7.23 per barrel, roughly the same as in the second quarter. The chart on slide eight provides a regional view of the change in adjusted earnings compared to the previous quarter. In total, the Refining segment had adjusted earnings of $134 million, down $18 million from last quarter. Regionally, the Atlantic Basin of the West Coast had lower earnings than last quarter primarily due to lower market cracks. The Central Corridor had adjusted earnings that were $87 million higher than the second quarter resulting from improved market cracks and benefits from higher margins on Canadian crude. In the Gulf Coast, earnings were slightly lower than the second quarter due to increased costs related to plant maintenance activity. Next, we'll cover market capture on slide nine. Our worldwide realized margin for the third quarter was $7.23 per barrel versus the 3:2:1 market crack of $12.96 per barrel, resulting in an overall market capture of 56% compared to 62% in the second quarter. Market capture is impacted in part by the configuration of our refineries and our production relative to the market crack calculation. With 84% clean product yield for the quarter, we made less gasoline and slightly more distillate than premised in the 3:2:1 market crack. Losses from secondary products of $2.94 per barrel were $0.47 per barrel lower this quarter as the price differential between crude oil and lower-valued products such as coke and NGLs increased. Feedstock advantage was approximately $1 per barrel lower than the second quarter, as crude differentials tightened further, especially the LLS mild spread. The other category mainly includes costs associated with RINs, outgoing freight, product differentials, and inventory impacts. These costs were lower than the second quarter due to improved product differential and crude purchasing timing, partially offset by higher RINs prices. Let's move to Marketing and Specialties, where we posted a strong third quarter. Adjusted earnings for M&S in the third quarter were $267 million, up $38 million from the second quarter. In Marketing and Other, the $29 million increase was largely due to increased margins in both the US and Europe. The iron wholesale business was sold in September as part of the Whitegate refinery disposition. Specialties' adjusted earnings increased by $9 million primarily as a result of improved base oil margins and higher volumes at the XL joint venture. On slide 11, the Corporate and Other segment had adjusted after-tax net costs of $110 million this quarter, an improvement of $1 million from the second quarter. Slide 12 shows year-to-date cash flow. We began the year with a cash balance of $3.1 billion. Excluding working capital impacts, cash from operations for the first three quarters was $1.8 billion. Working capital changes increased cash flow by $500 million. Phillips 66 Partners raised $1 billion in a public equity offering through the third quarter. We have funded $2 billion of capital expenditures on investments and year-to-date we’ve distributed nearly $1.8 billion to shareholders in dividends and share repurchases. We ended the third quarter with $521 million shares outstanding. At the end of September, our cash balance stood at $2.3 billion, up slightly from $2.2 billion at the end of the second quarter. Earlier this month, PSXP raised $1.1 billion in the debt capital markets that will positively impact the fourth quarter cash balance. This concludes my review of the financial and operational results. Next I’ll cover a few outlook items. In the fourth quarter in chemicals, we expect the global O&P utilization rate to be in the mid-80s due to planned turnaround activity. In refining, we expect the worldwide crude utilization rate to be in the low 90s and before-tax turnaround expenses to be $170 million to $200 million. We expect corporate and other costs to come in between $130 million and $140 million after tax due in part to increased interest expense from the recently issued PSXP notes and companywide, we expect the effective income tax rate to be in the mid-30s. With that we will now open the lines for questions.

Good morning, everyone. Just on the cash generation I mean obviously, cash generation this year has been a lot lower than last year part of that is the margin environment part of that investing in CPChem, but may be just talk a little bit about whether you’re concerned about the cash flow drop and obviously you got some leads as to improve it what those big ones are?

Well, we always tell this wasn’t – always be a very volatile business and I think we plan for that as we think through mid cycles we should generate $4 billion to $5 billion of cash and $1 billion to $2 billion coming out of the MLP and we think that’s sufficient to fund a $1.3 billion dividend going and to fund a $3 billion-ish capital program and $1 billion to $2 billion-ish every purchase. I think we feel pretty comfortable within that context.

If I could just add onto that so as we move into 2017 I think there is a couple of things one is, capital certainly has come down this year. We are guiding to something under $3 billion in 2017. At CPChem as we finished up the cracker in these big projects we get the benefit of that. You get the incremental earnings coming off from these projects. So we think crude cash flow actually starts to build into 2017.

Okay and then back in September 2015 as you talk about this not pivot but sort of emphasis on improvement refining tool you did give some self-help actual numbers by region obviously margin outlook may have changed since then. Do you feel comfortable those ranges are still reasonable for sort of planning purposes?

Yes I think they are still fairly reasonable. I think that returns are going to be just a little lower but as we went back and we back half season with these projects we would still make these investments in refining.

Thanks everybody. Greg I want to take two quick ones. First of all, it looks like your NGL business, DCP quarter looks like it started to improve a little bit I don't know if that's macro on the higher oil price if now feels as if you have got that thing stabilized and turning to the right direction. I just wanted to know if you can characterize, this is not bottomed out?

No. I am happy to do that. I think couple of things, first of all I think that the work that DCP has done to reduce our cost structure, cash breakeven nearly dropped from kind of $0.60 per gallon NGL somewhere below $0.35 gallon NGL. So you see in that benefit show up. NGL prices quarter-on-quarter actually just a little bit lower but natural gas prices were up about $0.80 or so $0.89 I think. And so that was the benefit to DCP. So you had a combination effect of ore cost plus good throughput volumes and then kind of neutral on NGL prices will better on gas prices.

The other thing I would add maybe to that is that there has also been progress, continued progress converting some of the commodity-based contracts to fee base and that's helped that a bit as well. So this is really about the three points that Greg talked about that helped drive that improvement.

Okay. Thank you.

Good morning. I would like to ask question on the Freeport LNG terminal obviously LNG or LPG exports have been rising in the US broadly and you are coming on with inventories relatively high and opportunity to export. Could you talk about what you are seeing demand-wise what arbitrage looks like in exporting LPGs and kind of how that's evolved this year?

Yes Jeff, this is Tim. Yes, I would say that from a demand standpoint still strong when you look at the numbers on the export side because the length in the US for particularly propane coming out of the US to international markets, so propane hydro plants for instance require a propane pick stock in the Asia, the heating markets and but the challenges has been as energy prices have deepened and narrowed really across around the world the arbs on those have come in substantially. From the short term I think we still see good demand. We feel good about that but we look at it and say on the commercial side, the arb between the US net-back price and the destination price in Europe and Asia is lower than what we would expect long term. So I think when we start up, we would expect to see that. That said, we are still seeing good underlying demand for the cargoes and the terminal.

And seeing new construction of new facilities that are going to increase LPG demand in Asia in the years ahead as well?

Yes, I mean there is infrastructure, there is European interest, Latin American as well and the other thing that is out there of course, the flexibility of crackers to run more LPG in place of NAFTA on top of new petrochemical projects for instance that the propane dehydro that are very specific to propane and then there is continuing growth in the thermal market, the heating market for that as well.

Thanks Tim. Thanks everybody. Greg I want to take two quick ones. First of all, it looks like your NGL business, DCP quarter looks like it started to improve a little bit I don't know if that's macro on the higher oil price if now feels as if you have got that thing stabilized and turning to the right direction. I just wanted to know if you can characterize, this is not bottomed out?

No. I am happy to do that. I think couple of things, first of all I think that the work that DCP has done to reduce our cost structure, cash breakeven nearly dropped from kind of $0.60 per gallon NGL somewhere below $0.35 gallon NGL. So you see in that benefit show up. NGL prices quarter-on-quarter actually just a little bit lower but natural gas prices were up about $0.80 or so $0.89 I think. And so that was the benefit to DCP. So you had a combination effect of ore cost plus good throughput volumes and then kind of neutral on NGL prices will better on gas prices.

The other thing I would add maybe to that is that there has also been progress, continued progress converting some of the commodity-based contracts to fee base and that's helped that a bit as well. So this is really about the three points that Greg talked about that helped drive that improvement.

Okay. Thank you.

Great. Thank you, good morning.

Hi, Roger.

Hey. I guess two things here. One is a follow-up on Blake's question about DAPL. Are there any seasonal concerns if we don’t get started sooner rather than later that you can't do the construction work up there?

No. I think they will be able to do the drill and do what we need to do. Yes, essentially you're preparing, you doing a ditch work now and the weather is fine. So, either drill is not really that impacted from a weather standpoint.

Okay. Perfect, thanks. And then a little more on this sort of the midstream with the changing in the overall CapEx structure and total plans and which is say some change in the ownership structure one of your JV partners. How do you think about M&A in the midstream sector I mean generally speaking when things start to tighten up and slow down cash gets a little harder to get than M&A should pick up and I guess we have seen that somewhat in the MLP sector that controls most of those assets. How do you look at M&A opportunities and what is your appetite for that sort of thing right now?

I think, we kind of look like everyone. We look at everything that's out there. I think our assessment is, the values are still relatively high aspirations levels are high. We did three smaller transactions at PSXP level in the quarter or I guess one will close in this quarter but so I think that we will look at everything that's out there. There is nothing big that I see at this point on the horizon for us. We still have a great organic portfolio of opportunities to invest in and this still makes sense for us to invest at 6 or 7 build multiple and trade that up versus paying 15 or 20 times or something out there.

Yes, I guess, my question that was along the lines, if you are personally a little less interested in scaling into larger projects are you seeing any change in the value of those larger projects that are already in existence or they just remain at the very high multiples?

No. I don't think our view is, we haven't seen the valuation come down and I think, I am kind of the view right now is that I think Permian is going to be more challenging in the future than it has been in the past and that existing assets strictly poised is probably going to be more valuable in the future than it is today.

So wouldn't that argue to make an acquisition today?

Yes probably so, you could try the right acquisition but same thing I think we still have the ability to grow our portfolio, to hit our targets that we have laid out there for folks and feel comfortable we have got that opportunity portfolio in front of us well on hand.

So I think historical answer is still a good answer for us. So we are not in a hunt for anyone that are for sale today. Yes having said that if we could find the right assets for the right value certainly we would look at it, but none of the ones that are on the market today we are not in a hunt for those.

Thank you Julie and thank you all for your interest in Phillips 66, if anyone has any additional questions please give C.W. or I a call. Thank you.