Phillips 66 (NYSE:PSX) has done a wonderful job creating value for investors over the years, including Warren Buffett’s Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B), which remains a major shareholder. Overall, the refining company has produced more than a 345% total return since its formation in 2012, which has obliterated the S&P 500‘s nearly 160% total return over that timeframe.
Despite that strong performance in its stock price, which is up nearly 265% during that period, Phillips 66’s management team believes its shares are cheap these days. That was one of the key nuggets in the company’s third-quarter conference call.
Our discipline dictates where we allocate capital
Phillips 66 CEO Greg Garland led off the call by briefly discussing the company’s third-quarter results, noting that it generated another $1.7 billion of cash flow. He pointed out that the company distributed $841 million of that money to investors through its dividend ($402 million) and share repurchase program ($439 million) while reinvesting the rest on its expansion projects.
Garland discussed the company’s balanced approach to using its cash flow:
Disciplined capital allocation is fundamental to our strategy, and it creates value for our shareholders. Over the long term, we will reinvest 60% of our operating cash flow back into the business and return 40% to our shareholders, through dividends and share repurchases. We’re dedicated to a secure, competitive, and growing dividend. We buy back our shares when they trade below intrinsic value. We’re buying shares today.
Instead of pouring all its money into expanding its business, Phillips 66 takes a more holistic approach. It invests only in projects that meet its high bar for returns. That allows it to return cash excess to investors through the dividend, as well as a buyback when that makes sense.
The company’s management team clearly thinks repurchasing stock is an excellent use of its excess cash these days, believing its shares trade at a discount to the underlying value of the business. That’s why Phillips 66 recently announced a new $3 billion share repurchase program, giving it the firepower to take advantage of this disconnect.
A buyback the moves the needle
With that latest authorization, Phillips 66 will add to a program that has already repurchased roughly $12 billion in shares since 2012. Those repurchases have reduced the company’s share count by 32% from the initial level following its spinoff from oil giant ConocoPhillips. Given where the stock is trading these days, its refreshed repurchase program can retire another 5.5% of its outstanding shares.
To put the impact of the buyback into some perspective, we’ll look at how it benefited the company during the third quarter. Overall, the refiner reported $1.4 billion of adjusted earnings during the period. Divide that by its total shares outstanding during the period (451 million), and its adjusted earnings were $3.11 per share. Now, let’s assume the company never bought back any shares. If that were the case, its adjusted earnings would have been only around $2.35 per share during the period. Clearly, the buyback has moved the needle for investors.
Now, let’s see what the latest authorization could do to earnings in the future by fast-forwarding a few quarters to the completion of its current buyback program. Let’s assume it bought back about 5.5% more of its stock while its adjusted earnings remained at the current level of $1.4 billion of adjusted earnings. Using these figures, the per-share result would be almost $3.30.
As this math indicates, Phillips 66’s buyback program has created lots of value for shareholders over the years by giving them a larger slice of the company’s earnings. That trend should continue in those to come as it keeps buying back a meaningful portion of its stock. That’s one of the many reasons Buffett’s Berkshire Hathaway continues to hold a meaningful stake in the refining company.
An ideal energy stock for the long haul
Phillips 66 doesn’t plow all its cash into expanding its operations, since that approach probably won’t create the most value for investors. Instead, the company remains disciplined in allocating its money toward a balance of high-return expansions, dividends, and buybacks when they make sense because that balance can create more value over the long term. With the company sticking with what works, including aiming to buy back more of its cheap shares, it appears poised to continue enriching investors, including Warren Buffett, over the coming years.