This New Refining Stock Could Be a Winner


Last July, ConocoPhillips (NYS: COP) decided to spin off its refining and marketing arm into a standalone, publicly traded company. A few days back, I mentioned why the upstream division stands to gain post-separation. Today, we'll see whether the downstream segment, christened Phillips 66, will also benefit in a similar way.

Will it work?
Phillips 66 will include Conoco's refining, marketing, transportation, and chemicals segments. In addition, the new entity will house the midstream and emerging businesses. Management plans to run the integrated downstream company as a tax-free distribution. This means, in all likelihood, that Phillips 66 will become a master limited partnership -- an MLP, in short.

An MLP is a legal structure whose profits aren't taxed at the corporate level. Instead, the profits are distributed to shareholders as dividends, who are then taxed individually according to their share of the income. Consequently, because of the high payout ratio, the dividend yield is way higher than that of most corporations. It's a popular vehicle among companies owning pipelines, refineries, terminals, and other natural resources that qualify as MLPs.

The obvious question is: Will this benefit Phillips 66? Well, right now it's pretty difficult to give a straightforward answer. The overall refining industry in the U.S. is in the doldrums, thanks to high input costs (read: high crude-oil prices). Profits have been either drying up or falling below analyst estimates. Since MLPs are required to distribute a major percentage of their profits to shareholders as dividends, this kind of a corporate structure might not attract strong investor interest for the downstream company -- at least till the refining industry recovers.

There's hope
But that doesn't necessarily mean failure. There's still a lot to look forward to. Post spin-off, Phillips 66 will become the country's second largest independent refiner, with a working interest in 12 refineries. Out of these, six are located in the Mid-Continental region and the Gulf coast. Refineries in these regions have the advantage of being located close to the delivery point of WTI crude oil in Cushing, Okla. These refineries could obtain the cheaper WTI blend as compared with the more expensive Brent crude, the international benchmark. Refiners such as HollyFrontier (NYS: HFC) and Western Refining (NYS: WNR) has taken advantage of the situation in the past 12 months -- particularly at HollyFrontier, which saw operational earnings skyrocket.

Conoco's Chemicals segment, CPChem, has been looking promising as well. While this segment currently represents just 2% of the total assets of the integrated giant, the future looks good. With joint ventures with companies based in Qatar and Saudi Arabia, CPChem has ambitious plans to expand into world-class ethane cracking and polyethylene facilities.

Foolish bottom line
While the overall picture isn't incredibly compelling at the moment, things can certainly change in a hurry with commodities. In addition, with current CEO James Mulva set to retire after the completion of the spin-off, the onus of turning around the business will be on the new management, led by Greg Garland. The job won't be easy. Meanwhile, we'll be bringing to you the latest news and analysis on ConocoPhillips and its imminent spin-off. All you need to do is add the company to your free Watchlist.

However, if you like energy stocks, we have a stock idea that could knock your socks off. Read about it in The Motley Fool's special free report on the energy industry and its best prospects. It's free for a limited time.

At the time thisarticle was published Fool contributor Isac Simon owns no shares of any of the companies mentioned in this article. The Motley Fool owns shares of Western Refining. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.