Phillips 66 (NYSE:PSX) Q1 2024 Earnings Call Transcript

Phillips 66 (NYSE:PSX) Q1 2024 Earnings Call Transcript April 26, 2024

Phillips 66 misses on earnings expectations. Reported EPS is $1.9 EPS, expectations were $2.05. Phillips 66 isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the First Quarter 2024 Philips 66 Earnings Conference Call. My name is Lydia, and I’ll be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Jeff Dietert, Vice President, Investor Relations. Jeff, you may begin.

Jeff Dietert: Welcome to Philips 66 first quarter earnings conference call. Participants on today’s call will include Mark Lashier, President and CEO; Kevin Mitchell, CFO; Tim Roberts, Midstream and Chemicals; Rich Harbison, Refining; and Brian Mandell, Marketing and Commercial. Today’s presentation materials can be found on the Investor Relations section of the Philips 66 website along with supplemental financial and operating information. Slide two contains our Safe Harbor statement. We will be making forward-looking statements during today’s call. 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 SEC filings. With that, I’ll turn it over to Mark.

Mark Lashier: Thanks, Jeff. Welcome everyone to our first quarter earnings call. We continued to progress our strategic priorities and we returned significant cash to our shareholders. While our crude utilization rates were strong during the quarter, our results were affected by maintenance that limited our ability to make higher value products. We were also impacted by the renewable fuels conversion at Rodeo, as well as the effect of rising commodity prices on our inventory hedge positions. Currently, our assets are running near historical highs and we are ready to meet peak summer demand. Before we provide an update on our strategic priorities, we want to recognize our midstream, refining and chemicals businesses, which have all received honors for their exemplary safety performance in 2023.

Our midstream gathering and processing business received the top 2023 GPA Safety Award in the large operator division. In refining, the Rodeo and Sweeney facilities both received the AFPM Distinguished Safety Award, which is the highest annual safety award in the industry. This was Sweeney Refinery’s third straight year to receive the honor. The Ponca City refinery earned the Elite Platinum Award and the Lake Charles refinery secured the Elite Gold Award. In chemicals, CP Chem received two AFPM safety awards. I’m very proud of our employees and the employees of CP Chem for their commitment to safety. I would like to congratulate them on a job well done. Today, beginning on slide four, we’ll highlight the progress we’ve made on our strategic priorities.

Next, we’ll discuss our first quarter financial results. Then we look forward to your questions. We previously announced plans to monetize assets that no longer meet our long-term objectives, and we set a target to generate over $3 billion in proceeds. The expected proceeds will support our strategic priorities, including returns to shareholders. This quarter, we launched a process to divest our retail marketing business in Germany and Austria and communicated the plans to employees. Completion of the dispositions is subject to satisfactory market conditions and customary approvals. We have distributed almost $10 billion through share repurchases and dividends since July of 2022. Over the remaining three quarters of 2024, we expect to achieve our $13 billion to $15 billion target.

Share repurchases will continue to be an important component of our capital allocation. We’re committed to return over 50% of our operating cash flows to shareholders. Recently, we announced a 10% increase in our quarterly dividend, contributing to a 16% compound annual growth rate since 2012. The dividend increase reflects the confidence we have in our growing mid-cycle cash flow generation and our disciplined approach to capital allocation, including a secure, competitive, and growing dividend. In refining, we continue to run at crude utilization rates above the industry average for the fifth consecutive quarter. We remain focused on improving performance, increasing market capture, and reducing costs to enhance our earnings per barrel. We have achieved over $560 million or more than $0.80 per barrel in run rate cost reductions from business transformation.

We expect to achieve our full $1 per barrel run rate target by the end of the year. In Midstream, our NGO wellhead to market business is focused on capturing operating and commercial synergies of over $400 million by year-end 2024. Midstream’s estimated 2024 mid-cycle adjusted EBITDA is $3.6 billion, providing stable cash generation that covers the company’s top capital priorities, funding sustaining capital, and the dividend. During the first quarter, we achieved a major milestone with the startup of our Rodeo Renewable Energy Complex. Slide five summarizes our journey to transform the San Francisco Refinery into one of the world’s largest renewable fuels facilities. The facility benefits as a superior location to secure renewable feedstocks and market renewable fuels.

The project leverages existing assets and is expected to generate strong returns. We began producing renewable diesel from our Unit 250 hydrotreater in April of 2021. We have gained valuable operational experience and market knowledge that positions us for success in our expanding renewable fuels business. Unit 250 continues to exceed expectations and has increased production to approximately 10,000 barrels per day. Our Rodeo Renewable Energy Complex is producing 30,000 barrels per day of renewable fuels. We’re on track to increase production capability to full rates of approximately 50,000 barrels per day by the end of the second quarter. Once complete, we’ll have the ability to produce renewable jet, a key component of sustainable aviation fuel.

We’re proud of the team’s strong project execution and appreciate their commitment to operating excellence in achieving this significant milestone. The Rodeo Renewable Energy Complex positions Phillips 66 as a world leader in renewable fuels. Slide six provides an update on business transformation progress. Our run rate savings were $1.24 billion at the end of the first quarter, comprised of $940 million of cost reductions and $300 million of sustaining capital efficiencies. Through the first quarter, we’ve achieved $750 million in annualized cost reductions. The majority of these cost reductions relate to refining operating and SG&A expenses, as well as benefits to equity earnings and gross margin. We’re on track to realize $1 billion of cost reductions in 2024 to sustain higher cash generation.

Before I turn the call over to Kevin to review the financial results, I want to stress that the market fundamentals are good, our assets are running well, and we have a clear path to achieving our strategic priorities and growing cash flows.

Kevin Mitchell: Thank you, Mark. Slide seven summarizes our first quarter results. Adjusted earnings were $822 million, or $1.90 per share. Operating cash flow, excluding working capital was $1.2 billion. We received distributions from equity affiliates of $348 million. Capital spending for the quarter was $628 million, including $171 million for a midstream joint venture debt repayment. We distributed $1.6 billion to shareholders through $1.2 billion of share repurchases and $448 million of dividends. Net debt to capital ratio was 38%. Slide eight highlights the change in results by segment from the fourth quarter to the first quarter. During the period, adjusted earnings decreased $540 million, mostly due to lower results in refining, midstream, and marketing and specialties, partially offset by improved results in chemicals.

In midstream, first quarter adjusted pre-tax income of $613 million was down $141 million from the prior quarter, reflecting lower results in transportation and NGL. Transportation results were down mainly due to a decrease in throughput and efficiency revenues, partially offset by seasonally lower maintenance costs. The NGL business decreased primarily due to a decline in margins, as well as lower volumes reflecting impacts from winter storms. Chemicals adjusted pre-tax income increased $99 million to $205 million in the first quarter. This increase was mostly due to higher polyethylene margins driven by improved sales prices and the decline in feedstock costs, as well as lower turnaround costs. Global O&P utilization was 96%. Refining first quarter adjusted pretax income was $228 million, down $569 million from the fourth quarter.

The decrease was primarily due to lower realized margins. Our commercial results were less favorable than the previous quarter, in part due to inventory hedging impacts in a rising price environment and less advantageous pipeline arbs. In addition, realized margins decreased due to lower Gulf Coast clean product realizations. Our refining results and market capture of 69% were also negatively impacted by maintenance activities on downstream conversion units, as well as the renewable fuels conversion at Rodeo. Marketing and specialties adjusted first quarter pre-tax income was $345 million, a decrease of $87 million from the previous quarter. The decrease was mainly due to lower domestic marketing and lubricant margins. Our adjusted effective tax rate was 21%.

Slide nine shows the change in cash during the first quarter. We started the quarter with a $3.3 billion cash balance. Cash from operations excluding working capital was $1.2 billion. There was a working capital use of $1.4 billion, mainly reflecting a $2.6 billion increase in inventory, partially offset by benefits in accounts payables and receivables, which included the impact of rising commodity prices. Net debt issuances were $802 million. We returned $1.6 billion to shareholders through share repurchases and dividends. Additionally, we funded $628 million of capital spending. Our ending cash balance was $1.6 billion. This concludes my review of the financial and operating results. Next I’ll cover a few outlook items for the second quarter.

In chemicals, we expect the second quarter Global O&P utilization rate to be in the mid-90s. In refining, we expect the second quarter worldwide crude utilization rate to be in the mid-90s. Turnaround expense is expected to be between $100 million and $120 million, excluding Rodeo. We anticipate second quarter, corporate and other costs to come in between $330 million and $350 million, reflecting higher net interest expense. Now we will open the line for questions, after which Mark will make closing comments.

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Q&A Session

Operator: Thank you. We’ll now begin the question-and-answer session. [Operator Instructions] Our first question comes from Neil Metter of Goldman Sachs. Your line is open. Please go ahead.

Neil Mehta: Yes, good morning, Mark and team. I guess the first question was just refining in the quarter, the capture rates were really noisy and 69%, I know you guys target 75%. It looks like a lot of that was on the West Coast, because of Rodeo and then also secondary products. So you alluded to some of this in the prepared remarks, but maybe you can just talk a little bit about what happened there? And your confidence about the progression as we work our way through the year?

Mark Lashier: Yes, good morning, Neil. That’s a great question. Thank you for asking that. The way I’m looking at this is those first quarter headwinds that you mentioned in refining are all related to activities that will position us to deliver medium and long-term tailwinds in support of our strategic priorities. And so it’s some of the fundamental work going on around Rodeo and some of the work around our turnarounds are critically important. And Rich and Kevin can drive into that a little bit more, and including some of the activities in commercial that we underwent over the last several quarters that will contribute to our long-term success. So Rich, do you want to dive in?

Rich Harbison: Yes, Mark. And Neil, when I reflect back on the quarter, I look at the metrics, and we ran pretty well. But the market capture, obviously was challenged. And it was primarily driven by activity in the Gulf Coast and the West Coast. We achieved about an 84% clean product yield, which where our assets is pretty good, it’s actually 1% higher year-over-year. So it is a sign that our margin projects are actually pulling into the bottom line here as we move forward. However, quarter-over-quarter we were 3% lower than the fourth quarter, 1% of that’s very clearly it’s seasonal, it’s butane blending related to our conversion as we move towards summer gasoline over the quarter. Another 2% is really related to our turnaround activity and this was principally focused in the downstream catalytic units across our system and it was concentrated in the Gulf Coast area.

This has really two effects when it comes to market capture and clean product yield. It reduces our ability to produce higher value products and it increases our intermediate inventories over the period. Now on the West Coast we have the conversion of the Rodeo facility, which is a compounding event. Essentially, it effectively had an under $180 million loss and adjusted pre-tax income in the quarter as we transformed the business. And if you think about the business, it went from active to idle to reactive across this first quarter. The good news is we’re near completion of the Rodeo conversion, and I actually would say we’re well into the wind-up phase now. So to summarize, I guess the Rodeo startup is on schedule, ramping up production, approximately 50,000 barrels a day of renewable fuels will be achieved out of that facility in the second quarter.

And we positioned our units across the system to run full conversion rates with fresh catalysts and ample intermediate inventories for the upcoming driving season. Kevin, did you want to add anything to that?

Kevin Mitchell: Let me just put a couple of numbers to some of these items. So in terms of commercial impacts that we talk about on Gulf Coast product pricing differentials in absolute terms that was a $50 million headwind in the first quarter. The inventory hedges that I referenced in the earlier comments, which primarily impact central corridor that was a $100 million headwind in the first quarter these are not variances, these are absolutes in the quarter. And then on the West Coast, Rodeo in overall terms was a $180 million negative or loss for the quarter. So the West Coast results are bearing that drag from the impact of the Rodeo conversion.

Mark Lashier: Yes, and I think just to put that in context, we’re taking a disadvantaged refinery and converting it into one of the world’s largest renewable fuels facilities. And so to bridge to that, we took the heavy lift this quarter, and now we’re well positioned to start delivering value again from the Rodeo facility as we continue to push it to full rates through the second quarter. And then on the Gulf Coast, the way you have to think about that is we’re still maximizing our crude utilization throughput, but that crude turned into intermediates instead of clean products by design, because of the turnaround work we had underway. So now we’ve got that inventory of intermediates poised to be converted into clean products as we continue to ramp back up into the summer season. So we’re well positioned going forward.

Neil Mehta: Thanks, team. That’s a lot of good color. The follow-up is just on balance sheet. [Indiscernible] is a noisy order for working capital and that cash flow bridge, Kevin, is really helpful. But just your perspective on where you want to get your net debt capital over time, what’s the path to get there, including potential asset sales, and then how do we think about working capital in that equation. So big picture question around that metrics?

Kevin Mitchell: Yes, Neil, so let me hit on the working capital piece first. So, negative $1.4 billion in aggregate, but $2.6 billion of that is a function of inventory build. And so, we did have some partial offsetting benefit in payables and receivables and that was driven by two items. One the rising price, the absolute rising price environment generally is positive for net APAR, so we saw some benefit there, but we also benefited on receivables by collecting in the first quarter cash from fourth quarter inventory drawdown and that was several hundred million dollars that showed up in there. But on the inventory build it’s a sizable build and I would say it’s really a function of both commercial opportunity inventory, as well as some operational driven inventory.

And the way to think about that is the operational barrels will turn into margin at a future point in time, like the intermediates that we’ve talked about. The commercial inventory bill, those will generate a return that will be in excess of anything we will realize on cash balances and fundamentally it’s all still sitting in a liquid asset on the balance sheet. So that kind of talks to the working capital and consistent with normal practice you’d expect that inventory to come back down towards the end of the year and you’ll see some of that cash coming back to us. In terms of balance sheet and leverage levels, we are above our targeted range, so 25% to 30% target range, still comfortable with that target. You’ll notice that we’ve been leaning into the share repurchases quite heavily and that’s a function of our confidence in the business, in the outlook, our growth that we see coming in terms of the $14 billion of mid-cycle adjusted EBITDA.

And so it feels like still a pretty compelling opportunity for us to be buying shares back even if in the near-term it’s at the expense of that leverage metric. So still expect to get there to that level. That’s still our objective. And the other comment I’d make on leverage, the other metric, the other way we look at this is the non or the much less commodity sensitive businesses, the midstream and the marketing specialties business is our ability for those businesses to basically be able to bear the debt that the company has. So on a combined basis, that’s circa $6 billion of EBITDA generation. And you think of a typical leverage multiple for businesses like that, call it 3 times, that’s $18 billion of net debt, which is roughly where we are.

And so that’s the other measure we look at. And that keeps the refining business, the avoid that volatility being part of that, the way we look at that debt level. So it keeps us very comfortable from a valency standpoint.

Neil Mehta: Thanks Kevin.

Operator: Our next question comes from Roger Read of Wells Fargo Securities. Your line is open.

Roger Read: Yes, thank you. Good morning, everybody. I’d like to — if we could maybe look at, I guess it’s a combination of the OpEx that we’re seeing and refining, and I guess let’s say juxtaposed against the progress you’re making in overall cost reduction. So during the first quarter going from $6.30 to $7.15 on a cumulative basis. I look at Cash OpEx, it’s kind of stable over the last three quarters. I recognize a lot of stuff is going on, but if you could help us kind of put those two together and maybe where you see the impact on Cash OpEx or maybe if it’s embedded in the actual refining margin, where we’re seeing the cost savings manifest in refining?

Mark Lashier: Yes, I think that certainly the majority of our business transformation cost impact is showing up in refining, and we’ve been out delivering our targets, over delivering against our targets and certainly continue that into 2024. There’s always a lag and we talk about run rate and then we talk about realized and we have to make sure that you keep track to the run rate is where the speedometer is at this point in time. The realized is what we’re actually seeing show up in the numbers. And we’ve seen good progress in refining and we’ll continue to see that throughout this year as we rise up to our forecasted $1.1 billion in cost and $300 million in capital synergies, capital savings. And so Rich can drive into those cost numbers for you, Roger, and give you some color around that.

Rich Harbison: Yes, so the end of last year, Roger, we on a run rate basis, passed the $500 million or $0.75, roughly $0.75 a barrel number and run rate last year and realized about $0.41 of that last year. As we fast forward now into through the first quarter here, we see that realized number creeping up to the $500 million actually slightly over the $500 million number, so it’s coming in at that $0.75 and it’s roughly that delay that Mark’s talking about roughly 90 day delay in achieving that. So when we go back and we validate those spends, and remember those spends are over 900 separate initiatives that we’ve completed across the organization, we go back and revalidate these. So we are seeing those start flowing to the bottom line for refining.

And if you look at our year over year OpEx, it is noticeably lower, even in the face of inflation, pretty heavy inflationary period here that we’ve faced over the period of time. So we’re happy with the progress. On a run rate basis, at the end of the first quarter, we’ve achieved $560 million of run rate, which is — equates to about $0.80, and that’s on a trajectory for the year end of $1 a barrel target that’s set for the organization, which is roughly $650 by the end of the year. So we’re well on that pace to achieve that when and the program is pressing forward and like I had mentioned earlier it’s a seriatim of 100s if not 1,000s of initiatives to execute and it’s really intended to drive work and efficiencies out of our work process and as that happens we want to make sure that, that changes how we do our work, and influences how we make decisions, but it should not compromise safety, reliability, or earnings power for the organization.

Mark Lashier: Yes, Roger, and I really want to drive home what Rich just said that the cultural impact on the organization has been impressive, particularly out in the field, whether it’s midstream, refining, wherever you are. And we have a workforce that has bought into it and is committed to driving higher levels of performance. They understand right out of the front lines. They understand what our strategic priorities are and how they can contribute to us getting there. And so they’re digging in and they’re looking at those opportunities every day. And across the organization, we continue to simplify work to make work easier for people to get done, so get people the right digital opportunities, so they can make better decisions faster whether it’s commercial or whether it’s an operator out in the front line.

And the organization, we’re also simplifying. And we want to ensure that we’ve got a streamlined organization that will support sustainable success around both cost and performance and we’re seeing that live as we move forward.

Roger Read: I appreciate the detail there, everybody. Just a follow-up question on the announcement of the potential sale of the European retail assets. How does that affect the partial ownership you have in refining assets on Mainland Europe, MiRO specifically?

Kevin Mitchell: Yes, Roger, it’s Kevin. So we’re selling the jet Germany and Austria retail assets, like we said, that’s a company-owned dealer operated model, primarily almost a 1,000 sites across those two countries. It’s a high performing business, top rated, many years in a row 10%, so the market share in each country and great business, but doesn’t really integrate with the core strategic focus areas that we have as a company. So here’s a little bit of background as to why those assets, it does not include our ownership in the MiRO refinery in Germany. And the reason for that is the majority of buyers for those type of retail assets would not be interested in refinery ownership. If there’s a buyer that is interested then that’s a separate conversation and we’ll handle that separately, but this package right now is focused on those marketing assets.

Roger Read: Great. Thank you.

Mark Lashier: Thanks, Roger.

Operator: The next question comes from Ryan Todd of Piper Sandler. Your line is open.

Ryan Todd: Sorry, getting off mute there. Maybe if I could start with one on Rodeo. Congrats on getting the project, the Rodeo Renewed Project up and running. You mentioned the loss in the first quarter. I know like early days are challenging. You need to ramp towards full capacity and optimized performance. But can you walk through maybe what to expect over the next few quarters there? When do you anticipate hitting full production capacity? How do you anticipate the feedstock mix to change over the next few quarters as you run more advantaged feeds? And how should we think about that negative $180 million moving towards profitability from a timeline point of view as we look over the course of this year?

Rich Harbison: Sure, Ryan, I got that. This is Rich here. So maybe first I’ll start with a timeline of the Rodeo facility. As you know, we’ve been ramping this facility down and hit a milestone in February of this year with a complete shutdown of the facility after 128 years of legacy of running as a crude processing site. That first transition occurred on the first hydrocracker and they went into renewable fuels feedstock production in March of this year. So that first phase is up and running and that’s that milestone we’re talking about here. And that’s allowed the facility in complement with the Unit 250 operation that Mark mentioned in the earlier comments with the first hydrocracker to produce about 30,000 barrels a day of renewable fuels.

The second hydrocracker and the pretreatment unit will both finish construction in the May timeframe, and we will start those up in the June timeframe. So by the end of the second quarter, the facility will be at full production rates. Now, what does that all mean when it comes to margin? So margin in this business is driven a lot by the carbon intensity of the feedstocks. And Brian’s team has been actively engaged in that over the last couple of years on aggregating a number of feedstocks. So the way we see this is we will start with essentially the pre-treated material in the second quarter, a higher CI, roughly 50 CI number. And over the third quarter we see the carbon intensity of our feedstocks continually ramping down through that third quarter — by the end of the third quarter, I would expect to see us in the lower to mid-CI range of 30s in that range.

And that’s primarily driven by processing more recycled fats, oils, and greases that are aggregated throughout the world. So — and then as a supplement to all of that, we’re seeing a growing interest in sustainable aviation fuel as well. So we have positioned the facility to begin production of sustainable aviation fuel, which is a key component is the renewable jet that’s blended into that. And that production will be capable of starting in the third quarter, as well and we do expect to be a prominent supplier in the market on that. So the good news is you know Rodeo’s through that, that startup process that shut down startup process and now we’re in the ramp up phase I’ll call it. It’s online and we’re ramping up production right now.

Mark Lashier: Yes Ryan, when we get up to full rates we’ll be able to produce something on the order of 10,000 barrels a day of renewable jet fuel, which gets blended up then to sustainable aviation fuel in the marketplace. And this kit is going to be designed for continuous optimization, whether it’s the split between jet and diesel fuel or the feedstocks coming in because of the feed pretreatment unit we’ll have, we’ll have great flexibility. So we’ll optimize on CI cost and revenue, as well as the incentives that are out there. So it’s going to be an interesting facility to have in our kits and we’re looking forward to getting it fully online and generating cash.

Rich Harbison: I think it’s supplemented as well by the last mile strategy that Brian’s team’s put in place. That prevents leakage of value as we deliver the product to the end user there and that should play out nicely as we increase production from the facility.

Ryan Todd: And do you have you signed contracts on the SAP front? Are you in ongoing negotiations there with partners?

Mark Lashier: We’re concurrently in negotiations with partners. We’ve seen a lot of interest in SAP.

Ryan Todd: Great. Thanks. That’s maybe just one changing gears, the chems, on the chemical side, better than expected performance at CP Chem. Can you talk about kind of the drivers of improvement there? Is it primarily feedstock related? Are you seeing any signs of underlying improvement in market conditions and maybe how you’re looking at the rest of the year?

Tim Roberts: Yeah, Ryan, this is Tim Roberts and I’ll chat about that. I’ll cover three things because I think there’ll be other questions around it. First one I wanted to talk about is actually more on the leadership side. I just wanted to recognize Bruce Chinn, who is the recently retired CEO at CP Chem. He did a really good job there. Great leadership, great drive for excellence and he’ll be missed. We have an internal candidate, Steve Prusak, who’s assumed the role of CEO. Steve’s been very successful in all phases of the chemical business, and we are highly confident in his ability to lead and take CP Chem to the next level of industry-leading performance. So, that I want to thank both of those guys. Now on the macro side, let me talk about that and then I’ll get specific to CP Chem.

Macro, clearly the heavy light spread with regard to being light feed versus heavy feed, it’s really been a boon to those that can crack the light feedstock, especially CP Chem, who’s well positioned, not only the U.S. Gulf Coast, but in the Middle East. And so the advantage is pretty wide right now. And so they’ve been able to take advantage of it. In fact, the industry in the U.S., if you’re cracking light, you like it. However, I will tell you, we are not at mid-cycle market. It has come off the bottom, which is good. A lot of that is really related to more about feedstock. So, you know, natural gas has come off, it’s come down, and subsequently ethane’s come down with it, as has some propane and butane as well. And so, subsequently, that gap has gotten bigger, and then anyway, that’s showing up.

And then also, the lower feedstock and natural gas relative to utility cost. So the combination of those two, as well as just a little bit of support on polyethylene pricing, not a lot, but enough to help widen up that chain margin a little bit. So I think that’s been good. We still think though that although we’re off the bottom, we still think it’s hard to see us getting to mid-cycle anytime during 2025. But certainly supply demand fundamentals as de-stocking goes, we do see that it’s sometime after 2025, you can see it rebalance and then get back into a mid-cycle environment. Specifically to CP Chem though, I do want to highlight as well with them that they’ve had a couple of their mid-cap projects that did come on stream late last year.