Why Phillips 66 (PSX) Earnings Will Start Shrinking

Phillips 66 (NYSE:PSX) will release its quarterly report on Wednesday, and ever since its initial spin-off from ConocoPhillips (NYSE:COP), favorable trends in the refining industry have helped to boost the company’s profits and send the refiner’s stock soaring. But lately, those trends have started to reverse, and the impact on Phillips 66 (NYSE:PSX) earnings could be a nasty surprise to those who’ve gotten used to the shares only moving in one direction.

In particular, Phillips 66 (NYSE:PSX) has seen huge benefits from the massive expansion in domestic energy production in recent years, as prices of domestic crude fell well below prevailing prices on the world markets. Yet as those spreads have shrunk to nearly nothing in recent quarters, Phillips 66 (NYSE:PSX) will now have to deal with a much more neutral earnings environment even as some other challenges begin to rear up and affect its earnings potential. Let’s take an early look at what’s been happening with Phillips 66 (NYSE:PSX) over the past quarter and what we’re likely to see in its quarterly report.

Stats on Phillips 66

Source: Yahoo! Finance.

Is the growth story for Phillips 66 earnings dead?
Analysts have dramatically reined in their views on Phillips 66 (NYSE:PSX) earnings over the past several months, cutting their June-quarter estimates by nearly 20% and lopping more than $0.50 per share from their full-year 2013 consensus earnings figures. The stock has stopped its upward move, falling about 4% since late April.

One of the biggest drivers of earnings growth for Phillips 66 and its peers came from cheap U.S. oil. Even as their input costs stayed low, refiners benefited from high prices for refined products like gasoline and diesel fuel, and that helped create massive profits. That led refiners to take extraordinary steps to obtain cheap crude from hard-to-reach domestic sources, including Phillips 66’s decision to transport oil by rail to its refineries.

Lately, though, domestic crude has seen its cost advantage almost disappear, creating a potential reversal of the profit bonanza. Valero Energy Corporation (NYSE:VLO) said last week that it expects discounts for domestic crude to return, restoring its long-term benefits, but in the meantime, its profits dropped 44% in its second-quarter report compared to year-ago levels.

But having learned a lesson from its parent, Phillips 66 recently had great success doing a spin-off of its own, putting many of its pipeline and terminal assets into the master limited partnership Phillips 66 Partners LP (NYSE:PSXP) and seeing the shares of the newly public MLP soar on their IPO day. The move has worked so well in the industry that other refiners like Valero Energy Corporation (NYSE:VLO) have made plans to put their own midstream assets into MLPs in order to help investors take advantage of tax benefits that the entities enjoy compared to regular corporations.

In the Phillips 66 earnings report, watch for signs about its expectations for spreads between domestic and global oil prices. If it projects further weakening, then it could be a while before profits return to past levels. Moreover, keep an eye on the regulatory front to see if pollution-reducing proposals will actually get implemented, potentially costing the refiner billions in capital expenses.

The article Why Phillips 66 Earnings Will Start Shrinking originally appeared on Fool.com and is written by Dan Caplinger.

Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool has no position in any of the stocks mentioned.

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