3 Things to Watch When Phillips 66 Reports Earnings This Week

By Matthew DiLallo Markets Fool.com

Phillips 66 (NYSE: PSX) is coming off a difficult year, capped by a very disappointing fourth quarter. All four of the company's segments slumped due to a range of issues, though its refining business was by far the worst after it sank into the red because of shrinking margins and a major turnaround at a refinery. Given those challenges last year, investors certainly have a lot to keep an eye on when the company reports first-quarter results later this week. Here are three things that stand out as must-watch items.

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Is the refining market finally showing signs of life?

Last year was a tough one for refiners, and it only got worse in the fourth quarter. Phillips 66 noted that the central corridor region experienced a 25% decline in the crack spread, which is the difference in price between oil and refined products. According to the company, several other items also negatively impacted clean product realizations in the Gulf region. Because of these and other factors, margins contracted significantly, which when added to other issues caused the company's refining segment to fall into the red.

Image source: Getty Images.

That said, it would appear that some of those problems are in the rearview mirror. That's at least the inference investors can make after a glimpse into the refining market earlier this week when Valero Energy (NYSE: VLO) reported first-quarter results. While the refining giant noted that it continues to incur high costs to comply with its current biofuel blending obligations, it still managed to beat analysts' expectations. Furthermore, Valero CEO Joe Gorder offered an optimistic outlook on 2017, noting:

U.S. refined product inventories have declined and are within their five-year ranges. Demand for gasoline and distillate remains strong both domestically and internationally. Combined with expectations for continued sweet crude oil production growth and relatively low prices for crude and refined products, consumer demand should be robust this year.

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Given that outlook, investors should see whether Phillips 66 expects 2017 to be a better year for its refining segment as well.

Did the midstream business turn around?

Another trouble spot last quarter was its midstream business, where adjusted earnings plunged 57%. One culprit was the NGL business, where profits dropped from $15 million in the third quarter to $7 million due to start-up costs for the company's new Freeport LPG export terminal and lower equity earnings. Meanwhile, it recorded a $6 million loss from its investment in DCP Midstream (NYSE: DCP), reversing the prior quarter's $9 million in adjusted earnings, though that was primarily due to the timing of reliability and maintenance spending.

It's unclear what to expect from the midstream segment this quarter because, unlike with Valero giving a hint about the refining segment, investors are flying blind here since DCP Midstream won't report earnings until next month. However, given that most of DCP Midstream's issues last quarter were related to timing and that the company recently completed a consolidation transaction with its master limited partnership, there's reason to be optimistic that midstream earnings will improve. Furthermore, Phillips 66's NGL business should benefit from a full quarter of Freeport, which began commercial operations last December.

Image source: Getty Images.

Any new strategy updates?

In some regards, 2017 will be a transitional year for Phillips 66 since many of its major construction projects are winding down and starting to enter service. Not only did Freeport begin commercial operations last quarter, but oil is about to start flowing through the Dakota Access Pipeline, and the company is finishing up the capacity expansions at its Beaumont Terminal. Because of that, capital spending is falling while cash flow should start heading higher.

While the company has plenty of options for its growing stream of excess cash, including dividends and buybacks, one potential destination of that incremental cash flow could be the Rodeo Project that the company unveiled last month. That's after Phillips 66 announced an open season for a pipeline to move oil from the Permian Basin to the Gulf Coast, with hopes of bringing a 130,000-barrel-per-day pipeline on line by the second half of next year. That said, it's not the only new Permian pipeline project in development, so investors should keep an eye out to see what the company says about the likelihood that it'll move forward with this project. Meanwhile, investors should see what the company has to say about other projects in development, which could help it begin to replenish a depleting backlog.

Investor takeaway

After a challenging 2016, Phillips 66 investors are hoping that 2017 will be a better year. There's reason to be optimistic because if Valero's first-quarter results and outlook are any indication, it appears that a rebound in refining is in the forecast. Investors, however, need to see similar results from that segment and within its midstream business this quarter to convince them that better days are up ahead.

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Matt DiLallo owns shares of Phillips 66. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.