Better Buy: Phillips 66 vs. Valero

Markets Motley Fool

Many energy investors pay the most attention to the companies that pull oil and natural gas out of the ground. However, there are many more steps that need to happen before you can buy the gasoline and other energy products you use every day. In particular, refiners like Phillips 66 (NYSE: PSX) and Valero Energy (NYSE: VLO) rely on cheap sources of crude oil and then reap profits based on the spread between their input costs and what they can charge for gasoline, diesel fuel, and other refined products on the open market. In addition, Phillips 66 does a lot more than refining, with midstream operations as well as chemical manufacturing facilities. Conditions for refinery stocks were tough last year, but things have improved more recently, and interested investors want to know which industry giant is the smarter play right now. Let's look at Phillips 66 and Valero using a variety of key metrics to see which one might be the better buy for investors.

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Valuation and stock performance

Valero has dramatically outperformed Phillips 66 stock over the past year. Valero is up 26% since June 2016, but Phillips 66 has only been able to eke out a 2% rise in its share price over the same period.

From a valuation standpoint, earnings multiples in the refinery industry have been generally attractive, reflecting both cyclical and longer-term concerns about the future of the energy segment. When you look at earnings over the past 12 months, Valero appears to have a big advantage, trading for just 14 times trailing earnings compared to a trailing multiple of 25 for Phillips 66. However, when you incorporate near-term future earnings projections into the equation, the short-term issues that have hit Phillips 66 harder than Valero mostly disappear. Phillips 66's forward earnings multiple of 13 is a bit higher than Valero's corresponding price of 11 times forward earnings. That gives Valero a valuation edge despite its better recent performance, but it isn't a huge advantage.

Dividends

Refinery stocks are known for their healthy dividends, and Phillips 66 and Valero are part of the cream of the crop among the stock market's higher-yielding dividend stocks. Valero currently has the edge with a 4.2% dividend yield, but Phillips 66's 3.5% yield is also impressive.

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Recent earnings results from Phillips 66 make its dividend look more dangerous than Valero's. Valero has a payout ratio of about 55% of earnings, compared to more than 70% for Phillips 66. Again, though, if Phillips 66 rebounds as expected, then the payout ratios between the two refinery stocks should converge. Dividend growth has been sizable for both companies as well. Valero's quarterly dividend has tripled since 2013, whereas Phillips 66 has seen its distributions more than double over that timeframe.

Overall, Valero has a slight edge on the dividend front. As we saw with valuation, though, the advantage isn't huge and could reverse itself in the future.

Growth prospects and risk

When you look at how Phillips 66 and Valero Energy have performed lately, it's interesting to see the similarities and differences. For Phillips 66, having a polyethylene and ethylene chemical production facility, a midstream pipeline and terminal network, and a marketing and specialties segment gives it valuable diversification from the refinery sector. Indeed, the company itself sees that diversification as essential, because even its own executives aren't certain that the refinery industry has many prospects for growth over the long haul. Instead, Phillips 66 expects growth from its other businesses, and it's investing the vast bulk of its capital expenditures on the chemicals and midstream areas. That sets Phillips 66 apart from the rest of the refinery industry and is an important aspect for energy investors to remember in considering the stock.

Meanwhile, Valero has largely borne out Phillips 66's viewpoint on the growth potential for refineries. In its first-quarter earnings, Valero saw continued pressure from low refining margins, and the need for planned refinery shutdowns for maintenance also led to some sluggishness in its growth. Although recent oil price declines have reduced input costs even further, market prices for gasoline and other refined products have generally followed the price of oil downward. Valero sees demand for gasoline remaining strong, but high inventories will take time to work themselves out. In the long run, Valero hopes that its efforts will set it up for greater strength when the industry fully rebounds.

At this point, Phillips 66 looks like the better buy. Even with a higher apparent valuation and a weaker dividend, Phillips 66 has a lot more potential for immediate growth than Valero does. Only if you believe that the refinery industry will rebound quickly does it make more sense to choose Valero as the purer play on refining.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.