Deciphering the Optimal Energy Investment

One glance at the upward trajectory of over 25% this year for both energy giants Philips 66 (NYSE: PSX) and Valero Energy (NYSE: VLO) may lead investors to believe they are peaking. While PSX sits at a slightly elevated valuation of 0.5x trailing revenues compared to VLO’s 0.4x, the former boasts a modest revenue growth whereas the latter shines in profitability. Unraveling the right investment choice requires a nuanced look into the intricate landscape of market dynamics. Profits often equate to market dominance, a factor that can’t be overlooked.

Peeling back the layers on stock returns reveals a remarkable story. PSX witnessed a staggering surge of 145% from $70 at the start of 2021 to around $170 presently. In a similar vein, VLO experienced a meteoric rise of 270% from $50 to about $185 over the same timeframe. Both overshadow the S&P 500’s modest growth of around 40% during this period.

Triumphs and Trials in Stock Returns

Despite PSX and VLO emerging as rare gems with consistent value appreciation over three successive years, outperforming the market consistently remained elusive. The narrative for PSX unfolds with returns of 4% in 2021, 44% in 2022, and 28% in 2023. VLO, on the other hand, saw gains of 40% in 2021, 74% in 2022, and a mere 2% in 2023. The S&P 500, meanwhile, navigated fluctuations with returns of 27% in 2021, -19% in 2022, and 24% in 2023.

Beating the S&P 500 consistently in today’s volatile stock market is akin to taming a wild stallion. Even behemoths like XOM, CVX, and COP in the Energy sector, alongside tech luminaries GOOG, TSLA, and MSFT, have grappled with this challenge. In stark contrast, the Trefis High Quality (HQ) Portfolio, comprising 30 stocks, has outshined the S&P 500 every year. What sets them apart? The HQ portfolio offers superior returns coupled with minimized risk, evident in their performance metrics.

Amidst the murky waters of the current macroeconomic landscape, with soaring oil prices and looming interest rates, could PSX and VLO find themselves in a familiar rut of underperformance? Will they rise like a phoenix from the ashes? As of now, both stocks exude full valuation.

1. Phillips 66’s Revenue Growth Paints a Rosier Picture

• Phillips 66 steals the limelight with a robust 32% revenue growth since 2021, outshining Valero’s 27%.
• The revenue uptick for both giants emanated from surging crude oil prices, a resilient demand backdrop, and stringent supply conditions.
• The ascension of WTI crude price from $75 in late 2021 to the current $87 underpins this growth.
• However, 2023 witnessed a sales dip for both entities amidst plummeting crude prices. WTI surged from $75 in late 2021 to over $120 in mid-2022, before cascading down to $71 by late 2023.
• While Phillips 66 endured a 13% y-o-y revenue decline in 2023, Valero’s revenues plummeted by a stark 18%.
• The demand for oil remains robust on a global scale as per the International Energy Agency (IEA), which hiked its oil demand growth forecast to 1.3 million barrels per day post a robust 2023 growth of 2.3 million barrels per day.
• IEA projects constricted supply dynamics owing to prolonged production cuts by OPEC+ members. Geopolitical uncertainties like the Ukraine-Russia tussle and the Israel-Gaza turmoil may keep oil prices at an elevated threshold in the near term.

2. Valero Emerges as the Profitability Maestro

• Valero witnessed a substantial uptick in its operating margin from 1.9% in 2021 to 8.2% in 2023. Conversely, Phillips 66’s operating margin swelled from 0.4% to 5.4% during this period.
• A closer look at the latest twelve-month horizon showcases Valero’s robust operating margin of 8.2% towering over Phillips 66’s 5.4%.
• While Phillips 66 saw its refining margin per barrel escalate to $17.32 from $7.42 in 2021, a dip to $21.55 in 2022 ensued due to the fuel price slump.
• Valero encountered a dip in its overall refining margin by $4.4 billion y-o-y, settling at $19.0 billion in 2023.
• Treading the water of financial risk, Valero emerges as the winner. Phillips 66 grapples with a 26.5% debt-to-equity ratio, trumped by Valero’s 20.9%. Additionally, the cash cushion underscores Valero’s strength with 8.6% cash as a percentage of assets compared to Phillips 66’s 4.4%, delineating a better debt stance for the former.

3. Sorting Through the Bottom Line

• A closer examination surfaces Phillips 66’s buoyant revenue growth against Valero’s profitability prowess and solid financial standing.
• Gauging the future outlook based on P/S amidst the erratic P/E and P/EBIT landscape, both stocks ping on the radar of full valuation.
• Note the premium at which both stocks trade concerning their historical averages. While VLO stands at 0.4x trailing revenues compared to the five-year mean of 0.2x, PSX is perched at 0.5x trailing revenues versus the historical norm of 0.4x.
• An upward revision in valuation multiples seems rational given the robust demand scenario and tightened crude supply. However, post the recent ascent, the positives appear baked in, prompting prospective investors to bide their time for a market dip.

The trajectories of PSX and VLO may echo the song of full valuation, yet diving into Philips 66’s Peers for a comparative analysis on pivotal metrics can untangle investment complexities. Explore a plethora of industry comparison nuggets at Peer Comparisons.

[1] Returns as of 4/8/2024
[2] Cumulative total returns since the end of 2016

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The views and opinions expressed herein signify the author’s perspective and may not align with those of Nasdaq, Inc.