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Kevin Kersten's Analyst Insights

Options Analyst Writer
Kevin Kersten
Author Bio

January 28, 2013 - Can you fuel steady returns?

As the oil executive rode down the road, he asked the driver, "How fast are we going?"  We are going 66 miles per hour on Route 66. At that moment a name was born and the gasoline the Philips Company made was named "Philips 66."  Going 66 mph in the early days of the automobile was fast. Route 66 is one of the most famous roads in America. Called "Main Street America" the road stretches from Chicago to Los Angles was the first paved road to the West Coast, as the automobile was revolutionizing transport.

Soon Philips 66 gas stations sprang up along Route 66 and elsewhere fueling up traffic heading west to new beginnings. It is the road followed in Steinbeck's "Grapes of Wrath" and in 1928 even hosted a transcontinental footrace. The road became immortalized in American culture as a classic road to the West and new opportunities in California.

Powering these was gasoline and the company behind it. The company was successful and merged with Conoco in 2002 and then was spun off in 2012. When Conoco Phillips (COP) wanted to split, the Phillips 66 (PSX) name was chosen for the spun-off company. Conoco Phillips is one of the largest independent oil and gas companies in the world. The company has operations all over the world, with significant drilling in the United States, Canada and Europe. All exploration and production is down by Conoco Phillips while refining and marketing is done by the spun-off Phillips 66. Phillips 66 is the second-largest independent refiner and marketer of gasoline. The company competes with Marathon Petroleum (MPC), Valero (VLO) and many others.

Oil and energy are a very attractive industry. Oil demand was very strong until the financial crisis caused economies to slow and demand to fall. Oil prices remain high, and long term international growth coupled with a weak US dollar means prices are likely to stay high. Domestic US energy production has risen significantly with all the oil booms in North Dakota and Canada providing relief from the need to import oil. Conoco Philips continues to develop new oil fields and Philips 66 is refining and marketing the product that America uses. While both sides of the business look good, we like the consumer side as falling domestic oil prices have allowed margins to rise.

Phillips 66 needs to buy it crude oil to fuel the 15 refineries it runs to produce 2.8 million barrels of gasoline a day. The company has an array of pipelines and ports to feed the refineries. While the company can use oil from anywhere, the increased production in the United States has caused crude oil prices here to fall. Using cheaper domestic production to offset imports is good for the bottom line. Operating income is expected to rise from $3.8B to $4.7B on revenues of near $182B.

Phillips 66 is set to report earnings on January 30, 2013 before the market opens. Analysts expect the company will report EPs of near $1.72 a share. Numbers for last year are not available because of the spin-off, but in the prior quarter the company reported $2.51 per share. The stock has been on an uptrend since the spin-off, rising from the mid thirties range. The stock has four STARS S&P buy rating.

Take a look at covered call on Philips 66 (PSX). The stock is trading near $55 and the at-the-money covered call caught our attention. An investor can buy the stock and sell the May $55 call for a $51.17 net debt. The trade has a 7% assigned return rate and 7% of downside protection. The 7% return over four months is a 25% annualized return rate (for comparison purposes only). There 1.8% dividend yield actually rises up to 1.95% with the lower holding cost of the covered call.

Demand for oil and natural gas are going to remain strong and will even rise as the US economy continues to recover. Oil companies have been making steady profits; which are improving as the US becomes a little less dependent on foreign oil. 

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