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Phillips 66 Looking Beyond Refining

NEW YORK (TheStreet) -- For Phillips 66 (PSX - Get Report), will higher margins mean a higher stock price?

The energy company, which has seen a profit decline in its core refining business, is diversifying by investing more in its higher-margin midstream and chemical businesses.

This year, Phillips 66 and its joint ventures will spend $4.6 billion in capital expenditures, primarily to expand the company's midstream and chemical businesses, both of which posted higher earnings last year. Midstream is the business of transporting and processing oil.

Phillips 66's expansion in the higher margin operations will likely boost the company's profits, and investors are optimistic, as the company's shares have rise 25% over the past 52 weeks. They were recently trading at $77.82, up 26 cents.

The stock trades at 13.1 times trailing earnings, close to its highest level ever. But then again, this stock comes with just two years of trading history and is priced much lower than the industry average of 30.6 times trailing earnings, according to data compiled by Thomson Reuters.

Phillips 66 operates 15 refineries, including 11 in the U.S. About 55% of the company's refining capacity lies in the Mid-Continent and the U.S. Gulf Coast, where the refineries can tap into unconventional fuels. Seven refineries are located in coastal areas that allows the company to capture higher prices in the international markets.

But Phillips 66's refining segment has lagged its other businesses, which is why it is investing more in its chemical and midstream segments. Last year, chemical earnings rose 19% to $986 million and midstream earnings rose nine-fold to $469 million. Earnings in the much larger refining segment fell 43% to $1.8 billion. Phillips also has a marketing segment.

Phillips 66's midstream segment includes a 50% interest in DCP Midstream (DPM) and its oil transportation-focused master limited partnership, or MLP, Phillips 66 Partners (PSXP). The chemical segment is almost entirely represented by the Chevron Phillips Chemical Co., also called CPChem.

Last year, CPChem had a profit margin of 20%, while midstream's margins were 8.5%. The refining unit's margins were 3.5%.

Phillips 66 has allocated about 52% of this year's capital budget of $2.7 billion to its midstream segment. That excludes investments by DCP Midstream, its limited partnership and other joint ventures that fund their own capital programs. It is investing money in its terminals and processing plants on the Gulf Coast.

The company is also moving $700 million in assets, known as a dropdown, to Phillips 66 Partners. By putting assets in an MLP, Phillips 66 will get tax advantages as well as a cash infusion that it can use to expand its midstream business.

Meanwhile, CPChem, which has already built five big projects in the Middle East, has now turned toward the Gulf Coast. The chemical business will spend $6.5 billion to expand its capacity by 25% over the next four years.

Phillips 66 is funding some of its expansion through asset sales. Last year, Phillips 66 sold $1.2 billion worth of assets, an increase from $286 million in 2012. Management has said that when it comes to refineries that are performing poorly, the company will "either get those out of the portfolio" or work to improve their performance.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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