Should You Buy The Market's Most Controversial Stock?

Chad Tracy's picture

Thursday, June 27, 2013 - 10:00am

by Chad Tracy

T. Boone Pickens has been around a long time.

Born in 1928, the 85-year-old billionaire has amassed a fortune by investing in the industry he knows best: oil and gas.

He came from an oil and gas pedigree. His father worked as a landman leasing oil and mineral rights in Oklahoma. Pickens' first job out of college was with Phillips Petroleum. He later worked as a wildcatter.

In 1956, he founded the company that would become Mesa Petroleum and helped it grow into one of the largest independent oil companies in the world.

During the 1980s, he became famous for his acquisition of other oil and gas companies, including Pioneer Petroleum and Gulf Oil. His newfound notoriety landed him on the cover of Time Magazine and prompted him to consider a presidential bid during the 1988 elections.

When it comes to investing in the U.S. oil and gas sector, one would be hard pressed to find a more knowledgeable or experienced person anywhere on the planet.

According to 13F filings, Pickens opened five new positions in oil and gas companies during this year's first quarter.

Through his investment firm, BP Capital Management, Pickens opened positions in Apache (NYSE: APA), Tesoro (NYSE: TSO), Marathon Petroleum (NYSE: MPC), Gulfport Energy (Nasdaq: GPOR) and Phillips 66 (NYSE: PSX).

As you might expect, these stocks have all done well this year. Gulfport has seen the biggest gains, up 28%. The only laggard of the bunch is Apache, up "only" 8%.

So, considering the big gains we've already seen in this sector, are any of these picks still a good investment at today's prices?

While I strongly believe all five companies should remain on investors' short list of stocks to watch, I think Phillips 66 offers the best value at today's prices.

Phillips' strength lies in the diversification of its assets. Although it is known primarily as a refiner, the company also owns interests in pipelines and chemical assets that help boost earnings and provide stability, and help to differentiate the company from its peers.

As part of a joint venture with Spectra Energy (NYSE: SE), Phillips owns a 50% interest in DCP Midstream Partners (NYSE: DPM). DPM owns or operates 62 natural gas processing facilities and 12 NGL fractionation plants. And it services these facilities through its massive, 62,000 mile natural gas pipeline system.

Regular StreetAuthority readers are probably already familiar with our fondness for "irreplaceable" assets like pipelines. These assets are very difficult to replicate, which discourages competition and helps maximize profits. StreetAuthority expert Elliott Gue has recommended a number of these investments in his Top 10 Stocks newsletter. For example, subscribers who took his advice and bought Brookfield Infrastructure (NYSE: BIP) are up more than 48% on the recommendation.

In addition to its position in DPM, Phillips holds other midstream assets, including a 25% interest in the REX pipeline and investments in fractionation plants.

Although Phillips has been publicly traded only since May 2012, it has already increased its dividend twice. It currently pays a rate of 31 cents a share, which comes out to a yield of 1.78% at today's prices.

The company's core refinery business also continues to churn out profits. Phillips operates a total of 15 refineries, 11 of which are in the U.S. It also operates one refinery in each of Malaysia, Germany, the U.K. and Ireland. (In fact, the Whitegate plant in Ireland is the only refining facility of its kind in that country.)

The amount of free cash flow the company generates has grown enormously over the past three years. During the past 12 months, PSX reported almost $5 billion in free cash flow, a fivefold increase over the $946 million reported in 2010.

Free cash flow is an important metric to consider because it indicates that a company has cash to expand, develop new products, buy back stock and pay dividends. Rising free cash flow is a good indicator of a healthy, thriving company.

In taking a closer look at current shareholders, I also discovered that T. Boone Pickens is not alone in his fondness for PSX. Warren Buffett's Berkshire Hathaway (NYSE: BRK-B) owns over 27 million shares of the company -- an investment of more than $1.9 billion.

As they say -- great minds think alike.

Risks to Consider: In December, PSX announced it would form a master limited partnership (MLP) sometime in the second half of this year. Transportation and terminal assets typically do well as MLPs, and some of these assets are likely to be the foundation for Phillips' new entity. However, if PSX decides to consolidate all or some of its pipeline assets into an MLP, it could damage diversification and reduce one of the company's key advantages.

Action to Take --> PSX is currently trading at a forward price-to-earnings ratio of 7.4 and a price-to-book ratio of 1.8, both of which are slightly lower than the industry average. The stock rates a buy below $60 per share.

P.S. -- Much like Phillips 66, Brookfield Infrastructure deals in long-lived, irreplaceable assets. My colleague Elliott Gue thinks Brookfield's headed for big things in the coming years, which is why he's named it one of his Top 10 Stocks for 2013. To find out more about his other "Top Stocks for 2013," click here.

Chad Tracy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of BIP, GPOR, SE in one or more of its “real money” portfolios.