Activist Elliott has unfinished business at Phillips 66. How its plan to build value may unfold

Enterprise: Phillips 66 is an power manufacturing and logistics firm. It operates by way of the next segments: Midstream, Chemical compounds, Refining, and Advertising and Specialties (M&S). The Midstream section gives crude oil and refined petroleum product transportation, terminaling and processing providers, in addition to pure fuel and pure fuel liquids (NGL) transportation, storage, fractionation, gathering, processing and advertising service. The Chemical compounds section consists of the corporate’s 50% fairness funding in Chevron Phillips Chemical Firm LLC (CPChem), which manufactures and markets petrochemicals and plastics on a worldwide foundation. The Refining enterprise refines crude oil and different feedstocks into petroleum merchandise, corresponding to gasoline, distillates and aviation fuels, in addition to renewable fuels, at 12 refineries within the U.S. and Europe. Lastly, the Advertising and Specialties section purchases for resale and markets refined petroleum merchandise and renewable fuels.

Inventory Market Worth: $52.88B ($128.04 per share)

Possession: ~4.6%

Common Value: n/a

Activist Commentary: Elliott is a really profitable and astute activist investor. The agency’s crew contains analysts from main tech personal fairness corporations, engineers, working companions – former expertise CEOs and COOs. When evaluating an funding, the agency additionally hires specialty and common administration consultants, knowledgeable price analysts and trade specialists. It usually watches firms for a few years earlier than investing and has an in depth secure of spectacular board candidates. Elliott has traditionally targeted on strategic activism within the expertise sector and has been very profitable with that technique. Nevertheless, over the previous a number of years the agency’s activism group has grown, and it has been doing much more governance-oriented activism and creating worth from a board stage at a a lot bigger breadth of firms.

On Feb. 11, Elliott issued a letter and presentation to the Phillips 66 board outlining “Streamline66,” a plan to resolve the corporate’s continued underperformance and poor company governance practices regardless of its portfolio of engaging property. It contains the next steps: (i) streamline the corporate’s portfolio by way of a sale or spin-off of the midstream enterprise in addition to a possible sale of its curiosity in CPChem; (ii) provoke an working evaluate by committing to formidable refining targets and shutting the EBITDA-per-barrel hole with its friends; and (iii) improve oversight and bolster accountability of Phillips 66’s administration crew by including new impartial administrators to the board.

Phillips 66 (PSX) is an power manufacturing and logistics firm. The corporate maintains 4 beneficial asset segments, every providing scalability and powerful aggressive positioning. Its Midstream section operates a vertically built-in wellhead-to-water pure fuel liquids (NGL) enterprise throughout the Permian and DJ basins. The Chemical compounds section contains their world-scale petrochemical three way partnership CPChem. The Refining section is without doubt one of the largest refining methods within the U.S. The Advertising and Specialties section consists of a scaled fuels advertising enterprise and manufacturing of specialty merchandise. Regardless of the attractiveness of those property individually, Phillips trades at a major low cost to its sum-of-the-parts valuation. Whereas roughly 70% of the corporate’s earnings earlier than curiosity, taxes, depreciation and amortization comes from the premium a number of Midstream, Chemical compounds and Advertising segments, which commerce as excessive as 10-times EBITDA, PSX trades nearer to the a number of of its lowest-valued Refining section at 6.6-times. Because of this, the corporate has considerably underperformed the common of its closest friends, Valero Power (VLO) and Marathon Petroleum (MPC), in cumulative complete return by 9%, 33%, and 97% over the previous 1-, 3-, and 5-year intervals, respectively.

Elliott first publicly engaged PSX in November 2023, when the agency despatched a letter to the board of administrators asserting its $1 billion funding within the firm. Elliott criticized PSX for its historical past of underperformance, citing points corresponding to shifting away from and being poorly ready to reap the benefits of the refining super-cycle in ’22 and ’23, rising refining working expenditures (OPEX) per barrel in absolute and relative phrases in comparison with friends VLO and MPC, and rising prices relative to friends within the wake of a cost-reduction program. Elliott noticed a possible inventory value of greater than $200 per share on the time, however the agency shared Wall Road’s concern that PSX was primarily an execution story.  

Regardless of this, Elliott acted the way in which we wish lively shareholders to take action, versus how they’re perceived by many. The agency gave CEO Mark Lashier the chance to reveal significant progress on his targets of $14 billion of mid-cycle EBITDA by 2025, non-core asset divestitures of $3 billion and rising PSX’s long-term capital return coverage. They rapidly and amicably agreed with the corporate so as to add two new administrators with refining expertise to the board. The corporate added Robert Pease, a former govt of Cenovus, to the board in February 2024, and agreed to proceed to work with Elliott on figuring out a second director within the coming months. The second director by no means materialized.

Now, greater than a yr later, Elliott has elevated its place to $2.5 billion and goes to develop into extra lively in creating shareholder worth, issuing a public letter and presentation to “Streamline66.” Elliott identifies three major sources of PSX’s underperformance. First, the agency argues that the corporate’s intrinsic worth has been obscured by its inefficient conglomerate construction, leading to it buying and selling in keeping with its lowest a number of refining section regardless of a majority of EBITDA coming from its different premium companies. Second, PSX’s working efficiency has failed to fulfill administration’s targets and profitability continues to lag friends. In 2024, PSX delivered annualized adjusted EBITDA of between $4.5 billion and $8.7 billion, effectively wanting its $14 billion 2025 mid-cycle goal. The corporate’s OPEX per barrel has risen in two consecutive quarters, and its EBITDA per barrel profitability hole has solely widened versus VLO. Third, Elliott asserts that administration’s steady declare of a profitable turnaround with none tangible monetary outcomes has eroded their credibility with buyers. The agency additionally mentioned the board has failed in its basic oversight duties, rewarding administration with compensation disconnected from the corporate’s efficiency.

That is what has led Elliott to releasing its three-pronged plan to: (i) streamline PSX’s portfolio, (ii) evaluate operational efficiency with a watch towards refining margin enhancements, and (iii) enhancing administration credibility with the addition of recent administrators. First, Elliott suggests spinning or promoting PSX’s midstream property, estimating that they might ship roughly $40 billion to $45 billion as a standalone or in a sale to a strategic purchaser. As well as, Elliott additionally suggests the sale of CPChem and JET, estimating that web proceeds of $48 billion from the three property could be equal to 96% of the corporate’s present market cap. The elevating of that quantity of capital may enable PSX to repurchase between 60% and 90% of the corporate’s shares excellent and improve the payout ratio to 100% of free money circulation like its refining friends. With enhanced oversight enabled by the addition of recent administrators with trade and operational expertise, PSX may get on monitor in direction of enhancing its EBITDA per barrel and progress in direction of its refining targets.

Elliott estimates that this plan may yield a share value of roughly $200 per share. Furthermore, the agency asserts that if PSX executes the playbook Elliott employed in its engagement at MPC, shares may improve to over $300. At Marathon, Elliott helped facilitate the addition of a brand new director, transition to a brand new CEO, closure of the hole in per barrel EBITDA with VLO, retirement of fifty% of its shares excellent since 2021, and sale of the Speedway retail operation for $17 billion in after-tax money proceeds. Since Elliott despatched its first letter to Marathon on Nov. 21, 2016, MPC has outperformed VLO and PSX by 56% and 116%, respectively.

Having an excellent plan is step one, implementing it’s one other story. This time, Elliott is not going to be settling for one or two administrators, particularly after PSX did not observe by way of on the settlement final time so as to add a second director with refinery expertise. Elliott gave administration time to execute. Administration failed. Now, Elliott will do what the board is meant to do, however didn’t: maintain administration accountable. Elliott doesn’t explicitly state that it is seeking to substitute senior administration, nevertheless it does focus on administration’s broken credibility and eroded investor confidence, and that’s laborious to repair with out changing administration. Furthermore, Elliott does cite CEO substitute as the primary merchandise which led to profitable turnarounds of their engagements at Marathon and Suncor. With the corporate’s nomination window closing this week and 4 administrators on the 14-person board up for election, we anticipate Elliott will nominate a full slate of 4 administrators, if solely to protect its choices whereas discussing governance with the board.

Ken Squire is the founder and president of 13D Monitor, an institutional analysis service on shareholder activism, and the founder and portfolio supervisor of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.