Phillips 66 - 3.96% Dividend Yield and Massive Buybacks Are Attracting Value Investors

Phillips 66 (PSX) recently hiked its dividend by 8% to $4.20 per share annually, 2 days after announcing Q4 earnings. This now gives PSX stock, at $106.02 on March 3, an attractive 3.96% dividend yield. Moreover, Phillips 66 announced a huge increase in its buyback program by $5 billion. Both of these developments are pushing value investors to the stock.

Granted, earnings for Q4 were lower than expected. They made just $4.00 in adjusted earnings per share (EPS), lower by 8% than the $4.30 that was projected by analysts.

Nevertheless, its cash flow and free cash flow were very strong. From $10.2 billion in cash flow from operation (CFO), free cash flow came in at $8.6 billion, during 2022, after capex spending of $2.2 billion (see slide below). This was well more than enough to pay for the $3.3 billion in dividends and share buybacks during the year. 

In other words, there is plenty of room for the company to pay its dividends and buybacks, assuming the weakness in the prices of oil and gas continues.

Large Share Buybacks

Moreover, the company also said it hiked its buyback program by $5 billion. Management said in the earnings release that since July 2022, we have returned $2.4 billion to shareholders through share repurchases and dividends

In fact, the company plans to return $10 billion to $12 billion by the end of 2024, over the next two years. We can use that information to estimate how much it will spend on buybacks. 

Since there are 466 million shares outstanding, the $4.20 per share dividend costs $1.957 billion per annum. Let's assume the company raises the dividend by 8% in 2024. That brings the total in 2024 to $2.113 billion. 

So, over two years, the next two years that dividend will be $4.07 billion. This leaves between $6 billion and $8 billion in share buybacks over the next two years, or $3b to $4 billion per year. That is on track with the $753 million in buybacks it did during Q4 (i.e., $3 billion per annum run rate).

How Buybacks Help the Dividend per Share

Here is why this is important. If Phillips 66 buys back $3.5 billion on average per year of its shares, this works out to 7% of its $49.8 billion market valuation right now. That is an additional return to remaining shareholders since it lowers the share count and hikes the earnings and dividends per share.

For example, let's assume that the dividend is $2.1 billion at the end of 2024. With 2 years of 7% reduction in share count or 14% in total, the shares outstanding will fall from 466 million to 400.76 million (i.e., 466 x 0.86). 

As a result, the new annual dividend will be $5.24 per share (i.e., $2.1 billion/400.76 million shares). That works out to a 24.8% hike in the dividend per share after two years - almost 25% (i.e., $5.24/$4.20). This growth rate outpaces the dividend growth cost to the company. It rose just 8% to $2.1 billion from $1.957 billion in our assumed model.

In other words, by buying back shares, the dividend per share will be 200% higher in the next years than it would otherwise be (i.e., 24.8%/8%=3x-1=200%). 

The bottom line here - this massive growth in the company's buybacks is attracting value investors, who, just like Warren Buffett, see the logic behind share buybacks, as he discussed in his latest shareholder letter.

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