Phillips 66 (PSX) hiked its dividend by over 4.3% on April 21, despite lower earnings and cash flow. PSX stock looks cheap with its 4.5%+ annual dividend yield, well over its historical average. Moreover, out-of-the-money (OTM) short-put plays one month out yield 2.4%.
PSX stock is at $105.72 in midday trading on Tuesday, April 29. That is well off its peak of $136.53 on Dec. 6, although up from a recent trough of $92.87 on April 8. This article will show that PSX could be worth significantly more based on its historical yield, and a way to play this is by shorting OTM puts.
Results and Dividend Cost
With Phillips 66's recent dividend per share (DPS) hike to $4.80 annually, investors now have a 4.5% yield (i.e., $4.80/$105.72 = 0.0454 = 4.54%). This high yield could be due to the company's recent results.
Phillips' management and board are facing a proxy battle with Elliott Management for four board member seats. The latest results from Phillips may not have helped the company's case, as evidenced by Elliott's analysis of Phillips 66 in its April 29 presentation.
For example, on April 25, Phillips 66 reported lower Q1 earnings with an adjusted earnings loss of $368 million compared to a loss of $61 million last year. In addition, its adj. EBITDA (earnings before interest, taxes, depreciation, and amortization) was $736 million, lower than last year's $1.2 billion adj. EBITDA.
The same was evident with its operating cash flow (before working capital). At $259 million, it was down from $901 million last year. Moreover, the dividend per share cost $469 million, higher than the operating cash flow. This is also before the $423 million capex cost during the quarter.
Phillips 66's April 28 presentation indicates that the company's total shareholder returns (i.e., buybacks and dividends) since 2022 with the new CEO have outperformed the S&P 500 Energy index. However, the new Elliott presentation today points out that Phillip's returns from dividends and share buybacks are lower than its peers over the last 10 years.
Dividend Yield and Price Target
Nevertheless, one thing is for sure. Right now, the PSX 4.5% dividend yield is higher than its historical average. For example, here are three results for the stock's 5-year average yield:
Seeking Alpha …… 3.71%
Morningstar ………. 3.99%
Yahoo! Finance …. 4.20%
The average of these 3 surveys is 3.967%. Therefore, if PSX stock were to rise to the point where it has a 3.97% yield, here is what the target price would be:
$4.80 DPS / 0.0397 avg yield = $120.91 target price
That is over+14% higher than today's price of $105.72.
The bottom line for investors is that if PSX reverts to its average yield, no matter what happens at the 2025 annual meeting, the stock has good upside.
One way to play this, in order to set a lower buy-in price target, is to sell short out-of-the-money (OTM) puts in nearby expiry periods.
Shorting OTM Puts
For example, the $100 strike price puts for the May 30 expiry period show a high midpoint premium of $2.43 per put contract. That means that a short seller at this price, which is 5.1% below today's trading price (i.e., out-of-the-money), is 2.43% (i.e., $2.43/$100.00).
This provides investors a way to set a lower buy-in target and still get paid while waiting to see if PSX stock falls to the $100 strike price. Even if it does, the investor's breakeven price is lower at $97.57 ($100 - $2.43).
More risk-averse investors can sell short the $99.00 strike price puts, which have a lower delta ratio. This strike price has a roughly 26.5% chance of getting assigned to the short-seller, vs. a 29.1% probability for the $100 strike price, based on historical volatility.
However, that strike price short-put play has a lower 2.15% yield over the next month, vs. the 2.43% yield at the $100.00. In any case, both of these are over 2%, a very good yield, especially if it can be repeated each month.
Nevertheless, the risk here is that PSX falls further, and the investor is assigned to buy shares at these strike prices. Keep in mind, however, that at $100, the $4.80 annual DPS gives the investor an annual yield of 4.80%. This is a good yield for a patient long-term investor and well over its average yield.
The bottom line here is that PSX stock looks cheap based on its average historical yield. One way to play this is to sell short out-of-the-money puts.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
