Moody's Lowers Outlook on Phillips 66 (PSX) to Negative; Ratings Affirmed

October 11, 2016 11:06 AM EDT

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Moody's Investors Service, ("Moody's") changed Phillips 66's (P66)(NYSE: PSX) outlook to negative from stable and affirmed its A3 senior unsecured rating. Moody's also affirmed the Prime-2 rating assigned to Phillips 66 commercial paper program and took other rating actions as listed below.

"The change in Phillips 66's outlook to negative reflects our expectation of elevated consolidated leverage as the company continues to debt fund share buybacks in a refining down cycle." said Terry Marshall, Moody's Senior Vice President. "The announced $1.1 billion debt issuance at Phillips 66 Partners (PSXP, Baa3 stable) to fund a drop down from Phillips 66 coupled with reduced cash flow in the currently weak refining environment will result in higher consolidated leverage than we associate with the Phillips 66's A3 rating through 2017".

Upgrades:

..Issuer: Phillips 66

....Senior Secured Regular Bond/Debenture, Upgraded to A3 from Baa2

Outlook Actions:

..Issuer: HydroServe Westlake, L.L.C.

....Outlook, Changed To Negative From Stable

..Issuer: Merey Sweeny, L.P.

....Outlook, Changed To Negative From Stable

..Issuer: Phillips 66

....Outlook, Changed To Negative From Stable

..Issuer: Phillips 66 Company

....Outlook, Changed To Negative From Stable

Affirmations:

..Issuer: HydroServe Westlake, L.L.C.

....Senior Secured Regular Bond/Debenture, Affirmed A3

..Issuer: Merey Sweeny, L.P.

....Senior Unsecured Regular Bond/Debenture, Affirmed A3

..Issuer: Phillips 66

.... Issuer Rating, Affirmed A3

....Senior Unsecured Commercial Paper, Affirmed P-2

....Senior Unsecured Regular Bond/Debenture, Affirmed A3

..Issuer: Phillips 66 Company

.... Issuer Rating, Affirmed A3

RATINGS RATIONALE

Phillip 66's A3 senior unsecured rating is driven by the scope and diversity of its refining business, which represents about one-half of its proportionately consolidated EBITDA, coupled with the diversity provided by ownership of growing chemicals and midstream businesses. P66's 50% interests in both Chevron Phillips Chemical Company LLC (CPChem; A2 stable) and DCP Midstream LLC (DCP; Ba2 stable), as well as its 57% interest in Phillips 66 Partners LP (PSXP; Baa3 stable) represent both diversity of cash flow and material asset value, and are the growth vehicles for P66. This diversity somewhat mitigates an increase in leverage that has been partially caused by ongoing shareholder payments despite a weakening refinery market: adjusted consolidated retained cash flow/debt may approximate 15% at the end of 2017, down from 33% at the end of 2015. The rating considers the volatility and secular decline in the refining segment, which is currently facing narrow crack spreads, and the structural subordination of distributions received from Phillips 66's equity investments. CPChem's A2 rating is supported by a diverse portfolio of petrochemical businesses, low cost joint ventures with declining non-recourse debt, and strong credit metrics. DCP and its master limited partnership, DCP Midstream Partners LP (DPM; Ba1 stable) have suffered low NGL and natural gas prices and resultant high leverage, which should gradually decrease as commodity prices improve and the fee-based proportion of revenues increases.

Phillips 66 has excellent liquidity, including $2.2 billion of cash at June 30, 2016 and almost full availability under its $5 billion revolving credit facility maturing in October 2021, which will be ample to fund our expectation of about $2 billion of negative free cash flow and expected share buybacks for the four quarters to June 2017. The Phillips 66 revolver has no material adverse change conditionality on drawings, and a financial covenant of maximum net debt/capital of 60%, with ample headroom.

The negative outlook reflects our expectation of elevated leverage (mid-teens retained cash flow/debt expected by Dec17), partially due to expected ongoing shareholder dividends and share buybacks ($1.5 billion in 2015) despite an expected ~40% drop in EBITDA in a currently weak refining environment. The outlook could be stabilized if RCF/debt trends back above 20%.

Phillips 66's ratings could be downgraded if Moody's was to expect RCF to debt to remain below 20% on a sustained basis.

Phillips 66's ratings could be upgraded if the company generates strong free cash flow, shareholder returns are managed within free cash flow, the principal equity investments and Phillips 66 Partners (PSXP) self-fund, balance sheet debt is reduced and RCF to debt is sustainable above 40% in a refining industry down cycle.



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