This research report was jointly produced with High Dividend Opportunities co-author Philip Mause.
Enviva Partners (NYSE:EVA) is the largest manufacturer of wood pellets in the world with roughly 14% of the total market. The stock traded recently at $27.20. Its latest quarterly dividend was 61.5 cents, which is $2.46 annually, and it generates a yield of 9.0% on the current price.
EVA’s basic business is the production of wood pellets, a form of solid biomass product, for use as fuel in electric generating facilities. In Europe, pellets are classified as a form of renewable energy. Wood pellets have a number of advantages over raw wood, including dryness which makes them burn more efficiently. They generate nearly 70% more energy per pound as compared with raw wood. They are also easier to transport and have greater energy density. Wood pellets can be transported in standard dry bulk vessels and do not require specialty fleet vessels. They have become the preferred source of wood generated electric power.
EVA has substantial pellet manufacturing facilities in proximity to its raw material forest products – primarily in North Carolina and Southern Virginia – and uses mostly pine and mill residue as feedstock. It uses the parts of trees which are not usable for other purposes and therefore has low feedstock costs. EVA has been acquiring its own port terminal facilities. It has structured its business so that transportation costs for pelletizing plant to port terminal are very low.
Almost all sales are for export. At this time, exports go to Europe (the UK, Denmark, the Netherlands, and Belgium), but EVA is about to ship on a large scale basis to Japan and South Korea. More than 40% of renewable energy production in the European Union is from solid biomass, while Japan is targeting 6.0 to 7.5 gigawatts of biomass-fired generation capacity by 2030.
Demand is growing for several reasons. The market countries are all committed to reducing carbon dioxide emissions, and the use of wood pellets is scored favorably for this purpose because trees which replace those are taken down to generate pellets capture carbon. Wood pellet power plants operate with less interruption than wind or solar plants and generally achieve higher capacity factors. Wood pellet incineration produces much lower local pollution than the combustion of coal. Wood pellets can be mixed with coal in certain plants to alleviate pollution and allow the plant to continue operation. Wood pellet plants have become one of the lowest cost sources of electricity and are competitive with other sources – even disregarding their substantive advantage in producing less net carbon dioxide in the atmosphere.
The Business Structure
EVA’s business is structured to minimize risk. Its sales are under long-term contracts which generally are set up to guarantee cost recovery. EVA is the largest player in the pellet business, and pellets can be produced in the United States at a much lower cost than in Europe or Asia so that EVA is in a strong negotiating position. This is especially true because its customers appear to be committed to large-scale expansion of wood pellet powered generating facilities.
EVA also operates with relatively low leverage. Depending upon how you measure it, EVA’s debt to adjusted EBITDA ratio is in the neighborhood of 3.
EVA has a sponsor corporation which develops new facilities and then effectuates “drop down” transactions when EVA locks in long-term sales contracts to absorb the new production.
EVA has been growing steadily and should continue to grow.
- Demand for pellets in Europe is expected to grow at a 13% annual growth rate.
- Demand for pellets in Asia is expected to grow at a 35% annual growth rate.
- On a year-over-year basis, revenue is up 18.7% and adjusted EBITDA is up 14%.
- EVA is projecting distributable cash flow (DCF) of between $69.5 and $71.5 million. Using a midpoint of $70.5 million, this works out to a per diluted unit DCF of $2.57.
- At a DCF of $2.57/share, the current dividend of $2.46 is covered at 105%. EVA’s long-term target dividend coverage ratio is at 115% but has dipped slightly during 2017 due to reasons we will explain below.
Valuation: EVA is now trading at a modest price to DCF ratio of less than 10.5.
Recent Price Pullback
EVA’s stock price has pulled back over 13% in the past 2 months:
There are 3 reasons that can be attributed to the pullback:
1 – Temporary and transitional operational issues: Perhaps the most important reason for the pullback is that the company has added many new customers this year and made efforts to ensure production was ramped up safely in advance of delivery dates. In addition, EVA has made some changes to its production process which improve efficiency, but the transition temporarily reduced output and resulted in lower than expected earnings and dividend coverage in the 2nd and 3rd quarter. According to management:
We’re serving an increasing customer set. We started the year serving three customers in addition to doing some smaller single contract deliveries. But we’re exiting the year with five or six new customers, and we took the opportunity to get ahead of it. It certainly took us a bit longer at some of our facilities than we had originally expected. But we took the opportunity, because this is important to maintaining our market leadership.”
Based on management last earnings call, these issues seem to be behind it, and EVA should ramp up sales nicely in Q4 and into 2018. This is what management said in its Q3 earnings call:
The fourth quarter is shaping up to be stronger than any quarter we’ve ever had driven by the strong operating performance of our facilities so we continue to expect to deliver a per unit distribution for full year 2017 of at least $2.36 …. We expect the fourth quarter to be strong driven by the strong operating performance of our plants and favourable contract mix.
2 – Expiry of tax credit for renewable energy: Wind and solar are two of the fastest-growing sources of power in the United States. During the past few weeks, most renewable energy stocks have been seeing weakness because of news that the new tax plan could include a series of provisions that scale back incentives for wind and solar power while bolstering older energy sources like oil and gas production. It seems EVA also sold off along with other renewable energy stocks, even though EVA does not benefit from U.S. tax credits and has 100% of its sales in Europe and East Asia where renewable energy is still in high demand and growing.
3 – Dispute between the U.S. and Canada over lumber exports: Another factor that could have affected the price of EVA is news that the United Stated Department of Commerce has accused Canada of dumping Lumber in the U.S. and recently imposed high tariffs on Canadian Lumber exports. This is also should not have any impact on EVA: First, EVA sources its products from the Southeastern parts of the U.S. (not Canada). Second, EVA does not rely on grade Lumber in its wood pallets. EVA produces wood pallets from the following sources:
- Low-grade wood fiber: Wood that is unsuitable for or rejected by the saw-milling and lumber industries because of small size, defects (e.g. crooked, knotty, etc.), disease, or pest-infestation
- Tops and limbs: The parts of trees that cannot be processed into lumber;
- Commercial thinnings: Harvests that promote the growth of higher value timber by removing weaker or deformed trees to reduce competition for water, nutrients, and sunlight; and
- Mill residues: Chips, sawdust, and other wood industry by-products.
Therefore, any increase in the price of grade lumber should not affect the production cost of EVA.
EVA’s gross debt is $343 million. Backing out balance sheet cash of $9 million, EVA’s net debt is $334 million. EVA is guiding to adjusted EBITDA of between $104 million and $106 million for fiscal and calendar year 2017 so that the debt/adjusted EBITDA ratio is slightly more than 3.
Investors should be aware that – like many commodity producers owning their own terminal facilities, EVA carries substantial inventory as an asset. EVA’s combined accounts receivable and inventory is booked at $93 million while its accounts payable is booked at only $23 million. This $70 million difference between the sum of inventory and accounts receivable on the one hand and accounts payable on the other hand should arguably be offset against debt which would have the effect of reducing the above ratio considerably.
- Execution risk: EVA is seeing large growth in its customer base, and it is possible that it may face similar execution issues as it has faced earlier this year.
- Counter-party Risk: EVA’s primary industrial customers are located in the United Kingdom, Denmark, and Belgium. Three customers accounted for 96% of the product sales for the year 2017. Should one of its large customers face financial problems such as bankruptcy, it could significantly affect EVA’s profitability. It is worth to note here than EVA is currently increasing its customer base, and this will reduce counter-party risk.
EVA has increased its dividend for 9 straight quarters and has signaled that it will increase the third quarter level of 61.5 cents to 62 cents in the fourth quarter, as it guided its 2017 dividends to be at least $2.36. Below is a table showing EVA’s dividend history.
Source: EVA website
What is worth to note in the table above is that the dividend has increased a whopping 40% over the past 2 years (since Q3 2015).
The company has also indicated that it plans to continue increasing its dividend throughout 2018. In view of the current fast growth, EVA is likely to keep implementing steady quarterly dividend increases over the next two years at least.
After pulling back over 13% for reasons we believe are unjustified, EVA provides an excellent buying opportunity. EVA has restructured to minimize risk and will be able to produce steady growth due to growing demand and a business strategy designed to generate reliable cash flow. The current low price is unlikely to last. We recommend EVA as an investment for high-yield income seekers, as this stock provides long-term growth potential, in addition to an increasing dividend. The current yield of 9.0% is very attractive!
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Note: All images/tables above were extracted from the Company’s website, unless otherwise stated.
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Disclosure: I am/we are long EVA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.