Enviva Partners (EVA) is a new MLP with a juicy 8.2% yield and is the largest global producer of utility-grade wood pellets used in power generation.
It is not our intention to cover new IPOs. However, in the past two months there has been interesting niche companies coming to market with a MLP or REIT structure favoring higher distributions. Last month it was InfraREIT, an electric transmission utility structured as a REIT, and this month it is Enviva Partners (EVA), a wood pellet manufacturer structured as a MLP.
EVA is a new offering by Riverside Fund, a private equity firm, and Hancock Natural Resources Group, a registered investment advisor and a wholly owned subsidiary of Manulife Financial Corporation. This joint venture was the previous owners of the production facilities. The JV built four plants and acquired an additional plant. The JV is also building more plants in anticipation of dropping them down into EVA.
These five plants have current production of 1.7 million metric tons of utility-grade pellets, which is a lower grade of pellets than the “premium” grade used in residential pellet stoves. There are plan to increase production to 2.0 million tons over the short term.
EVA has long-term “take or pay” contracts for 100% of its production until 2017 and then 50% of production after 2018. In other words, the factories are sold out for the next 2 ½ years – and all to the export market.
With over 170 pellet manufactures in the US, why is EVA of interest? The Europeans are much further ahead of the US in converting their coal-fired power plants to biofuel, with pellets being the preferred biofuel. Japan and South Korea are also growing utility-grade pellet markets. Overall, the US supplies 60% of the global wood pellet market, and EVA is the largest.
In 2014, power generation in Europe consumed 9.2 million metric tons of utility-grade pellets, with the UK representing 50%. Annual pellet European consumption for power generation is expected to grow by 21% a year, representing a market of 25.8 million metric tons by 2020.
In the US, natural gas is being used as a coal replacement due to low gas prices – just ask any natural gas E&P investor. However, with limited domestic supplies of gas and international pricing for LNG gas running 3 to 4 times the price in the US, wood pellets are becoming an important fuel source in Europe, in tandem with a reduction of coal generating capacity. Wood pellets have the immense advantage of being a base-load fuel source rather than the intermittent nature of solar and wind.
In addition, EVA owns a pellet export terminal in Chesapeake VA to facilitate the export process.
Pellet plants usually source their raw materials within a 75-mile radius and the five plants are strategically located in the southeast: two in northern North Carolina, two in Mississippi and one in the panhandle of Florida.
The JV, also acts as the General Partner, Enviva Holding GP and is building three more pellet plants, which should be sold to EVA over the next three years. The additional production should increase current capacity by 75%. EVA also has the right of first refusal on two more export terminals in Wilmington NC and Pascagoula, MS.
The initial distribution is pegged at $0.41 a quarter, or $1.64 a year. At a current price of $19.90, the yield is a juicy 8.2%.
On a pro forma basis, 2014 reported cash available for distribution was $1.46. Importantly, it does not include production acquired in Jan 2015 that substantially increased capacity.
Based on expanding capacity from the dropdowns and the additional export facilities, EVA is expected to increase EBITDA over the next three years. This could equate to annual distributions close to the 50% top tier of the General Partner’s Incentive Distribution Rights IDR. See the article in “Strategic Subject of the Month” section for an explanation of IDRs. While the General Partner will see substantial per unit fee income, unit holders will be still be adequately rewarded.
Investors could see their annual distribution increase to $2.47 from the initial target distribution of $1.61 year.
EVA began trading at the end of April, and the quiet period expired at the end of May. While the underwriters of the IPO have an ingrained self-interest in EVA doing well, the recent consensus is a “buy” with a price target of $25.
According to benzinga.com, Goldman Sachs has a “Buy” recommendation and a $25 target price. From their report,
The analysts believe that the stock offers an attractive investment option, given its leverage to rapidly growing wood pellet demand, its low cost asset base, a favorable contract structure, a strong dropdown pipeline and distribution/unit growth, and compelling valuation relative to its closest comparison set.
The company is well positioned to leverage the continuing growth in wood pellet demand. This demand is being driven by major utilizes that are converting their traditional power or heat plants to burning wood pellets in an attempt to meet the EU 2020 renewable energy goals. This is especially true in key European countries, such as the UK, Netherlands, Denmark and Belgium.
The analysts also expect that EVA's sponsors will drop down six additional plants through 2019 given favorable wood pellet fundamentals, while also expecting the company to witness distribution growth at a robust 17 percent CAGR through 2018, driven by a robust dropdown pipeline and cost execution.
CitiGroup, Barclays, Raymond James, and RBC have a “Buy” on the stock. These are also some of the book-runners of the IPO.
If their target market grows to 25 million tons and EVA’s capacity grows to 3.4 million tons by 2019, their market share of European pellets will decline from the current 18% to 14%, but still represents a substantial share.
Investors willing to take on a bit higher risk should be amply rewarded over time. While there is risk concerning fall-off of take or pay contracts past 2017, the growth and strength of the underlying utility-grade pellet market in Europe should alleviate much of those concerns.
For more information, the SEC IPO prospectus is linked below:
This article first appeared in the June issue of Guiding Mast Investments
Thank you for reading, George Fisher