Description

Overview

We recommend Enviva Partners, LP (“EVA”) as a long at $18.44/unit (2/8/2016). We think that this is a very attractive business that has gotten caught up in the tidal wave of asset flows out of the MLP space despite having no leverage to energy prices.

Enviva is the world’s largest producer of wood pellets. The Company’s primary customers are European utilities who are transitioning away from coal and other fossil fuels to renewable energy sources as required by EU, country specific, and global energy policy mandates. Due to its successful operating history and strong customer track record, the Company enjoys very attractive relationships with its customers characterized by long-term take or pay contracts with limited commodity price exposure. In addition, as a result of the global push toward renewable energy, the Company enjoys a highly visible growth runway. The Company is currently majority owned by the Riverstone Funds which currently hold 58% of the LP units as well as Enviva’s GP. By virtue of its substantial LP holdings, Riverstone’s interests are well aligned with public LP unit holders as demonstrated by the very favorable economics of Enviva’s first drop down transaction completed in December 2015 as well as significant insider buying.  

Despite these positives, EVA trades at an attractive valuation: ~7.5x 2017P EBITDA which represents a 17.5% levered free cash flow yield. We believe that due to its contracted cash flows, credit-worthy counterparties, and growth runway, EVA should trade at $35 per unit which would represent 11.4x 2017P EBITDA and a 9% PF levered free cash flow yield.

Context

Immediately after going public in April 2015, Enviva’s units were hit by a confluence of negative events unrelated to the Company’s business fundamentals causing the units to trade down from their offering price of $20/unit to $12/unit. We believe that Enviva traded down due to the drop in crude prices and asset flows out of the MLP space. While Enviva’s units have rebounded somewhat, we believe that EVA remains underfollowed and undervalued due to its small market capitalization and its status as the sole public wood pellet producer, providing sell side analysts very little research leverage and very little reason to cover it. Despite Wall Street’s lack of interest, insiders have been significant buyers of EVA, investing approximately $3mm in open market acquisitions since the IPO.

With respect to ownership, Enviva remains majority owned by its sponsor, the Riverstone Funds. Public unitholders currently hold approximately 42% of outstanding LP units while Riverstone and management own the remaining 58% interest as well as Enviva’s GP.

Company Overview

Enviva supplies wood pellets to European utilities who are making the transition away from coal and other fossil fuels to biomass as required by EU and country specific mandates. We believe Enviva is a stellar business for the following reasons:

Advantaged wood pellet and logistics assets:

Due to the high cost of transporting Enviva’s pulpwood feedstock, proximity to ample feedstock and scale are key determinants of cost competitiveness among wood pellet producers. As all of Enviva’s wood pellet plants are located in the southeastern United States, the lowest cost and most dense fiber basket in the world, and as 75% of Enviva’s capacity is derived from world scale plants with greater than 500kmt/py capacity, Enviva is the global low cost producer of wood pellets.  

Enviva derives an additional competitive advantage from its owned and operated wood pellet terminal assets. By virtue of its ownership of these terminal assets, Enviva is able to control its own logistics costs and is also able to offer its European utility customers CIF as opposed to FOB pricing, which enables them to maintain shipping flexibility and manage port congestion. Our work indicates that this is a meaningful differentiator versus other wood pellet suppliers and commands a premium in contract negotiations.

Finally, our work suggests that Enviva is a reliable operator and has not suffered any fires (Fram, Rentech) or development delays (Rentech) that have beset other operators. This successful track record is an additional differentiator in customer contract negotiations.

Long term, fixed margin, off take customer contracts:

In order to guarantee a steady wood pellet supply, Enviva’s utility customers have entered into contracts that are highly advantageous to Enviva. The contracts are typically characterized by ten year terms, take-or-pay minimum volume commitments, and pass through clauses for most commodities and general inflation. As a result, approximately ~95% of the Company’s capacity is contracted in 2016 and 2017 and approximately 90% is contracted through 2022. As a result of the pass through clauses, margins are pretty much guaranteed providing for highly visible volumes, revenue, EBITDA, and cash flows for the next several years.

Highly credit worthy counterparties

The experience of SunCoke Partners and various mid-stream MLPs over the last several months has made it abundantly clear that long term, fixed margin off take agreements mean nothing unless one’s customers are solid credits. Our research indicates that both of Enviva’s primary off take customers, Drax (67% of Enviva’s capacity) and RWE (20% of Enviva’s capacity), are indeed solid credits.

Drax is a GBP 1B market-capitalization UK utility operating three biomass and three coal plants. While one could write a book about the outlook for Drax and UK energy policy, we believe it is sufficient to note the following:

1. Drax currently has a net cash position of GBP 225mm (debt less cash less ROC assets)

2. Drax’s biomass plants are supported by various renewable energy subsidies that are guaranteed through 2027

3. Drax’s coal plants are among the newest in the country and the lowest cost source of electricity in the UK after nuclear (10% of total UK supply) and biomass (less than 5% of total UK supply)

4. The UK power grid currently has a margin over peak demand of less than 5% whereas Drax currently supplies 8% of the UK’s electricity

RWE is a EUR 7.4B market capitalization European utility with operations in six European countries (Germany, UK, Spain, Netherlands, Poland, and Italy). We take comfort in RWE’s role as a critical electricity supplier in each of its markets and its conservative leverage profile (2.0x net debt / EBITDA).

Limited competition

Enviva’s competition includes potential vertical integration by its customers and a highly fragmented base of third party pellet suppliers. Neither appears to pose much of a threat to Enviva. With respect to its existing business, Enviva’s long term customer contracts insulate it from any sort of competitive take away or vertical integration by its customers for the foreseeable future. With respect to potential future business, we expect Enviva to remain in pole position and its competitive environment to remain highly favorable. So far, the utility grade wood pellet industry has been characterized by one-to-one build to suit plants. In other words, there are no utility scale plants currently being built on spec without an off-take agreement in hand. We believe this dynamic will continue going forward and limit wood pellet capacity. Future customer contracts should therefore be characterized by terms and economics similar to Enviva’s current contracts.

Highly visible growth

In addition to the attractive business fundamentals and virtually guaranteed cash flows noted above, we like Enviva due to its strong growth profile consisting of both accretive near term drop downs and longer term growth resulting from global energy policy mandates.

Near term drop downs

Enviva completed its April 2015 IPO with a robust inventory of drop down assets including a fully contracted 510kmt/py wood pellet plant located in Southampton, VA (“Southampton plant”) which commenced operations in 2015; a second fully contracted 500kmt/py wood pellet plant (“Sampson plant”) commencing operations in early 2016; and a deep-water terminal in Wilmington, NC (“Wilmington terminal”) commencing operations in early 2016.   

Enviva completed the drop down of its Southampton plant in December 2015. As a result of Enviva’s management and sponsor’s substantial stake in the LP units (noted above), the drop down was highly accretive to Enviva unit holders and was completed at 6.0x 2016P EBITDA which compared to Enviva’s then trading multiple of ~7.1x EBITDA. The acquisition was funded primarily through debt and cash on hand while the sponsor took approximately ten percent of the purchase price in Enviva units issued at a 10% premium to Enviva’s then unit price. We believe that this sets a very good precedent for future drop downs. The transaction was completed on very favorable terms to unit holders and provided a unit holder friendly signal that EVA is undervalued.

We expect Enviva will drop down the Sampson plant and Wilmington terminal later this year after operations ramp and the Sampson plant’s offtake agreement commences September 1, 2016. Per the IPO prospectus, this drop down should contribute approximately $21mm in incremental EBITDA and should be very accretive if completed on terms similar to the Southampton drop down. See pro forma valuation below.

Global energy policy to drive future growth

Global energy accords such as the Paris climate deal signed last December and the EU’s renewable energy directive have hastened the shift away from fossil fuels to renewable energy sources. The EU itself has set a binding target of 20% final energy consumption from renewable sources by 2020 with member states setting their own national renewables targets. Beyond 2020, EU countries have agreed on a new renewable target of 27% of final energy consumption across the continent by 2030. As biomass is among the cheapest and most reliable forms of renewable energy, we believe that it will play a key role in this shift toward renewable energy. The charts below show the progress of certain EU member states against their renewables targets, and the relative costs of various forms of renewable energy as estimated by the UK Department of Energy and Climate Change. As biomass is the cheapest route to renewable energy and given that many EU member states are severely lagging their legally binding renewable energy targets, we believe that biomass will figure prominently in these member states’ long term energy policies. Specifically, we expect biomass to figure prominently in the long term renewable energy plans in both the UK and Netherlands and for both countries to clarify their long term biomass incentive schemes later this year providing an upward catalyst for Enviva’s units.

Valuation

In the table below, we present EVA’s valuation pro forma for the Southampton drop down completed in December 2015 and a second valuation pro forma for the Sampson and Wilmington dropdowns planned for Q4 2016 (note that the Sampson and Wilmington dropdowns are incremental to the Southampton dropdown). As shown, the pro forma valuation indicates a very modest valuation of 7.5x PF 2017 EBITDA post Sampson and Wilmington drop down, corresponding to a 17.5% free cash flow yield and a 14% distribution yield at a conservative 1.15x coverage ratio. Due to a lack of comps, it is difficult to point to exact valuation metrics, but given Enviva’s business fundamentals, visibility of cash flows, and growth profile, we feel that EVA should trade closer to a 7% dividend yield or $35.00 per share. We believe that this is in-line with where other MLPs trade that have solid counterparties, limited commodity price exposure, solid balance sheets, and long runways of future drop downs e.g. RMP, AM.

Conclusion

In conclusion, we believe that there is a lot to like about EVA’s business and that its current share price is a very attractive valuation. With respect to the business, we believe that EVA presents a rare combination of long term, contracted cash flows; solid, creditworthy counterparties; no commodity price exposure; and a strong, unit holder oriented sponsor as demonstrated by insider buying and precedent drop downs. We believe that the current unit price is attractive because EVA is an underfollowed small-cap MLP that has been caught up in a wave of asset flows out of the sector despite its attractive underlying fundamentals.

Catalyst

Sampson and Wilmington asset dropdowns; UK and Netherlands renewable energy policy clarity expected later this year; investors do the work to understand the business and analyze it