EVA - Enviva Looks Like A Zero

2023-11-25 05:09:14 ET

Summary

• Enviva withdrew its full-year guidance and issued a going concern warning, stating it would likely break its debt covenants.
• A bad contract at the end of last year unexpectedly exposed the company to the spot market, despite the company touting its long-term take-or-pay contracts.
• Enviva's future prospects depend on a rebound in the spot market for wood pellets and renegotiating its contracts to improve profitability.

Back in February when I first looked at Enviva (EVA), I questioned the long-term viability of a business that was very dependent on EU subsidies and noted that I did not think the company was covering its dividend as it claimed. However, at the time I didn't see an immediate catalyst that would send the shares lower, as I believed its current contracts should give it some visibility. I followed that up in June , saying that despite insider buying and the potential for a rebound, EVA's high leverage, poor operational results, and reliance on subsidies make it a risky investment. The stock has since collapsed, and I while I wasn't high on the stock, I could have certainly been even more bearish.

Company Profile

As a quick refresher, EVA makes utility-grade wood pellets that it processes from low-grade wood fiber. The wood it uses to make its pellets is supposed to be waste byproducts that generally have no other uses. These pellets are then sold into the European and Asian markets as a replacement for coal. The company owns 10 production plants, and is currently constructing an 11th plant, while it also owns two ports and leases four ports along the east and Gulf coasts.

Q3 Results And Bankruptcy Risk

EVA reported its Q3 results earlier this month , seeing revenue decline -2% to $320.6 million. That fell short of the analyst consensus for revenue of $350.5 million.

Adjusted EBITDA fell -40% to $36.6 million from $60.6 million. Its net loss plunged to -$85.2 million versus a loss of $18.3 million a year earlier.

The company saw its metric tons sold during the quarter rise 14% year over year, while volumes rose 10% sequentially. The company credit improvements at its plants for the improved volumes.

However, gross margin per metric ton plunged -61% from $25.28 to $9.90. Overall gross margins were 16.3% compared to 20.9% a year ago. The company said adjusted gross margin per metric ton fell 34% to $39.66 versus $59.99 a year ago. Adjust gross margin was 17.7% compared to 23.2% a year ago.

Moving forward, the company withdrew its full-year guidance and issued a going concern warning, noting it would likely break its debt covenants.

On its Q3 earnings call , CFO and interim CEO Glenn Nunziata said:

"Spot market prices for wood pellets this year have not evolved in the way we anticipated, and that weakness in the spot market caused us to significantly miss our expectations for the third quarter as well as materially reduce our expectations for the fourth quarter of this year. As a result, our profitability and cash flows are meaningfully lower than we had expected, putting pressure on our covenants under our bank facility and overall liquidity. To address these near-term headwinds, we are moving with urgency to execute a multifaceted transformation plan, consisting of three key undertakings. First, we have launched a very focused effort on improving the profitability of our contracts, with the intention of returning to a business model, which generates the vast majority of cash flow from predictable, profitable take-or-pay contracts. The single most important lever we have to ensure the long-term success of the business is improving the profitability of our current portfolio of contracts and ensuring that the value of those contracts more appropriately reflects the value we provide to customers. Second, we have engaged leading advisory firms, specifically Lazard, Alvarez & Marsal and Vinson & Elkins, to perform a comprehensive review of our capital structure, with the intent of improving our financial position and strengthening our balance sheet. And third, we announced a realignment of senior leadership to strategically focus our resources on those first two pivotal undertakings. The leadership realignment is primarily comprised of two key changes. First, the Board of Directors has appointed me interim CEO. In this expanded role, I will lead all facets of the important initiatives we are taking to ensure the turnaround of Enviva. And very importantly, I will work diligently to restore credibility among our key stakeholders, including our valued shareholders, lenders, bondholders, customers, vendors and employees."

The company is keeping former CEO Thomas Meth on to help renegotiate some of its contracts. Given that EVA had made some pretty nice long-term take-or-pay contracts, asking any other customers to renegotiate seems in really poor taste in my view. I think restoring credibility at this point will be difficult.

EVA has always touted its long-term take or pay contracts, but it blamed a deal it entered into Q4 of last year for much of its problems. During that time, the company entered into an agreement to purchase 1.8 million metric tons of wood pellets between 2023-2025 from a biomass trading company who was also a customer. These purchases, however, were more than its sales volumes over the same period and the purchase price was higher than the sales prices per metric tons it had under the pre-existing sales contracts. This in turn exposed the company to the spot market, which subsequentially collapsed.

Interestingly around the time of my first article, Blue Orca put out a short report on EVA criticizing the company, its practices, its leverage, and its accounting. However, it didn't point to what ultimately looks like what could be the demise of the company, which was this new contract. EVA also didn't indicate that this new contract was suddenly shifting much more of its sales to the spot market.

Looking at its balance sheet, EVA ended the quarter with $1.8 billion in debt and $315 million in cash and equivalents. The company said it was fully drawn on its $675 million senior secured credit facility. It would be in breach of covenants with leverage over 5.5x, or 5.75x during a material transaction period which it is currently in, or it must have a minimum interest coverage ratio not less than 2.25x. It does not expect to be in compliance with the covenants next quarter.

The company has generated -$25.6 million in operating cash flow so far this year, while spending $212.5 million on capex building a new plant.

Now a covenant default does not automatically cause a company to declare bankruptcy, and its lenders could waive the covenants, for a cost, to see if the company can get back on track. Given that Jeffrey Ubben is on the board could help in these negotiations, but his firm dumped 29% of the shares they held at $1.49 a share a couple weeks ago, so he may finally be abandoning ship.

Conclusion

At this point, it looks like EVA needs a big rebound in the spot market for wood pellets, and perhaps a cold European winter, to survive bankruptcy. Its former CEO made a really bad contract, and keeping him on to renegotiate it isn't exactly comforting. The question with the contract renegotiations, though, is whether there is a reason for this wood pellet broker to try and keep EVA solvent. I know in E&P bankruptcies, those companies were able to get better rates in bankruptcy court from midstream providers, so it could be in the wood pellet firm's best interest to renegotiate with EVA now. However, I think it makes more sense for EVA to recapitalize and give itself a fresh start at this point.

Right now, it seems like the two likeliest outcomes are that EVA reorganizes under Chapter 11, or it become a high debt zombie company that will continue to exist, but is unlikely to prosper. If you don't own EVA, I would continue to stay away. If you do own it, you can sell it for a tax loss of hold it as a lottery ticket. Sometimes stock will soar even after declaring bankruptcy, as short sellers look to cover. At this point, though, I think the equity will likely be a zero.

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