EVA - Enviva: The Business No Longer Looks Predictable

2023-06-20 22:42:49 ET

Summary

• Enviva, a company that processes low-grade wood fiber into utility-grade wood pellets, has seen its stock drop over 70% since my initial concerns were raised about its long-term prospects.
• The company recently cut its adjusted EBITDA guidance and eliminated its dividend, citing weak Q1 results, as well as delayed improvements in productivity and costs.
• Despite insider buying and the potential for a rebound, Enviva's high leverage, poor operational results, and reliance on subsidies make it a risky investment.

Back in mid-February, I wrote that I thought Enviva Inc. ( EVA ) should be fine in the near term, but that I had worries about the long term. A few months later the company lowered its guidance and eliminated its dividend, getting crushed in the process. The stock is down over 70% since my initial write-up. Let’s take a closer look.

Company Profile

As a reminder, EVA takes low-grade wood fiber and processes it into utility-grade wood pellets that is used as a replacement for coal in markets in Europe and Asia. The company claims the wood it acquires is by and large waste or byproducts that have no other uses.

The company has long-term take-of-pay off-take contracts that provide for fixed-price deliveries and include price escalators. It owns 10 production plants with a combined production capacity of 6.2 million tons per year. It also owns two port locations in Virginia and Mississippi, and it leases 4 others on the east coast and Gulf Coast. The six ports have 10.9 million tons of throughput capacity and 352,000MT of storage capacity.

Cut Guidance and Dividend Eliminated

Less than a month after my initial write-up, EVA posted weak Q4 results that it blamed on several transactions with a large customer with whom it buys and sells pellets with, which under accounting rules required it to be considered a change in a commercial contract. The company said this forced it to have to recognize deferred gross margins from the deals over the length of the contract which ends in 2025. The stock sold off about -15% the session following the report.

However, the company painted a bright picture for 2023 on its call, as well as at its analyst day a month later. At the time of its Q4 report it March, it forecast adjusted EBITDA of $305-335 million, and that it would pay out a $3.62 per share dividend. The company also planned to spend $365-415 million in CapEx.

At its April analyst day, meanwhile, the company boasted of its new build plans, which would add four new facilities over the next four years. It said conservatively each plant would add $80 million a year in EBITDA.

At its Analyst Day, Chief Development Officer Mark Coscio said:

“We expect collectively to generate over $180 million from the first 2 facilities in 2026. But I do want to highlight, as Thomas mentioned before, our base plan is the 4 plants, but in our development cycle, we have multiple other sites that we'll continue to have under option, and we'll be moving forward in our development cycle. So depending on what happens with the market dynamics, we'll look to the potential to continue to add growth depending on what happens with our demand. So now I'd like to bring this all together and just highlight a few things as we move forward. Enviva is really excited to introduce the EVA 1100 standard plant, it will be the largest wood pellet facility in the world, and it will reliably produce 1.1 million metric tons of wood pellets each year moving forward. It will put us on a path to more than doubling our EBITDA by 2026, over $500 million. As I mentioned before, the Epes facility and the Bond, Mississippi facility will be commissioned in 2024 and 2025, respectively. The other 2 facilities that we have in our development pipeline right now will be commissioned in 2026 and 2027, respectively. So these are the 4 plants that form our base plan we currently have right now for the next 4 years.”

A month later on its Q1 earnings call , the tone from management changed dramatically. Adjusted EBITDA guidance was cut to $200-250 million and the dividend was completely eliminated. The company said $30 million of the reduction was due to the weak Q1 results, while the other $65 million was the result of delayed improvements in productivity and costs.

The company had originally forecast Q1 EBITDA of between $40-50 million, but generated only $3.4 million. It blamed $16 million on customer mix, $10 million on unplanned maintenance, $5 million of professional fees, and $4.6 million on deferred margin accounting. The company gave guidance for the next 3 quarters, which show a big EBITDA ramp throughout the year. And as many readers probably know, investors generally aren’t a fan of backloaded guidance, particularly for a company that just missed near-term guidance so badly.

Looking at the issues EVA is facing, the company said managers at some plants were prioritizing production over costs, resulting in large cost overages. It also noted that one plant was significantly underperforming, and that it has hired an outside firm to help turn it around. It also said its contract labor costs were too high. On a positive not, it did say that the price of delivered wood had come down substantially.

EVA also noted that some contracted volumes were delayed until the second half. With take-or-pay contracts this is certainly odd, but the company said if a customer asks for a change in delivery it will make a change if it can do so in an accretive manner. However, it said it can force a customer to take the shipment.

As for the elimination of the dividend, the company said it will save them $1 billion from 2023 through 2026, so it doesn’t sound like a short-term temporary thing. The company also initiated a $100 million stock buyback program to repurchase shares opportunistically. As I noted in my initial write-up the company wasn’t covering its dividend at the time, and the company generated negative operating cash for 2022. In Q1 it did generate operating cash flow, but it has a lot of Capex in front of it with new plants.

Following its Q1 earnings announcement, the stock was down a whopping -58% the next trading session. Given that management didn’t reduce its full-year guidance at its analyst day a month earlier, when Q1 was already in the books, certainly didn’t help with any trust issues.

Insider Buying

A number of insiders stepped up with open market purchases of EVA in May . Director John Bumgarner Jr. has been the biggest buyer, spending nearly $3 million to purchase shares. The 80-year-old director has been on EVA’s board since 2015, and currently assists in operating a family-owned, multi-faceted real estate company. Directors Ralph Alexander, Gary Whitlock, and Gerrit Lansing Jr, have also been buyers, as has CDO Mark Coscio.

Notably, EVA saw a lot of insider buying last October when the stock was in the $50s. So it doesn’t necessarily mean these investors can predict the share price, although EVA is up nicely since the May 2023 buys.

Conclusion

While I wasn't bullish on EVA, I clearly should have been even more negative. I didn't see an immediate downward catalyst, but there was one lurking.

What is supposed to be a steady, predictable business given its contracts, EVA has delivered nothing close to that the past two quarters. Most of the issues appear to be on the cost and productivity side, although the delayed delivery and change in one contract have certainly been viewed as issues as well.

EVA trades at about 14.4x the 2023 EBITDA consensus of $187.9 million, and 9x the 2024 consensus of $301.6 million. While EVA doesn’t have a great comparison, it you want to compare it to the midstream sector, it looks priced still too high. Throw in its high leverage, its recent poor operational results, its customers' reliance on subsidies, and questions around the environment benefits of wood pellets, and it’s probably best to stay away.

There could be a rebound if the bar is indeed low and the company jumps over easy estimates, but this is a show me story.

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