Enviva Inc.
Q1 2016 Earnings Call Transcript

Published: 7 May 2016

[Operator:]

Ladies and gentlemen, good morning and welcome to the Enviva First Quarter 2016 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I’d now like to turn the conference over to Ray Kaszuba, Vice President & Treasurer. Please go ahead.

[Ray Kaszuba:]

Thank you. Good morning and welcome to the Enviva Partners LP first quarter 2016 financial results conference call. We appreciate your interest in Enviva Partners and thank you for participating today. On this morning's call, we have John Keppler, Chairman and CEO; and Steve Reeves, Chief Financial Officer. Our agenda will be for John and Steve to discuss our financial results for the first quarter released this morning and an update on our current business outlook. We will then open-up the phone lines for questions. Before we get started, a few housekeeping items. First, please keep in mind that during the course of our remarks and subsequent Q&A session, we will be making some forward-looking statements and we will refer to some non-GAAP measures. Our forward-looking statements or comments about future expectations are subject to a variety of business risks. Information concerning the risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements can be found in our press release issued this morning as posted on our Investor Relations section of our Web site, as well as our 10-K and other recent filings with SEC. We assume to obligation to update any forward-looking statements to reflect new or changed events or circumstances. Reconciliations of non-GAAP measures to GAAP measures may also be found in today’s press release. In addition, all references to 2015 amounts are as reported in our 10-Q filed today. I’d now like to turn it over to John.

[John Keppler:]

Thanks, Ray. Good morning, everyone. Thanks for joining us on today’s call. I think it’s worth noting that a year-ago almost to the day, we completed our initial public offering. Thank you all for the support. It was nice to see favorable finance media coverage recently that reflected on our IPO and recognized that Enviva is pretty unique. While as an MLP, we characteristically generate stable cash flows, underpinned by long-term contracted assets and have a backlog of organic and acquisition based growth opportunities. Our cash flow profile is independent from the traditional oil and gas sector. It’s a real strength in the energy space to have durable and growing cash flows unrelated to fossil fuel price volatility and one that we will continue to leverage. I hope that you’re not only as pleased as we’re about the operational and financial results today, but also as excited about the future growth prospects for Enviva. As Steve will describe further when he goes through the financial results for the first quarter, we continue to demonstrate the durability of our cash flows, derived from our portfolio of top performing production plants and long-term contracts. The day-to-day operational excellence of the Enviva team and our relentless focus on safety, reliability, sustainability, and continuous improvement delivered great results for 2015. That momentum continued right through the winter in 2016, which is when we’ve historically seen seasonality, given the colder wetter weather. Our solid first quarter performance, which beat the expectations we laid out in our last call, combined with the accretive cash flow acquired with the South Hampton drop, our first drop transaction, laid a great foundation for the remainder of the year, and gave us the ability to significantly increase or per unit distribution to $0.51 per unit, a more than 10% increase from the fourth quarter of 2015. That represents a nearly 24% increase from the minimum quarterly distribution announced at our IPO. We believe that level of per unit distributable cash flow growth really stands out, especially as compared to the cash flow volatility experienced by many in the broader energy market. What’s nice is we think we are just getting started. We expect to see continued organic growth within our existing assets as we optimize our portfolio of contracts and plants, and identify further debottlenecking opportunities to increase production and reduce costs. And the demand for our products continues to grow not only as a renewable drop in replacement for coal fired power generation in Europe and Asia, but in other geographies and applications as well. Forecast demand continues to outstrip available supply, underpinning our primary driver of long-term cash flow growth, new contracts and drops of newly built contracted production plants and ports developed by our sponsor. Two of these are on the near-term horizon. The 515,000 metric ton per year Sampson plant and the deep water marine terminal in Wilmington, North Carolina. The Sampson plant has begun commissioning. In fact, wood deliveries begin next week. And we expect to have the opportunity to acquire the Sampson plant along with a 10-year off take with an affiliative DONG Energy in late 2016, and the contracted Wilmington terminal in 2017. In addition, our sponsor recently received the air permit required to construct our next building copy plant, the 500,000 metric ton per year facility in Hamlet County, North Carolina. On top of the growth potential from dropdowns, as the market leader and a proven acquirer in an industry experiencing some dislocation, compelling opportunities may also be present for third-party acquisitions. I’ll return to discuss some specific market developments after Steve reviews the first quarter financial results.

[Stephen Reeves:]

Thanks, John. In what is historically our highest cost quarter, our underlying operating performance was strong. Our production was up and our fiber and operating costs were down compared to last year, and although we sold fewer tons due to ship timing and inventory carry-in, the underlying fundamentals reflect our commitment to continuous improvement. With respect to the specifics, on sales of 560,000 metric tons of pellets, net revenue for the first quarter of 2016 was $107 million, representing a decrease of 6% over the corresponding quarter of 2015. As I mentioned, the reduction in net revenue is a function of lower sales volume, the mix of FOB versus CIX shipments compared to last year, and pricing. We shipped the higher percentage of this quarter's volume under contracts with FOB shipping terms. As a reminder, the customer pays for shipping directly under FOB terms, which has the effect of reducing both revenue and cost of sales compared to contracts with swift terms. Other revenue increased during the quarter, principally due to the receipt of a $1.7 million payment from a supplier from whom we purchased pellets and provided logistic services who chose to terminate their agreement. It is appropriate to think about the payment as a prepayment of services to be provided over the course of the year and therefore an acceleration of timing rather than incremental to the year itself. Gross margin increased $4.1 million to $15.8 million for the first quarter of 2016, as compared to the corresponding quarter of 2015, principally driven by a favorable cost position of our delivered pellets as a result of increased plant utilization and lower fiber costs, lower depreciation and amortization and increased revenue from purchase and sales transactions and the aforementioned termination payment from the supplier. These items were partially offset by contract mix and lower sales volumes for the current quarter. Adjusted gross margin per metric ton also improved relative to the first quarter of 2015 from $34.16 per ton to $40.42 per ton, driven by many of those same factors. On net income of $7.5 million, adjusted EBITDA improved to $18.5 million for the first quarter of 2016. In addition to the termination payment, the improvement in adjusted EBITDA from the corresponding quarter of the last year was a function of improved operational performance, somewhat offset by higher general and administration -- general and administrative expenses associated with being a public company. After maintenance capital expenditures of $550,000, interest expense net of amortization of debt issuance costs and original issue discount of $2.9 million, and incentive distribution rights for our general partner of $156,000, distributable cash flow for the first quarter of 2016 was $14.8 million to our limited partners, which covers the $0.51 distribution announced yesterday at 1.18 times. Given the solid operating performance, we’re reaffirming the guidance for 2016 provided previously. Just for clarity, it should be noted that all amounts reflect the base business as of today and do not give effect to any potential dropdowns or other acquisitions occurring during the year, not even the Sampson plant. For 2016, we project to earn net income in the range of $43 million to $47 million, with associated adjusted EBITDA of between $83 million and $87 million. We expect maintenance capital expenditures of $4.1 million and interest less amortization of debt issuance costs and original issue discount for the same period to be $11.9 million. As a result, the partnership expects to generate distributable cash flow of $67 million to $71 million for the year, prior to any incentive distributions to our general partner. Although deliveries to our customers are generally ratable over the year, the mix and timing of customer shipments can impact results, which may vary somewhat quarter-to-quarter. As a result, our Board evaluates our distribution and coverage on an annual basis. Distributable cash flow is expected to be $2.71 to $2.87 per unit before any incentive distribution -- distributions paid to the general partner. Also as previously communicated, we reaffirm our expectation to distribute at least $2.10 per common and subordinated unit for 2016, while building coverage through the year. You may have noticed that we filed an S-3 shelf yesterday. With the anniversary of our IPO, we’re now S-3 eligible and it’s a prudent corporate finance practice to get that in place. Now I’d like to turn it back to John to discuss recent market activity.

[John Keppler:]

Thanks, Steve. Before we open the lines to Q&A, I’d like to take a few minutes to provide an update on the market and the implications for Enviva. We believe that recent developments continue to underpin the 20% year-over-year demand growth expected by industry experts. Let’s start with our core European market, as countries push towards their 2020 binding renewable energy requirements. In the UK, the Competition and Markets Authority recently recommended that the U.K. government allocate future Contract for Difference, or CfD incentives, based on the cost effectiveness of the renewable technology instead of simply by category of technology. If this recommendation is adopted by the U.K. government, new biomass conversions and co-firing projects would be well-positioned to receive future CfD incentives, especially if total system costs of renewable technologies are taken into account, which include the additional cost of backup generation, balancing services, and transmission enhancements needed for the intermittency issues associated with solar and wind. These developments are an important follow-on regulatory proposal consistent with the direction from the U.K. Department of Energy and Climate Change around balancing the trilemma of the cost effectiveness of decarbonization, energy security, and grid stability in the U.K., especially as the country looks to phase out all coal fire generation by 2025. In addition, the U.K. government confirmed that biomass combined heat and power projects would be eligible to compete for new CfDs in an auction planned for late 2016. We believe this can result in additional industrial scale pellet demand in the U.K. In that market, EPH, the vertically integrated energy utility with operations throughout Europe that purchased the 420 megawatt Lynemouth power plant from RWE, continues to move forward with plans to convert the facility to wood pellets. When the plant is fully ramped, the power plant is expected to demand approximately 1.5 million tons of wood pellets annually with delivery starting in 2017 and continuing through at least 2027. This facility received EU state aid approval of its CfD in late 2015, which Drax’s third unit is currently awaiting. Drax has received confirmation from the U.K. government that they can move forward under the Renewable Obligation Certification, or ROC, should their CfD, which has been granted by the U.K. government, not receive the pending EU state aid approval for some reason. The Drax unit is expected to need more than 2 million tons of wood pellets annually. In the Netherlands, the 2016 auction for the renewable energy program, called the SDE Plus, commenced with the initial round of applications in March. Biomass coal fired projects are eligible for the incentive, and while the applications are not public, we understand projects did apply for the incentive in this initial round with more expected to follow in the second final round in September. The significant increase in the budget from €3.5 billion for 2015 to €8 billion for 2016 is expected to help create demand for wood pellets, estimated by industry experts to be more than 3 million tons a year in the Netherlands by 2019. In addition, the Netherlands is also considering an eventual full phase out of coal fire generation following on the success seen in the U.K., with full conversions from coal to wood pellet fuel, which would lead to a significant increase in wood pellet demand. Strong signs of long-term demand growth are visible elsewhere in the world as well. In Japan, some are now expecting the demand for wood pellets to grow to 10 million tons a year by 2030, due to the government’s drive to reduce carbon emissions and replace nuclear power generation. In the Caribbean, a region we haven’t talked much about, French power plant developer Albioma has announced a 40 megawatt biomass fired conversion in Martinique with expected operation in 2017. Island nations in both this region, as well as the South Pacific and Indian Oceans is extremely high cost of electricity, often as much as $47 per kilowatt hour, using very environmentally challenging fuel sources like imported diesel and heavy fuel oil. We view this as an interesting emerging customer set that can provide for attractive power plant fuel choices that exist without the need for regulatory support. Here in the U.S., even while the Clean Power Plan continues its path to through the courts, biomass policy is gaining important footholds. The U.S Senate recently passed a bill with significant bipartisan support that classified biomass as carbon neutral, consistent with EU policy and the preponderance of peer-reviewed science. In addition, the state of Oregon recently passed legislation that makes biomass immediately part of the renewable portfolio standard, phases out the use of coal-fired power by 2030, and mandate 50% of the state’s power to be from renewable sources by 2040. These recent examples are a validation of what we do as an industry every day. Deploy capital to help decarbonize the economy, sustainably grow forests, and put people back to work in rural areas. So moving from the marketplace to an update on Enviva's sales book. On our last call, we announced that our sponsor’s joint venture with John Hancock signed a contract to be the sole source wood pellet supplier for the MGT Power Plant in Teesside in the Northeast U.K. It’s a roughly 1 million ton per year contract with 375,000 tons per year initially provided by the partnership, and the balance by the Hancock JV. These contracts are subject to financial close by MGT, which continues to progress and is currently contemplated for mid year. When firm, deliveries under this contract will begin in 2019 and continue through 2034. In December, we announced an off take contract to supply wood pellets to the Langerlo facility in Belgium. However, affiliates of Langerlo’s owner continue to experience financial distress, including insolvency filings. And while neither the Langerlo facility nor its owner are a part of the filings, we expect this distress to, at a minimum, delay commencement of physical deliveries under our off take contract. Our portfolio of long-term contracts has a weighted average remaining term of seven years from April 1 of this year, without considering our 15-year contract to supply MTG; our 10-year contract to the Langerlo plant; or the 10-year contract with DONG Energy held at our sponsor that commences in September, which we expect to have the opportunity to acquire in the fourth quarter. Our sales strategy is to fully contract the production capacity of the partnership. We’re fully contracted for 2016 and about 85% for 2017, not including the Langerlo contract. I think it’s worth pointing out that in addition to our long-term take-or-pay contracts, we also routinely sell volumes under shorter-term contracts that range in volume and tenor from several years to, in some cases, a specific single shipment. With these and our confidence in the discussions underway with customers for long-term take-or-pay contracts commencing in late 2017 and early 2018, we believe we’re extremely well positioned to be fully contracted going forward. So in closing, as I reflect back on the past year since the IPO, while we’re pleased with our accomplishments, I’m even more excited about the future. We are just getting started. We’ve positioned Enviva as the preferred supplier to generators and their investors seeking a drop in renewable replacement for coal. And the tailwinds behind conversions and co-firing are strong, both in our core European market and other geographies. We believe this demand, along with stable cash flows built on strong operating performance from our contracted asset base and conservative financial policies, will enable us to continue to increase our per unit distributions in 2016 and beyond. Thank you all for listening. As we close, I’d like to welcome two new members to our general partners Board

[Operator:]

Thank you. [Operator Instructions] Our first question is from Elliott Blonde of the Royal Bank of Canada. Please go ahead.

[Elliott Blonde:]

Good morning. Could you comment if and are there going to be any problems or circumstances with Brexit, if it occurs?

[John Keppler:]

No, thank you. That’s an interesting question. So, within the current contracted customer set, our agreements are bilateral agreements with private counterparties in the U.K. And they’re not subject to change in law or the provisions that a Brexit exit, and I would say if Brexit were to occur. The Contract for Difference, which is the principal vehicle for biomass conversions in the U.K., is also a private law contract between our counterparties in the U.K. government. And so again, there I don’t think we necessarily see the implications of Brexit affecting the contract structure. I think that over time that to the extent that is it -- the results of a Brexit positive or negative have longer term economic implications in the U.K. or whether that’s for currency or power prices, I think you’ve got enough economists on each side of that question that that remains a long-term open issue, but for both our existing contracted pieces, as well as what we see on the horizon, we do not expect a material disruption.

[Operator:]

Thank you. Our next question is from Pavel Molchanov of Raymond James. Please go ahead.

[Pavel Molchanov:]

Thanks for taking my question guys. And sorry to dwell on the U.K. policy, but kind of following up on the previous question, the existing policies coming out of the U.K. government that have supported retrofits off coal fired power plants to run on pellets, particularly Drax. Are any of those predicated on continuation of European Union membership?

[John Keppler:]

Pavel, that’s a great question. I mean, look, the -- each member nation under the EU develop their own renewable energy action plans. And the body of law that has emerged for those conversions, including I’d say notably the 2008 Climate Change Act. This is U.K. regulation, these are U.K. laws, these are not EU laws. And what I’d say is, you can take a look at the U.K's view on renewables, and that drive to eliminate coal entirely by 2025, that’s not an EU directive. That’s U.K. policy. So what we see here is a fairly significant body of law in the U.K. fundamentally independent from the broader EU and Brexit issues.

[Pavel Molchanov:]

Okay. And then, shortly after you guys had the earnings call in February, one of the biggest players in the wood pellet market filed for bankruptcy. Do you see opportunities for Enviva to perhaps increase your share of the global market, given that your biggest competitor is now insolvent?

[John Keppler:]

Pavel, the way that I’d answer that is I’d suggest that anytime you’ve a very large supplier that has obligations to deliver under contracts, and a portfolio of assets both in Europe, as well as some in the U.S., that is not capable of fulfilling those obligations, that does create opportunities for the larger supplier. The proven reliable supplier to ensure the stability of this industry.

[Pavel Molchanov:]

All right. I will leave it there. Thank you, guys.

[John Keppler:]

Thank you.

[Operator:]

Thank you. [Operator Instructions] At this time, there are no further questions, gentlemen. Would you like to make some closing comments?

[John Keppler:]

Again we certainly appreciate everyone’s time and attention on the call today. And we’ll look forward to continuing to communicate and look forward to chatting with you next quarter.

[Operator:]

Thank you. On behalf of -- apologies. On behalf of Enviva, that concludes today’s call. Thank you for joining us. You may now disconnect your lines.