Enviva Partners LP (NYSE:EVA)
Q2 2016 Earnings Conference Call
August 4, 2016 10:00 AM ET
Ray Kaszuba - Vice President & Treasurer
John Keppler - President & Chief Executive Officer
Stephen Reeves - Executive Vice President & Chief Financial Officer
John Ragozzino - Drexel Hamilton
Pavel Molchanov - Raymond James & Associates, Inc.
Poe Fratt - D.A. Davidson & Co.
Good morning, and welcome to the Enviva Partners Second Quarter Financial Results 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 this event is being recorded.
I would now like to turn the conference over to Ray Kaszuba, Vice President and Treasurer. Please go ahead.
Thank you, Waston. Good morning and welcome to Enviva Partners LP second 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 second quarter released this morning and an update on our current business outlook. We will then open 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 certain 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 and is posted on the Investor Relations Website, section of our Website envivabiomass.com as well as our 10-K and our other recent filings with the SEC. We assume no obligation to update any forward-looking statements to reflect new or changed events or circumstances. Reconciliation of non-GAAP measures to GAAP measures also may be found in today’s press release. In addition, all references to 2015 amounts are as reported on our 10-Q filed today.
I’d now like to turn it over to John.
Thank you, Ray. Good morning, everyone, and thanks for joining us on today’s call. As you likely saw in our earnings release published this morning, our operational and financial results for the second quarter were very strong. Steve will go into more detail, but we achieved our highest ever quarterly adjusted EBITDA and the results and expectations for the remainder of the year gave us the confidence to increase our full-year guidance for adjusted EBITDA and distributable cash flow.
We also continued our track record of increasing our distribution each quarter, our fourth consecutive increase since our IPO, I might add, increasing the distribution by just under 3% this quarter. This is another significant step towards the full-year distribution guidance for 2016, of at least, $2.10 per unit. This quarter’s results demonstrate once again the stability of our contracted cash flow position.
As you know, our business is underpinned by robust long-term take or pay energy supply contracts with large creditworthy counterparties that contain strong provisions designed to preserve the stability of our cash flows over long periods of time and insulate the partnership from volatility, be that from crude oil swings or political issues like Brexit.
The bottom line is that they work and our business is able to distribute stable and growing cash flow to our investors without the volatility in fossil fuel exposure experienced in the traditional energy sector, and our business is growing. In line with our sales strategy to fully contract our production, leveraging our position as the preferred supplier in the marketplace, we recently announced our entry into a major new off-take contract with Lynemouth project in the UK, supplying 800,000 metric tons per year, once the converted power station is fully ramped.
This contract further extends our durable cash flow profile. As our current production capacity of approximately 2.3 million metric tons per year is again substantially balanced with our sales book for the foreseeable future even with the NG contract potentially rolling off in mid-2017.
The Partnership’s weighted average remaining contract term is currently eight years and that’s without considering our 15-year contract to supply MGT Power’s Teesside Renewable Energy Plant in the UK, or the 10-year contract with DONG Energy held at our sponsor that commences in September.
Our primary driver of growth continues to be drop-down acquisition of contracted production plants and ports developed by our sponsor. The most visible of which are the 515,000 metric ton per year Sampson plant, which is currently being turned over to the operating team, and the deep-water marine terminal in Wilmington, North Carolina. We expect to have the opportunity to acquire the Sampson plant, along with a 10-year off-take with an affiliate of DONG Energy in late 2016 and the contracted Wilmington terminal in 2017.
As the opportunity for the drops is approaching at its meeting yesterday, the Board formed an independent conflicts committee to evaluate the potential acquisitions. Additional sponsor led development activities include commencement of detailed design for the build and copy production plant we have permitted in Hamlet County, North Carolina and our sponsor’s evaluation of the option of building and operating a marine export terminal at the Port of Pascagoula, Mississippi, where our sponsor has signed an agreement with the Jackson County Port Authority.
Along with the growth potential from drop-downs from our sponsor, we expect to see continued organic growth of 1% to 2% a year within our existing assets, driven by our day-to-day focus on operational excellence, which we define as safety, reliability, sustainability, and continuous improvement.
Finally, we are a proven acquirer and, where appropriate, we will assess interesting opportunities for third-party acquisitions.
I’ll spend sometime at the end of the call on a more specific market and contracting update after Steve reviews the second quarter financial results. Steve, over to you.
Thanks, John. The second quarter’s strong operating performance drove solid financial results for the business. Net revenue for the second quarter of 2016 was $119.7 million, representing an increase of 9% over the corresponding quarter of 2015.
Pellet sales revenue was $116.2 million on sales of 620,000 metric tons of pellets, an 8% increase over the corresponding quarter of 2015 of $107.2 million on 560,000 tons sold. The increase in product sales was driven by higher sales volumes due primarily to the timing of shipments, partially offset by more shipments under FOB terms, which have the effect of reducing revenue and corresponding cost of sales as we are not responsible for shipping.
Gross margin increased $4.3 million to $19.6 million for the second quarter of 2016, as compared to the corresponding quarter of 2015, principally driven by more volume sold, increased purchase and sales transactions, and lower depreciation and amortization, partially offset by contract mix for the current quarter. The cost position of our delivered pellets, primarily driven by plant utilization and raw material costs were consistent between periods.
Adjusted gross margin per metric ton also improved relative to the second quarter of 2015 from $41.94 per ton to $43.11 per ton. On net income of $12 million, adjusted EBITDA improved to $23.5 million for the second quarter of 2016, a 23% increase from the corresponding quarter of last year, driven by many of the factors that improved gross margin and also $800,000 lower general and administrative expenses.
After maintenance capital expenditures of $830,000, 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 $257,000 distributable cash flow for the second quarter of 2016 was $19.5 million to our limited partners, which covers the $0.525 distribution announced yesterday at 1.5 times.
We elected to build distribution coverage since the first-half of the year benefited from some timing favorability, and the incremental cash retained will be utilized for growth initiatives, including potential drop-downs. Because of the solid performance, we’re increasing full-year 2016 guidance for adjusted EBITDA and distributable cash flow. Just for clarity and consistent with prior guidance, all amounts reflect the base business as of today and do not give effect to any potential drops or other acquisitions occurring during this year, not even the Sampson plant.
For 2016, we now expect full-year net income in the range of $40 million to $42 million and increased adjusted EBITDA to an expected range of $86 million to $88 million. We expect maintenance capital expenditures of $4 million and interest less amortization of debt issuance costs and original issued discount from the same period to be $12 million.
As a result, the Partnership expects to generate distributable cash flow of $70 million to $72 million for the year prior to any incentive distributions to our general partner. As we have communicated previously, the mix and timing of customer shipments can impact short-term results, which may vary somewhat from quarter-to-quarter with less impact over a longer period of time as deliveries to our customers are generally ratable over the year. We are reaffirming our expectation to distribute, at least, $2.10 per common and subordinated unit for 2016, while building coverage through the year.
Now, I would like to turn it back to John for a market and contracting update.
Thanks, Steve. As the market leader, Europe continues to drive the bulk of the current demand for industrial wood pellets, underpinned by the supportive regulatory framework at the European Union and at individual country levels.
In the Netherlands, biomass co-firing and dedicated biomass combined heat and power projects were awarded €2.5 billion in funding through the first of two rounds of applications in 2016 for the renewable incentive program called the SDE Plus. Biomass co-firing projects owned by RWE and NG were among the initial recipients.
The budget for the program had already been substantially increased to €8 billion for 2016, up from €3.5 billion in 2015. However, the budget for the second round of applications later in 2016 was increased further from €4 billion to €5 billion after the first round was significantly oversubscribed.
In addition, other recent developments demonstrate the long-term tailwinds the renewable energy industry is experiencing in Europe. Of note, in late June, the European Parliament voted in favor of increasing the European Union’s target for renewable energy to, at least, 30% by 2030, sending a clear message to the European Commission to be more ambitious than the 27% level currently binding on the EU, when the commission brings their proposal forward at the end of the year.
The renewable energy mandate would be in place alongside the binding mandate of a 40% reduction in greenhouse gases by 2030 from 1990 levels. Also, the government of the Walloon region in Belgium issued a tender to support the establishment of new biomass units up to 200 megawatts in total capacity, with dedicated government support lasting up to 20 years. Applications are expected by November of this year.
In addition, the UK government also announced its fifth carbon budget with a target of 57% reduction in emissions from the 1990 levels by 2030. It’s important to note that this announcement was after the Brexit results, confirming the UK’s commitment to its climate change goals and notably, even more stringent than those of the EU. I think it’s fair to say that capital markets were surprised at the outcome of the recent referendum in the UK on its EU membership, and it certainly created some volatility in the financial markets.
However, within industry it seems to be largely business as usual for the biomass power generators in the UK. The ROCs and CfDs, the primary mechanisms received by our customers in the UK are enshrined in UK law, not based on EU regulations, and we do not expect Brexit to impact our firm long-term off-take contracts. And since we are discussing the UK, I wanted to provide a quick update on the MGT contract.
As a reminder, our sponsor’s joint venture with John Hancock signed a contract to be the sole source wood pellet supplier for the MGT biomass plant in Teesside. It’s an approximately 1 million ton per year contract with 375,000 tons per year provided by the Partnership.
In May, MGT appointed a consortium led by Samsung as its preferred bidder for the design, engineering, and construction of the plant. The off-take contracts are subject to financial close by MGT. And notwithstanding the outcome of the recent referendum in the UK, financial close is still contemplated in the near-term. When firm deliveries under this contract will begin in 2019 and continue through 2034.
As we reported in early June, Graanul Invest purchased the Langerlo power station in Belgium from an affiliate of German Pellets and intends to continue the coal to biomass conversion. We think the sale greatly improves the likelihood that the plant will be converted, as it has already received its subsidy from the Flemish government is an asset important to the Belgium grid and its conversion is critical to Belgium meeting its 2020 goals. While we don’t believe that our contract with the previous owner will be fulfilled by our counterparty and we continue to protect our interests, we are already in discussions with the new owner to directly supply the power station upon conversion.
As I mentioned, our book is balanced without this contract and we are excited about upside this potentially represents. Outside of Europe, we expect significant demand to materialize in Asia. Because of the cost advantage of fiber baskets in the Southeastern U.S., we believe our cost position, including shipping to Asia is cost competitive or even cost advantaged when compared to more proximate wood pellet producers.
In particular, the Japanese market appears to be maturing quickly seeking long-term contracts driven by the 20-year feed in tariff system in place to incentivize carbon emissions reduction and replace nuclear power generation.
As the market leader, we are excited about the real upside in all of these geographies for our contracted position and the opportunity to diversify our customer base. And we are also encouraged by what this means for the opportunities our sponsor may have to build substantial, new, fully contracted production capacity that would add to its inventory of potential drop-down assets.
So, in closing, we continue to demonstrate the durability of our cash flow profile derived from the combination of our long-term off-take contracts and the strong operational performance exhibited by our fleet of fully contracted production and terminaling facilities. And with the highly visible growth potential in front of us, I’m excited about the opportunities to continue to increase our per unit distributions going forward.
Thank you all for listening. As we close, I would like to thank all of the dedicated Enviva associates for their hard work resulting in another solid quarter.
Operator, can you please open the line for Q&A?
Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from John Ragozzino with Drexel Hamilton. Please go ahead.
Good morning, guys. Can you hear me?
Good morning, John.
Congrats on a great quarter. Just first really quick, can you quantify your exposure to the British pound? And do you employ any strategies to prevent any currency risk exposure?
So, at current timer, our exposure to the pound is reasonably minimal, representing 160,000 tons under the Lynemouth contract at the current time, and that doesn’t actually start until 2017 – in the back-half of 2017. So at the current time, we do not have any financial hedges in place. To the extent that the MGT contract is current, we’ll look to put in financial hedges that provide perhaps a stop-loss at some point that protects us on the downside relative to the sterling.
Okay, great. John, you mentioned the ability to sustain a 1% to 2% underlying organic growth rate through your operational excellence initiatives. How long can that be sustained? I mean, I know the most – the majority of the asset base is going to be pretty new and there is only so much juice you can squeeze from the fruit, if you will. I’m just trying to get a feel for when does that kind of level off?
I would say not in the foreseeable future. You’re right. You’re spot on that these assets are new. I mean, when you think about the industry generally, while we are on our seventh plant, the industry generally, I think, continues to see remarkable opportunity to debottleneck. I mean, these are large fixed assets, so very, very small changes and on a build and copy approach, it fits once, replicate across the fleet, remarkable opportunities. We are pretty excited about that for both the near and long-term.
Okay, thanks. And then can you clarify the comments you made about the Netherlands and just give me a little bit more color on the allocations? I think you mentioned some $8 billion of funding going towards renewable, and perhaps just a breakdown of how that falls into the different categories of wind, solar, biomass, et cetera?
So, I don’t think that we have full visibility into all of the contract recipients. What we do know is about €2.5 billion were directly awarded to biomass – dedicated to biomass and biomass combined heat and power as well as co-firing opportunities with two of our both current and former customers, RWE and NG, benefiting principally.
Okay. And then let me just ask a couple quick more housekeeping questions regarding the future drop-downs. Are you still comfortable with my assumption of using a similar multiple that we saw at the Southampton plant on future production facilities?
Yes, I think there’s nothing has changed relative to what historical observations would have been.
I would point out that the port drop would be a new asset class to be acquired by the partnership.
That was my next question is, I would expect there would be a slightly higher multiple. And can you maybe quantify that, or give me just an idea of how much greater that multiple might be just because of the different nature of the assets?
I think the – those are much more frequently transacted assets. And I think that you can find some points that would quite clearly points to an eight to nine multiple in that range. I would also point out that this is a negotiated transaction between the independently formed conflicts committee and ultimately they will be the ones negotiating the purchase price.
Great, that’s really helpful. And then one last one, you mentioned the cost advantaged position in the Japanese market. I know it hasn’t always been the case. Can you just walk me through what’s changed there in terms of tariffs or taxes there being imposed and how that puts you in a position where even with the cost of transport, your product is now cost advantaged over other sources?
That’s a great question and I think it’s a couple of things, right. The Japanese feed in tariff system is a robust mechanism to incense a substantial increase in investment in principally new distributed generation in Japan seeking to provide carbon beneficial generation and reduce their reliance on the nuclear restart.
Where we see our cost advantage is really principally driven by the fiber costs in the Southeast U.S. being substantially lower both on cost of harvest as well as cost of transport too on a logistics basis as well as then the logistics from port to our customers. And shipping there, we benefit from substantially lower shipping costs than we would have seen even three to four years ago. And that’s providing a durable long-term position for us entry into both, fiber as well as delivery contracts on a delivered product basis. That gives us a very competitive cost position into Asia.
All right. Thanks so much. I appreciate it and again, great quarter. I’ll let someone else hop on.
Our next question is from Pavel Molchanov with Raymond James. Please go ahead.
Hey, guys. Thanks for taking the question. As we kind of move into the peak of the election season, obviously one of the issues that divides the parties is the Clean Power Plan. While that’s still being litigated, not to mention the political discussion, I wanted to get kind of your perspective on, do you – in your conversations, do you see utilities in any U.S. geography that are actively preparing for a post Clean Power Plan framework? And if so, what are their considerations of pellets looking like?
Yes, Pavel, great question. Here is the way that we see the market continuing to emerge, is that the reverse inquiry we see from – and I would clarify that it is not just the utilities. It’s actually State Governors offices that are preparing their own compliance plans to meet the state level targets.
It’s that the level of reverse inquiry we see suggests that our customer set believes this will happen, and they believe that this will happen in a robust fashion such that pellets and biomass conversions co-firing is an important part of their pathways to compliance. And the relative importance of that really depends on states and their particular generating capacity as well as their opportunities for solar and wind alternatives.
And so the U.S., for us, it’s all upside. Again it’s not factored into any of our current market projections or the way that we think about this business developing, but it’s a great wildcard. And that same set of production assets that serve the export market today can just as effectively use logistics inbound barge, truck, and rail to meet the needs of a growing U.S. customer base as and when that emerges.
Okay. And geographically, is it the usual suspects in terms of very coal centric states, West Virginia, Kentucky, Indiana that you would kind of go to first if that were to materialize or would it be maybe larger, more kind of urban states on the coasts?
I think you are partially right on that. The Ohio River Valley, its coal generating fleet as well as southern states that have a particular challenge in meeting some of their renewable obligations presented to them. And I would say that there may even be opportunities in the Pacific Northwest given the favorability of places like Oregon and Washington that are placed on biomass.
All right, appreciate it.
Our next question comes from Poe Fratt with D.A. Davidson. Please go ahead.
Hi, good morning. I was just wondering about the longer route contract and replacing that volume. Can you give us any color on your discussions as far as whether volume timing kind of term and sort of the likelihood that you are going to be able to come to an agreement with a new owner?
Sure. And let me start by reminding everyone, that we are fully balanced, right. Our book is balanced for the foreseeable future. So we have recontracted that open position. It was principally filled by the Lynemouth contract, and so our discussions with the new owners at Graanul, I think are interesting and of course timely.
As one of the largest suppliers in the marketplace and a preferred supplier to, frankly, anyone that has done a principal conversion, we expect to continue to be a part of that. As our most recent contracts have indicated, we’ve generally taken down a principal portion of that, in the case of MGT 100% of that supply, and in the case of Lynemouth about 60% and we expect that trend to continue. And so, certainly as they proceed through their conversion opportunities, we’ll look forward to being a part of deliveries into their needs.
I think I would add to that that the current plan I think is probably for 2018 startup in that facility or that’s the current concept.
Great, thanks. And then when I read into your guidance, whether it’s EBITDA or DCF, it looks like you can sustain the higher level than you’ve reached in the second quarter and you’re not building in much growth beyond that. Is that accurate?
No. I think probably the way to valuate it. Our coverage ratio was higher in the second quarter, which is a function of some favorable timing that we saw here in the first half. So the actual pellet sales contracts are pretty ratable throughout the year, but there are other elements such as purchase and sales transactions that vary a little bit more from quarter-to-quarter.
So we have provided guidance on the distribution coverage at the minimum of $2.10 per year, which is a converts to effectively a coverage ratio of 1.2 to 1.3 times, a little higher than our objective of 1.15 times. And that gives us the flexibility to reinvest those opportunities in dropdowns or other accretive transactions or increase the dividend, if that’s prudent, later in the year.
Yes, I was more talking about your actual guidance looking at the run rate over the first-half of the year for EBITDA and DCF and just looking at the run rate for the second half of the year.
It looks like that there weren’t any unusual items in the second quarter that would fall off over the second half of the year?
Yes, I think that there are contravening effects. I think there were some favorable items, but I think there’s also cost improvement opportunities in the back half of the year. So your underlying premise that the run rate for the front half and the back half is accurate, I think that the mix is a little different.
And could you highlight those positives? Was it market disruptions that allowed you to backfill some volume in the quarter that you sort of talked about on the first quarter conference call? What was the positive that might not be evident in the second-half, or there in the second-half of the year?
Sure. So when you think about, as Steve mentioned, some of the purchase and sales transactions, you can comp that to the prior period of 2015, where we had the opportunity to acquire a vessel from a supplier that didn’t have a contracted position against that, sold it into our contracted book. We don’t actually take title in those transactions, so you see that presented in net revenue.
During the course of the first-half of this year, we were presented with some similar opportunities. As the largest book supplier in this industry with the largest book, it gives us great opportunities to acquire for instance when a – either when a potential supplier has additional product volume that isn’t sold or in the case of a supplier that may not have production due to an interruption. We can provide deliveries into that contracted position from our own portfolio.
Those are event driven, because of our size, we’re able to generally secure those quarter-over-quarter, but they may not appear in the same material component. And so I think what Steve is highlighting is a great quarter. It happened again in 2016, a good first-half. We’re looking forward to a very strong second-half on the underlying operating performance, and as a result have increased our guidance for both EBITDA and DCF for the full-year.
Yes, and then could you give me a flavor for your volume assumptions on your guidance for the second-half of the year?
Sure. I think, generally, what you would observe is, we more or less sell 600,000 tons per quarter. We sell – it’s worth noting that we sell in 25,000 ton to 45,000 ton increments. So, when a ship actually sails, we’ll move that from one quarter to another, but over a longer horizon, 600,000 tons per quarter is a good rule of thumb.
Great. And just one last nitpicky one, G&A looks like it dropped quarter-over-quarter. Do you expect a rebound in G&A or sort of what’s the run rate we should use for the second-half of the year?
Sure. I think the comp to last year was if you remember, our first quarter as a public company, so we had some reasonably extraordinary costs associated with specialty professional services. But I would say as you think about it, kind of the average of the front half on a quarterly basis is probably a good real rule of thumb as you look forward.
Great. And then just pulling forward a little bit, you formed the conflicts committee. Does that potentially imply that you might accelerate – and the plant Sampson is up and running, handed over to the operational team? Does that imply that you might pull forward the dropdown the timing might be a little more optimistic for the – than what you’ve been talking about really late 2016?
No, I would stick with our prior guidance that it will be a late 2016 transaction.
Great. Thanks for your help.
[Operator Instructions] At this time, I am showing no further questions. I would like to turn the conference back over to management for any closing remarks.
Thanks everybody for joining us on this quarter’s call. We’re pretty excited about what we’ve done. We’re pretty excited about what we have going forward, and we’ll look forward to catching up at the next quarter’s results. Thanks so much.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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