Wood pellets.
Who in the world would have thought they could make big business? For most of their history, these densely packed pills were almost exclusively used to heat rural northeastern homes during brutal winters.
But over the past five years, global demand has exploded. Northern European energy companies -- facing stiff mandates from the EU to reduce their carbon footprints -- have converted their traditional coal plants to run just as efficiently on industrial-grade wood pellets.
Image source: Getty Images.
At the time, there was no single supplier who could meet this demand.
Since then, a market-leader has emerged...and it's currently paying shareholders an 8.7% yield. What's more, it's using far less of its cash to pay the yield than similar peers, making the stock look particularly cheap today.
Enter our cheap, high-yielding dividend stock
In 2004, John Keppler founded Enviva Partners (EVA +0.00%) with a mission of developing a cleaner and more sustainable energy form. Wood pellets were his answer. But for much of the first decade, demand was tepid.
Then calls started arriving from Northern Europe, and the company went into hyper-growth mode. In 2010, Riverstone, a private energy investment group, and The Carlyle Group (CG +0.00%) essentially bought the company, provided it with capital to expand operations, and took it public in mid-2015.
Today, Enviva has wood pellet processing plants in North and South Carolina, Alabama, and Mississippi -- and is looking to expand with sites in Florida and Georgia as well.
Image source: Enviva.
Enviva has been able to make the huge capital investments in these plants because of its long-term, take-or-pay offtake contracts. The contracts allow Enviva to secure a stable flow of long-term revenue while allowing the energy companies to plan on a set price for wood pellets that aren't as subject to commodity fluctuations. Enviva annually produces 2.3 million metric tons of wood pellets, and every last pellet is spoken for (booked) "for the foreseeable future."
About that huge dividend
Enviva is a master limited partnership--and as is common in such structures, it regularly reports distributable cash flow (DCF). In essence, this is the amount of cash the company can safely pay out in dividends after taking maintenance, capital expenditures, and interest payments into consideration.
Since going public, Enviva has made no secret of the fact that its primary financial raison d'etre has been the payment of dividends. From the company's annual report (emphasis added): "Owning these cost-advantaged, fully contracted assets [...] provides us with [...] stable and growing cash flows [...] to increase our per-unit cash distributions over time, which is our primary business objective."
As you can see, DCF has shown marked increases over the past three years as well.
Keppler has said the company aims to have a coverage ratio of 1.15 on dividends--which means that the company has 15% excess DCF after the payout. Another way to look at it is to say that it aims to use no more than 86% of DCF to pay the dividend.
But Enviva is already ahead of this benchmark. For the year, the coverage ratio is expected to be 1.25 (80% of DCF used on dividends), and for the most recent quarter, it was 1.5 (only 67% of DCF used on dividends).
Management has said it expects to increase its quarterly payout every three months. The company has the cash flow to conservatively increase distributions by 2% per quarter -- given that no major acquisitions take place, which management is always careful to remind investors of.
Assuming this, the company could be yielding $2.48 per share by fiscal 2018. At today's prices, that means you'd be receiving a 10.4% yield.
Pricing power through logistics
One of the key advantages the company has -- other than being a first-mover -- is logistical. Enviva is vertically integrating over time -- from picking up the woodchips, to processing, to loading them on company-owned docks at major ports.
For all mid-Atlantic operations, Enviva uses the Port of Chesapeake. There, it has a wholly owned, deep-water site that allows ships to enter, collect the pellets, and send them to Europe. While purchasing the site was expensive, it represents a significant competitive advantage over time, as shipping costs are lower, and Enviva can pass those savings along to customers.
In the Ports of Mobile and Panama City, the docks are operated with third-party agreements. But Enviva is looking to build a wholly owned export terminal at the Port of Pascagoula in Mississippi for its Deep South operations.
Those moves have been important to scaling profitably. As you can see, revenue, net income, and the company's margin per ton of wood pellets have exploded since 2013.
Data source: SEC filings. Revenue and net income in millions. Margin per metric ton based on trailing 12 months (TTM) instead of results from 2016 thus far.
The financial advantages such logistics provide over the competition compound exponentially with such an increase in volume.
Cheap for a reason?
Currently, Enviva trades for just nine times distributable cash flow. It's tough to make apples-to-apples comparisons of how cheap this is--as the wood pellet business isn't crowded with publicly traded names. But consider that when Enviva went public on May 2015, it traded for 26 times the previous year's DCF. In other words, it's about three times cheaper right now!
But the stock is cheap for a reason; there are several risks investors need to be aware of. Chief among those risks is the possibility of Enviva's size and logistical advantages being eroded over time. The popularity of wood pellets has attracted competition.
Image source: Enviva.
To be sure, the ports in Chesapeake and Pascagoula are important, but other companies could make similar purchases. While the long-term nature of the offtake contracts provides stability, in order to justify a higher multiple, the company needs to add to its customer count.
Another risk Enviva faces comes from environmental groups. Both the Dogwood Alliance and the Natural Resources Defense Council have said that Enviva's practices are far more destructive than just taking the "leftovers" from the traditional lumber industry. Enviva argues that demand for pellets would actually lead to a restoration of forests, as landowners have a financial incentive to replant trees as soon as possible.
Karen Abt, a U.S. Forest Service research economist, concludes that, "There's a lot we don't know, it's going to be 20 years before we can tell exactly what's going on." If the company makes smart sustainability moves in the face of such scrutiny, it should be able to avoid the worst possible consequences.
But perhaps the most troubling -- and unknowable -- risk comes from potentially toxic corporate culture. On both the job review site Glassdoor.com and Indeed.com, reviewers paint a picture of a management team in over their heads, with high turnover rates at factory sites. At the same time, there are only a grand total of 16 reviews for a company that has 569 employees.
While investors should absolutely keep a close eye on all three of these risks, they are actually being paid for them with a higher dividend yield. I'm interested enough in the company that I'll be purchasing a small number of shares when trading rules allow, and giving it a thumbs up on my CAPS profile. Whether or not you do the same is entirely up to you, but the fact remains: This a cheap stock with a very high dividend yield -- such opportunities don't come along every day.
