For the second quarter in a row, Enviva Partners (NYSE:EVA) reported a year-over-year decline in distributable cash flow. Investors in master limited partnerships never want to see that happen, and it can sometimes be a signal for trouble. Despite this dubious cash flow streak, management believes it will easily meet its targeted distribution for the year.
Let's take a look at Enviva's most recent results to see why the company's cash flow generating abilities have stumbled a bit recently and what investors should be paying attention to long term.
By the numbers
|Metric||Q3 2017||Q2 2017||Q3 2016|
|Revenue||$131.4 million||$126.9 million||$110.8 million|
|Operating income||$13.9 million||$11.8 million||$13.7 million|
|Distributable cash flow||$16.9 million||$14.9 million||$18.2 million|
This quarter was a bit of a mixed bag for Enviva. Total wood pellet production increased 25% compared to this time last year to 668 metric tons. However, gross margins contracted from lower prices, higher production costs, and greater depreciation expenses. That kept operating income more or less flat for the quarter.
Perhaps the more alarming thing is the company's decline in distributable cash flow. This happened in the prior quarter as well as the company's wood processing facilities weren't running at full capacity because of upgrades. This time around, the decline is attributed to a $5 million increase in cash interest expenses related to debt used to finance the drop-down acquisition of its Sampson wood pellet processing facility in December of last year. Also, Enviva's general partner took a more substantial portion of cash through its incentive distribution rights. All told, its distribution coverage ratio was 1.04 for the quarter.
Even though those numbers don't sound encouraging, management reaffirmed that it will meet its distribution guidance of $2.36 per common unit for 2017. Management expects that the addition of its Wilmington export terminal will significantly boost takeaway capacity.
There was also some encouraging news related to new sales and contracts. It announced recently that its 450,000 metric ton contract with Engie Energy Management is now a firm commitment for 2018 and 2019. Also, it signed a deal with Dong Energy for an additional 200,000 tons of pellets on top of its existing contract starting in late 2018 to 2021.
With additional demand on the way, management expects that it will receive a 600,000 metric ton per year processing facility from its general partner in 2019 when it starts a major offtake contract with one of its customers.
What management had to say
In his press release statement, CEO John Keppler highlighted the progress Enviva made on upgrading its facilities and importance of its Wilmington export facility.
With the benefits of the process improvements we undertook in the first half of the year, our facilities are performing at or better than our expectations, generating strong cash flow in the quarter enabling our 9th consecutive quarterly distribution increase. In addition, we continue to build the foundation for long-term growth with increases to our contracted position and the completion of the Wilmington terminal drop-down acquisition, which adds capacity in the most critical portion of our logistics chain.
What a Fool believes
There is a lot to like about Enviva Partners' future. Adding the Wilmington port should help to lower production costs and enable the company to increase capacity significantly in the coming quarters. Also, another 600,000 tons annually from its new plant will be a substantial growth opportunity. Furthermore, the company continues to lock customers into these long-term supply contracts that suggest it will have steady revenue for years to come.
The one thing that looks like a concern is management's insistence on growing its payout to shareholders at breakneck speed. Even though it is a master limited partnership that should deliver a robust payout to its investors, it also wants to grow the business quite a bit over the next few years. A slower distribution growth plan would free up some cash for capital spending and not make the company reliant on the capital markets. There have been too many overambitious MLPs grow payouts at similar paces, only to cut them later when it needed the cash. This isn't to say it will happen to Enviva, but it looks like a plausible scenario.