Typically when a company experiences an "act of God" event like a fire or a flood, investors can shrug off the issue. This past quarter, though, a fire at one of Enviva Partners' (EVA) export terminals exposed something incredibly important about the business and some of management's recent decisions.
Let's take a look at Enviva's most recent earnings release to see what happened and why this one-time operational hiccup reveals an uncomfortable truth for investors.
By the numbers
|Metric||Q1 2018||Q4 2017||Q1 2017|
|Revenue||$125.8 million||$161.0 million||$122.4 million|
|Operating income||($11.3 million)||$18.1 million||$7.6 million|
|Distributable cash flow||$7.5 million||$20.9 million||$12.9 million|
The bulk of this past quarter's weakness is entirely attributed to the fire at its wholly owned Chesapeake, Virginia, export terminal on Feb. 27. Even though the fire was quickly put out, the facility has been down ever since and isn't expected to start back up again until the end of June. The fire reduced net income by $19.5 million ($0.78 per share) and ate up about $4.2 million in distributable cash flow.
Management thinks it will be able to redirect some of the shipments from Chesapeake through its other wholly owned port in North Carolina, but it will likely constrain some volume shipments as well as drastically increase costs for the upcoming quarter.
While it is fair to give Enviva the benefit of the doubt for this incident, the way that it is treating its finances seems a bit confusing. Even though this fire had a significant impact on operations and cash flows, the company elected to maintain its pace of double-digit quarterly distribution increases. As a result of the distribution increase and weak cash flow, Enviva ended the quarter with a distribution coverage ratio of just 0.46. For investors, that is an absolutely terrifying number. It's also likely that its cash flow this quarter won't meet its payout because Chesapeake will be down for the entire quarter. Management thinks that it will be able to continue its distribution growth as revenue and cash flow increase in the second half of the year and some insurance payments cover expenses and business losses.
What management had to say
CEO John Keppler explained in the press release how Enviva plans on handling the port outage and maintaining its distribution guidance for the year:
While we continue the process of restoring the Chesapeake terminal from the recent fire incident and maintaining an extended logistics chain, we are proud of our operations team for keeping our plants running at rates that exceeded our performance in the first quarter of last year. With our stable and growing production performance, our sales forecast remains consistent with our expectations for the full year and reinforces our confidence in distributing at least $2.53 per unit for 2018.
A small incident highlights a larger problem
When Enviva Partners went public in 2014, it looked like it had all the makings of a great income-generating master limited partnership. The company had created a steady revenue stream from selling wood pellets by signing up customers to very long supply contracts, it had a conservative balance sheet, and it was generating more than enough cash to cover its payout to investors. On top of that, there were some growth opportunities as its parent organization constructed more wood pellet processing facilities it could drop down to Enviva once complete. This looked like a business model where all that needed to happen for it to be successful was to have management not screw it up.
Unfortunately, it looks like management is screwing this one up.
The fire at the Chesapeake facility revealed a deeper concern for investors: Executives are running this business such that there is zero margin for error. Even before this incident, Enviva's distribution coverage ratio came in at 1.04 for fiscal 2017, when management had originally guided for a coverage ratio of 1.15. Also, since it isn't generating that excess cash flow to help pay for those dropdown acquisitions, Enviva has had to tap the debt markets, and its leverage is becoming rather high.
Look, no investor is blackmailing Enviva's management team and insisting that it grow its payout as fast as it is. This kind of "payout growth at all costs" mentality is much more symptomatic of the perverse incentive structure that is inherent in Enviva's corporate structure. Other master limited partnerships with the same general partner/limited partner structure where the general partner has incentive distribution rights has led management teams to push payout growth when it may not be the best long-term decision for the company. That's why so many other companies previously structured like this have restructured because of the inherent issues incentive distribution rights present later in a company's life.
Perhaps I'm overreacting to a one-time event, and it's entirely possible that Enviva Partners will be able to fix some of the issues we have seen in recent quarters. However, there are signs that management is setting Enviva down an unsustainable path that could ultimately lead to moves that kill shareholder value.