Wood Pellet IPO Holds Out Chipper Yield

Last October, Enviva Partners (EVA) filed initial paperwork to raise $100 million for the first MLP based on the sale of wood pellets. Updated paperwork filed a week ago has fleshed out details for the initial public offering.

The offering has now been upsized to 10 million shares with a midpoint price range of $20. The now $200 million IPO is expected to price on April 28. Enviva Partners has announced a targeted minimum quarterly distribution of $0.4125 per unit, or $1.65 per unit on an annualized basis. This equates to an 8.25% yield based on the midpoint of the IPO pricing range. If cash distributions to unitholders exceed $0.4744 per common unit and subordinated unit in any quarter, incentive distribution rights (“IDRs”) will be paid to the general partner (GP).

Enviva Partners entered into the wood pellet business in 2010, and is now the world’s largest supplier of utility-grade wood pellets to major power generators. It has executed multiple long-term, take-or-pay off-take contracts and has built and acquired the production and terminaling capacity necessary to fulfill them. Enviva’s production equals approximately 15% of current global utility-grade wood pellet supply and nearly 19% of European market demand.

The partnership owns and operates five production plants in the southeastern U.S. with a combined wood pellet production capacity of approximately 1.7 million metric tons per year. It also owns a dry-bulk, deep-water marine terminal at the Port of Chesapeake, reducing storage and ship loading costs. All of its facilities are located in geographic regions with low input costs and favorable transportation logistics.

Enviva projects demand for utility-grade wood pellets to rise at a compound annual growth rate (“CAGR”) of approximately 21% from 2014 to 2020. This growth is being driven by the conversion of coal-fired power generation and combined heat and power plants to co-fired or dedicated biomass-fired plants, primarily in northern Europe but increasingly in South Korea and Japan. These conversions are important because they help countries meet regulations regarding greenhouse gas (“GHG”) emissions and renewable energy usage. The technology for these conversions is mature, reliable, and cost effective in specific situations.

Between 2013 and 2014 Enviva Partners increased sales from $176 million to $287 million — an increase of 63%. Adjusted EBITDA over that same time period more than doubled from $12 million to $28 million. The partnership estimates that in 2014 it would have been able to cover 100% of the distribution to common unitholders but only 71.6% of the minimum quarterly distribution to subordinated unitholders. For the 12 months ending March 31, 2016 it estimates cash available for distribution of at least $45.2 million, which is approximately $11.5 million more than the pro forma cash available for distribution generated for the year ended Dec. 31, 2014.

As the first entry into the wood pellet MLP niche, this partnership comes with some notable tax risks. The Securities and Exchange Commission filing indicates that while it is organized as a limited partnership under Delaware law, it would be treated as a corporation for U.S. federal income tax purposes unless it satisfies a “qualifying income” requirement, as Enviva believes it does. The filing states that the partnership has requested and obtained a favorable private letter ruling from the Internal Revenue Service to the effect that, based on facts presented in the private letter ruling request, its income from processing timber feedstocks into pellets and transporting, storing, marketing and distributing such timber feedstocks and wood pellets will constitute “qualifying income” within the meaning of Section 7704 of the Internal Revenue Code.

However, no definitive ruling has been or will be requested regarding treatment as a partnership for U.S. federal income tax purposes. Failing to meet the qualifying income requirement or a change in current law could cause the partnership to be treated as a corporation for U.S. federal income tax purposes, in which case they would pay U.S. federal income tax on taxable income at the corporate tax rate (currently a maximum of 35%). Cash available for distribution would be substantially reduced in that case, and even if there are no cash distributions unitholders would be required to pay taxes on their share of taxable income.

Despite the risk, this is a partnership that warrants close attention. It is in a fast-growing business, and one that is likely to become increasingly important in the future. MLP investors who would like to make more investments in renewable energy will find a lot to like here.

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