Fitch Ratings has affirmed Enviva Inc.'s (EVA) Long-Term Issuer Default Rating (IDR) at 'BB-' and senior unsecured rating at 'BB-'/'RR4'.
The Rating Outlook is Stable.
EVA's ratings reflect the stable and predictable nature of contracted cashflows generated by its growing portfolio of wood pellet production plants, and also reflect its growing customer base, increasing scale of operations and regulatory support for biomass. EVA's revenues are largely derived from long-term take-or-pay contracts with creditworthy counterparties, including major power generators and, to a lesser extent, utilities and large industrial customers. Enviva continues to accelerate their growth plans and increase production capacity as they scale the business to meet rising demand.
Key Rating Drivers
New Plant Increases Scale: Enviva is moving forward with the construction of its new 1.1 million MTPY pellet production plant in Bond, Mississippi to meet growing customer demand in Europe, the Caribbean and Asia. The Bond plant is the third of four planned pellet production facilities at company's growing Pascagoula cluster of assets which includes a deep-water shipping terminal. This will be the second production plant that will be under construction at the Pascagoula terminal after the company broke ground on its plant in Epes, Alabama last year.
The Epes plant has an expected in-service date in 2024 and the Bond plant in 2025. Due to strong demand, the EVA expects to build four new plants over the next four years through an EPC contractor with each plant expected to cost $375 million on average.
Increased Plant Costs: While final plant construction costs have increased from projections of $250 million in early 2022 primarily due to inflation, optimization and reliability enhancements, and projected EPC costs, EBITDA projections have also increased to $75 million-$90 million of EBITDA per annum from $65 million during the same period due to higher sales prices. New plants coming online represent an EBITDA investment multiple of approximately 5.0x.
Gross Margin Deferral Impact Temporary: Fitch expects the negative impact of the deferral of $89 million of gross margin during the fourth quarter from one of its major customers to be temporary and considers it to be largely an issue of timing. Under GAAP accounting, $89 million of gross margin generated from the sale of wood pellets during 4Q 2022 to a major customer will not be recognized until 2024-2025, when the customers purchase of wood pellet volumes under its long-term contracts with EVA exceeds 1.8MTPY-the amount of wood pellet purchases by EVA from the same customer as a result of a purchase agreement signed in 4Q 2022 with deliveries scheduled in 2023-2025.
Volume Growth Under Long-Term Contracts: EVA maintains a robust pipeline of projects and contracts under negotiation that provide a pathway for significant growth over the next few years. EVA has a weighted average remaining term of approximately 13.7 years and contracted revenue backlog of approximately $23.5 billion for its overall contract portfolio. In addition, EVA has a robust backlog of contracts under negotiation that, if finalized, will allow for accelerated intermediate-term growth.
EVA's counterparty contracts are primarily take-or-pay contracts with a fixed price for the entire term of the contract subject to annual inflation-based adjustment and price escalation.
Creditworthy Counterparties: Enviva's contracts are primarily with large creditworthy counterparties, and Fitch expects a significant increase in the diversification of EVA's customer base over the next few years as Enviva continues to sign additional contracts and expands its operations in the U.K., Europe (mainly Germany) and, increasingly, Japan. Enviva continues to grow its customer base and recently announced three new contracts with European customers in Q1 2023 following the signing of nine new contracts in 2022.
In 2022, nearly all (84%) of EVA's revenue was generated from six major customers. Contracts with Drax Power Limited (a subsidiary of Drax Group Holdings Limited [BB+/Stable]), Lynemouth Power Limited, MGT Power, Orsted A/S (BBB+/Stable), Sumitomo Corp. and Mitsubishi Corp. represent substantially all of EVA's expected product sales in 2023.
Limited Size Constrains Ratings: EVA is growing rapidly, but at this time its limited size constrains its ratings as the company has faced headwinds in 2022 including pandemic-related labor, production, and logistics challenges, a six-month delay of the in-service date of their Lucedale production plant in Q1 2022 and higher costs for purchased wood pellets. These headwinds are largely expected to be temporary and are mitigated by higher sales prices with management targeting an increase of adjusted EBITDA to $305 million-$335 million in 2023, consistent with prior expectations.
Leverage Pressured; Deleveraging Expected: Fitch expects leverage metrics to remain elevated over the next two years as Enviva focuses on building two new wood pellet production plants (Epes and Bond) to support its growing contract backlog. Fitch expects that EBITDA leverage metrics will average 5.0x through 2023-2024 as capex peaks and strengthen thereafter and average approximately 4x in 2025-2026 as capital spending subsides. Leverage was pressured due to the Lucedale plant (750K MTPY) entering service in Q1 2022, six months later than expected, with full production capacity reached toward the end of 2022; leverage will strengthen following a full year of the plant's contribution of earnings.
Conservative Financial Strategy: Fitch expects that that FCFs will be fully contracted with creditworthy counterparties, and that they will be financed by a balanced 50/50 mix of equity and debt. Fitch believes EVA's publicly stated financial policy supports the current ratings. This includes achieving a 3.5x-4.0x leverage ratio, maintaining a forward-looking annual dividend coverage of 1.5x, and targeting a balanced 50/50 capital structure of equity and debt.
Regulatory Environment Should Remain Supportive: Fitch is concerned about nascent proposals in the European Union to legislate biomass as a carbon emitting fuel but believes the regulatory environment in jurisdictions that EVA serves should remain favorable in the near term. Favorably for EVA, the latest legislative proposals as part of the EU's Renewable Energy Directive continue to treat biomass as a renewable resource.
Negotiations between the EU Parliament, Commission and Council are ongoing and a final decision is expected in the first half of 2023. While a change in the classification of biomass to a carbon emitting fuel would be a credit negative, Fitch believes a trend of rising energy prices in Europe could forestall any changes to regulating biomass in the near term.
Derivation Summary
EVA is the world's leading supplier of utility-grade wood pellets to major power generators across the globe. The company's cash flow is supported by long-term take-or-pay contracts with utilities and power generators that are currently subsidized by their local government to produce electricity using renewable energy sources, such as biomass. There are limited publicly traded comparable companies for EVA given the size of the biomass sector as well as the competitive landscape.
EVA is growing rapidly, but exhibits a much smaller scale of operations than peers with expected annual EBITDA of more than $300 million in the near term. While EVA's credit profile is currently hindered by its small scale of operations, its ratings are reflective of long-term take-or-pay contract profile and a supportive regulatory environment for the biomass industry. Atlantica Sustainable Infrastructure Plc (AY; BB+/Stable) is a comparable for EVA in the renewable energy space.
AY is a dividend, growth-oriented company that owns and manages a diversified portfolio of contracted assets underpinned by long-term contracts with credit-worthy counterparties in the power and energy markets. Like EVA, AY generates cash flow under contract prices with counterparties that benefit from supportive government policies. However, AY is roughly 3.0x larger than EVA by size and cash flow.
Fitch projects EVA's FFO leverage will strengthen to and average approximately 4x in 2025-2026 as the company realizes a full year of earnings following plants placed in service, which is higher compared with AY's gross leverage ratio (HoldCo debt/CAFD) in the mid- to high-3x range, but is positioned well with respect to the higher rated YieldCo's negative sensitivity threshold of 4.0x. Sunoco LP (BB+/Stable) is a comparable within the midstream space, given that Sunoco also operates in a highly fragmented, competitive wholesale motor fuel sector. Similar to EVA, Sunoco also has 12-year, take-or-pay fuel supply agreement with a 7-Eleven subsidiary, under which Sunoco will supply approximately 2.2 billion gallons of fuel annually.
While EVA's projected leverage is similar to Sunoco's, with YE 2022 FFO leverage at 4.2x and a long-term target of 4.0x, EVA is one-third the size of Sunoco. Additionally, Fitch also does not expect Sunoco to have major funding needs in the near term
Key Assumptions
Fitch's Key Assumptions Within the Rating Case for the Issuer
Revenue and EBITDA growth driven by increasing wood pellet export volumes as well as annual inflation and price adjustment under existing and new contracts;
Accretive cash flow from construction of new pellet production plants;
Future construction of production plants averaging one per year are assumed in forecast periods financed with 50/50 mix of equity and debt;
Capex averages $338 million per annum in 2022-2025 with peak spending in 2023 and declines thereafter;
Regulatory environment remains supportive for the biomass industry in the jurisdictions that EVA's customers operate in.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Continued increase in size and scale of operations with EBITDA greater than $300 million;
Total debt with equity credit to EBITDA below 4.3x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Significant credit event with counterparties, including multi-notch downgrade at EVA's major counterparties, which will impair future cash flow into EVA;
Unfavorable changes in regulatory environment with regard to treatment and subsidies supporting biomass power generation as renewable generation;
Capex spending or unfavorable dividend policy that significantly reduces liquidity or increases leverage;
Total debt with equity credit to EBITDA above 5.0x.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Enhanced Liquidity: Since late 2021, EVA has increased its financial flexibility by amending and extending its secured revolving credit facility. The credit facility was upsized to $570 million from $525 million, borrowing costs remain the same, and the maturity was extended by approximately one year to June 2027.
As of Dec. 31, 2022, EVA had approximately $384 million of liquidity available under its $570 million revolving credit facility including $251 million of cash and cash equivalents. Fitch expects the company to have adequate liquidity to finance plant expansions and construction, fund its working capital needs and dividend distributions in the near term.
To alleviate financing needs in the short term, management has issued approximately $250 million of equity in March. This was consistent with prior expectations. Fitch expects management to maintain a disciplined approach in executing and funding its large capex program.
Issuer Profile
Enviva Inc. is the world's largest supplier of utility-grade wood pellets to major power generators by production capacity. The company procures wood fiber and processes it into utility-grade wood pellets, which are then transported to their customers overseas through vessels.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
ENVIVA INC. 
