Fitch Ratings has downgraded Enviva Inc.'s (EVA) Long-Term Issuer Default Rating (IDR) to 'CCC-' from 'B+' and its senior unsecured rating to 'CC'/'RR5' from 'B+'/'RR4'.
The ratings have been placed on Rating Watch Negative (RWN).
The downgrade of the IDR to 'CCC-' reflects a significant and material decline in earnings and cashflows versus prior expectations and a substantial increase in the possibility of default. Enviva has disclosed there is substantial doubt about its ability to continue as a going concern. The downgrade of the senior unsecured notes to 'CC'/'RR5' reflects anticipated creditor recoveries based on a going concern value which assumes wood pellet prices normalize to mid-cycle levels.
The RWN reflects the fact that absent an unexpected and significant improvement in wood pellet prices this year, or an unanticipated equity cure, or success in renegotiating existing contracts with customers including restructuring of its 4Q22 transaction, Fitch expects Enviva will likely breach its covenants under its secured credit facility as soon as Dec. 31, 2023. A downgrade to 'C' could result from a comprehensive debt restructuring or a distressed debt exchange (DDE), indicating a default or default-like process has begun. Resolution of the RWN will be resolved under successful contract negotiation of the $300 million liability associated with the 4Q22 transaction, which is uneconomic at current spot prices.
Key Rating Drivers
Default Risk: Fitch believes a default of some kind is probable in the coming months. On Nov. 9, 2023, Enviva filed an 8-K and 10-Q raising substantial doubts about the company's ability to continue as a going concern. Given current biomass spot prices around $200/ton (50% lower than 4Q22), and absent an equity cure, Enviva expects to breach its maximum leverage covenant of 5.75x under its revolving credit facility as soon as Dec. 31, 2023. The company's leverage ratio as calculated under the revolving credit facility agreement, was 5.11x as of Sept. 30, 2023. To enhance liquidity the company has fully drawn down its $570 million revolving credit facility.
Material Weaknesses: Enviva disclosed there is substantial doubt about its ability to continue as a going concern and retained advisory firms including Lazard, Alvarez & Marsal and Vinson & Elkins, to perform a comprehensive review of Enviva's capital structure. In addition, the company has made two key leadership changes, the appointment of recently hired CFO, Glenn Nunziata as interim CEO and the appointment of Mark Coscio, as Chief Operating Officer and has started contract renegotiations with existing customers. These actions underscore a real risk of default.
Earnings and Cash Flows Pressured: Enviva's cash flows have been under significant pressure over the last 12 months with Fitch projecting approximately $100 million of EBITDA for FY23, a significant decline from prior expectations of $225 million at the midpoint. Management has missed earnings targets announced earlier this year and anticipates the fourth-quarter results could potentially be weaker than results for third-quarter 2023. There has been a significant contraction of operating margin over the past year under existing contracts due to challenging price dynamics including the 4Q22 transaction which has resulted in a significant decline in EBITDA and significant liquidity erosion.
New CEO: The company appointed CFO Glenn Nunziata as interim CEO. Nunziata joined Enviva from Smithfield Foods Inc. where he served at CFO. Nunziata has initiated a comprehensive review of Enviva's current operations and has identified contract renegotiations with existing customers as the top priority. These discussions will be led by Thomas Meth, former CEO, given his longstanding relationship with current customers and the outcome of these efforts are uncertain at this time.
Negative and Significant Gross Margin Deferral Impact: Fitch remains concerned about the continued and significant negative impact of gross margin deferrals on earnings and cash flows. In 4Q22, Enviva entered into agreements with a customer to purchase approximately 1.8 MTPY of wood pellets between 2023 and 2025. Additionally, Enviva entered into additional wood pellet sales contracts that together with the existing sales contracts totaled approximately 2.8 million MT with deliveries between 2022 and 2026. Average purchase price under the purchase contracts are significantly higher than average sale price under the sales contracts. The transaction is uneconomic at current spot prices and Enviva is trying to renegotiate the terms of the contract with the customer. Failure to renegotiate the contract under favorable terms will likely strain liquidity and lead to a default.
Under GAAP accounting, the gross margin generated from the sale of wood pellets during 4Q22 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 4Q22. Enviva has $75 million of gross margin deferrals for YTD ending Sept. 30 and $89 million for FY22 and the financial liability for this transaction totalled $212 million as of Sept. 30. The negative impacts of sustained and continued gross margin deferrals will likely place further pressure on ratings.
Construction Updates: The company is moving forward with the construction of its wood pellet production facility in Epes, AL while potentially delaying construction on its new 1.1 million MTPY pellet production plant in Bond, MS by six to 12 months. Given Enviva's stressed liquidity the company has identified completion of its Epes plant as a top priority. The plant is approximately 40% complete and each plant was expected to cost $375 million on average which is up from $250 million estimated in early 2022. Fitch expects the company will have enough liquidity given current cash on hand to complete construction in the Epes plant. The Bond plant is the anticipated third of four planned pellet production facilities at company's growing Pascagoula cluster of assets which includes a deep-water shipping terminal. The Epes plant has an expected in-service date in 2024 and the Bond plant in 2025. Recent costs overruns highlight continued execution risks.
Fitch has maintained Enviva's ESG relevance scores for Governance and Management Strategy following ongoing management changes following a significant reduction in FY23 earnings relative to prior expectations. This change also reflects Fitch's concern over the operational issues at the plants and the company's inability to meet production levels and earnings targets as expected. This material adjustment highlights greater than expected operating and execution risks.
Derivation Summary
EVA is the world's leading supplier of utility-grade wood pellets to major power generators across the globe. 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 approximately $100 million in the near term. This is a significant decline from prior expectations of $225 million of EBITDA at the midpoint, which itself was a decrease from approximately $300 million in EBITDA Fitch had previously projected in late 2022. The significant contraction of operating margins over the last year has accelerated the erosion of the company's competitive profile and stressed liquidity.
Freeport LNG Investments, LLLP's (Freeport, IDR:B-/Negative) is a comparable for Enviva in the energy space. Like Enviva, Freeport ships energy - in this case liquified natural gas - to overseas customers. Like Enviva, both companies cashflows are structured under long-term take-or-pay contracts with creditworthy parties. Like Enviva, Freeport has experienced a significant contraction in earnings and cashflows over the last year although this was due to an explosion at one of its natural gas liquefaction plants. While Fitch projects Freeport's leverage to decline, approaching its positive sensitivity of 7.0x by 2024, Fitch expects Enviva's leverage to increase. Absent any improvement in wood pellet prices or contract negotiations with existing customers, and absent an equity cure, Fitch expects Enviva could breach its covenants under its secured credit agreement as soon as Dec. 31, 2023.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Assumed approximately $100 million of EBITDA in FY 2023;
Completion of the Epes plant and delay in the construction of the Bond wood pellet production plant;
No dividends;
Base interest rate forecast in line with Fitch Global Economic Outlook;
Fitch has updated its recovery assumptions given Enviva's s significant decline in earning and cashflows.
Recovery Analysis
Fitch's Key Assumptions Within the Rating Case for the Issuer Include
Recovery Rating (RR) Assumptions: The recovery analysis assumes the enterprise value of Enviva is maximized in a Going Concern scenario versus a Liquidation Scenario. Fitch contemplates a scenario in which default may be caused by a breach of its covenants under its secured credit facility as soon as Dec. 31, 2023. Continued softness in spot wood pellet prices that are approximately 50% lower than this same time last year has significantly eroded Enviva's earnings and cashflows while heightening competitive pressures.
The Going Concern analysis assumes new customer contracts with improved margins as wood pellet prices are anticipated to normalize to recent mid-cycle levels. Under this scenario, Fitch estimates a going-concern EBITDA of approximately $220 million. Fitch assumes Enviva will receive a going-concern recovery multiple of 5x EBITDA under this scenario, in line with historical transaction multiples of 5x-6x for the energy and utility sector.
At this time Enviva has fully drawn on its $570 million secured credit revolver and has a $105 million term loan due under its secured credit facility. Enviva also has $1.1 billion of unsecured debt. Fitch assumes a 10% administrative claim through a restructuring, resulting in a 29% recovery for the unsecured debt and a downgrade of the rating of the unsecured debt to 'CC'/'RR5'.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
A successful resolution to an expected covenant breach of its senior secured revolving credit facility without entering bankruptcy or conducting a DDE, while maintaining a sufficient level of liquidity to meet debt service and execute on its cost reduction and margin improvement plans;
Successful renegotiation of customer contracts including the 4Q22 transaction;
Filing of its financials, without a going concern qualification;
Successful execution of cost reductions and improvement in contract margins with existing customers.
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
A negative rating action could result from a comprehensive debt restructuring or DDE;
An inability to maintain sufficient cash levels to operator over the next 12 months.
Liquidity and Debt Structure
Stressed Liquidity: Enviva has faced significant pressure on its liquidity given a material decline in wood pellet spot prices since late last year and has fully drawn down its $570 million revolving credit facility as of Sept. 30, 2023. Enviva's liquidity is provided by a $570 million revolving credit facility and a $105 million secured term loan due June 2027 under its secured credit agreement.
Enviva had approximately $440 million of liquidity available as of Sept. 30, 2023 including $315 million of unrestricted cash on hand. Additionally, Enviva has $125 million of restricted cash to fund the construction of new wood pellet plants. However, Enviva is expected to breach its maximum leverage covenant of 5.75x under its revolving credit facility as soon as Dec. 31, 2023. The company's leverage ratio as calculated under the revolving credit facility agreement, was 5.11x as of Sept. 30, 2023.
Even if Enviva is successful in amending its financial covenants under its revolving credit facility, Fitch expects the company to have adequate liquidity to finance construction on its Epes plant in 2024 but will out of liquidity by 2025 given current levels of earning and cashflows. At that time, Fitch expects Enviva will need to access the capital markets to move forward with construction of its Bond plant in Mississippi. No long-term debt is expected to mature until 2026, when $750 million of senior notes are scheduled to mature.
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
Enviva Inc. has an ESG Relevance Score of '5' for Management Strategy due significant and continued deterioration of FY23 earnings and margin erosion relative to company targets which has a negative impact on the credit profile, and is highly relevant to the rating, resulting in multi-notch downgrades in 2023.
Enviva Inc. has an ESG Relevance Score of '5' for Governance Structure due to changes in executive leadership following failure to achieve strategic goals and stated company earnings targets in FY23, which has a negative impact on the credit profile, and is highly relevant to the rating, resulting in multi-notch downgrades in 2023.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
ENVIVA INC. 
