Darling Ingredients Inc. (DAR) Earnings Call Transcript & Summary

All right. Thank you. And good afternoon, everyone. My name is Adam Samuelson. I'm the agribusiness and packaging analyst here at Goldman Sachs. Very happy to continue our Global Energy and Clean Technology Conference with the company that's new to this event, Darling Ingredients. Darling is the largest independent render and collector of used cooking oil in the world. They're also a co-equity investor along with Valero in one of the largest producers of renewable diesel in the world in Diamond Green Diesel in Louisiana that will soon be 1.1 billion gallons of capacity next year once their third facility in Texas comes online in early 2023. From Darling, we're thrilled to have Randy Stuewe, who is the Chairman and CEO; Brad Phillips, who is their Chief Financial Officer, is also here; and also Melissa Gather, who runs their Investor Relations effort. Randy, thank you so much for joining us today.

Thanks, Adam. Happy New Year. Good To see you.

Happy New Year to you as well. So maybe just to start, let's talk about maybe first, the current business environment. Obviously, it's been a volatile -- a lot of volatility in the ag and energy markets over the last few months. Maybe just help frame and level set everybody in terms of how the business and the market environment has been performing through the fourth quarter? How we're entering 2022? And we'll -- then we'll jump into some questions specifically on base business on Diamond Green Diesel and you did an acquisition recently, but let's just level set maybe starting on the market environment.

No, I think it's a great place to start. I would summarize the fifth day of January as just awesome momentum, just carryover from 2021. We came out with a strong Q3, continue to give strong guidance into Q4. We saw a little volatility post the hurricane Ida as we have disrupted the kind of the very significant supply chain and vertical that we operate, that is fully recovered. . At the end of the day for us, if you just break our business into kind of 3 key parts of proteins fats, value-added products and then Diamond Green Diesel, that would be #4, but the protein and fat business around the world, demand remains strong. Raw material supplies are robust. Fat prices have improved. Protein prices have went steady. Now they're moving back up with the soybean complex, in our value-added collagen peptide business, we're just seeing additional new uses demands and getting our plants all up to speed here. And so it's just kind of the stars are aligning for us. I really thought '21 was all the stars in the line. But I think for '22, it's even a better environment for us as we move forward here. We've had great conversations with lots of current and, hopefully, future shareholders today talking about the outlook for our business and the guidance that's underneath it. It's kind of -- it's really a fascinating thing when you can sit down in our business now, and I'm at the honor of sitting at the chair for quite a few years here, and we're showing guidance next year of $1.550 billion versus finishing out this year between $1.225 billion, $1.250 billion. We're about a week from seeing the real numbers for Q4, but all signals are that things are pretty strong around the world. We're carrying that forward as we move into next year. We were an essential service to the COVID environment. And so our team has done a fabulous job of adjusting and practices and protocols and to be operate safely and deliver a record year for Darling. And I think we're -- as I sit here today on the fifth day of January, we're positioned even to have a better year next year all things aside right now.

All right. That's really helpful. So maybe let's unpack that kind of 2022 outlook. And you talked about $1.55 billion is kind of probably a midpoint of the range to think about. Maybe let's talk first on Diamond Green Diesel and help us think about what kind of assumptions are embedded in -- for Diamond Green Diesel, as you sit here today? For within that what I think previously, you talked to about $2 a gallon of margins for the fiscal year. Let's help us think about the risk to that outlook on the upside and downside, and maybe compare where we are today in the spot versus kind of that full year framing.

Yes. I think the first thing I always like to say is we've been pretty good with our margin predictions. First 5 years of operation, we told you a $1.26 a gallon. The second 4 years now, $2.26 a gallon. We never promised that for eternity. It's kind of hard to think of businesses that can sustain that type of margin when there's the build-out cost is $3.30, $3.50 a gallon. So when we're looking at this year, we're not really we're spotting the world right now, and we're just saying where feedstock costs are, where energy costs are both petroleum heating oil, natural gas, hydrogen cost, and then the green premium, which is a combination of RIN values, D4 RIN values and the LCFS and the blenders tax credit. We just look at it and say, we think, to a degree, it's an eyeball. $2 feels fine. Could it be $1.75? Sure. Could it be $2.25? Sure. Not sure it will be much higher than that this year because feedstock prices over the last couple of years now haven't specifically last year, reacted to what they should be doing in this case. What's interesting when we talk about it, 90 days ago, less than 90 days ago, we brought on a 450 million gallon plant. It's running at capacity alongside its sister plant. So we're saying we're going to make around 750 million gallons this year. That's pretty much boiler plate or maybe a little boiler plate plus 5% for -- to give the Valero engineers credit here, which they absolutely deserve. And it should run straight along there. The margins when we came on December 31 were around $2 a gallon. Today, they're $1.75, $1.80. So I think that's close for this type of work to think that you can get it within 2% to 3% to 5% here at this time. But what's notable to me is we brought on the capacity, we didn't impact the world market by any means, meaning we didn't blow up the RIN market, we didn't blow up the LCFS markets, and we're at capacity. We're sold out for this year, and we're 1 year away from #3 coming online.

Okay. So that's really helpful. So maybe let's put that framing into context of beyond this year and in the context of the industry. Because $2 a gallon, again, $2 a gallon of EBITDA margins relative to a $3.50 capital cost is still a really good economic return. You're seeing a lot of refiners, a lot of parties investing in capacity. How do you think about the cost curve for renewable diesel? And for biofuels generally, given increasing kind of production going into these low carbon markets and the constraints that it puts on the feedstock markets to supply the new capacity. As you think about the longer-term margins, and you've said, hey, $2-plus isn't going to be indefinite, how do you think about your cost advantage and your margin position versus others supplying similar kind of green products to underwrite the long-term investment in asset value here?

Well, number one, I always -- I don't spend a lot of time looking at rearview mirrors and trying to figure out what other people are doing. What I do know is we've done our homework I can't subscribe to some analyst reports out there of all this capacity that's under construction. I would just say, go get a rental car, hire a satellite service. And if you don't see a crane, it's not real. And I would tell you that most of it is not real out there. It's either not permitted or it just is not real. And we can go down one by one, someday if some people want to, and I'll give you an estimate of when we think it will run. So I think '22 is a very solid year for us as we go forward. I mean, the business, as we looked at it, we said there's not much fungible differentiation that you can do in making a fuel other than you can have the right location, the right people and the right customers and the right employees and stakeholders. And what I mean by that is as I look at it, I sit there and say, we selected the 2 premier properties in the United States with Valero on their site that have the best railroads, 4 railroads serving our 2 plants, barge receiving, water receiving, rail receiving, truck receiving, inbound outbound, the best logistics and pipelines to the Northeast and pipelines across the country that we can ship the product to. So locational economics are key to any type of business that remotely has the word commodity attached to it. So we've got that. The second thing is, when you look at our structure, what makes us so different, and I honestly don't understand why people don't get it, there is a vertical, a circular here second to none in the world. When you compare the model that we've built, Darling and Valero against Neste, there's absolutely no comparison. Why. You take the feedstock that's available in the vertical, meaning for both Darling system, it's used cooking oil, it's animal fat and Valero's corn oil, and DGD1 and DGD2 are 100% hedged in our global system today. We don't have to rely on outside feedstock. So when people want to have that discussion, I say, so what? We own the arbitrage. The fun part is less than half of Darling's production to date goes to DGD. Why? Because we have a better sale. We're able to maximize profit. And arbitrage around it, and the joint venture can originate cheaper from others. So end of the day, that's a beautiful part. We'll talk later about the acquisition. That's done to help us cement and further that vertical as we go into #3 here. Now you look at what else is important. What we look at is the combination of our companies and the internal intelligence of the teams has allowed us to then look at the vertical in the sense of CI management. Not only do we process animal fats, we pick up used cooking oil. And oh, by the way, if we don't run the used cooking oil through a cooker and we settle it, but that's a different CI score. And -- but you have to do the homework. You have to do it, go back to car, apply for it and improve your CI and your pathway for that product. We're doing that constantly. The next thing is we put in the naphtha recovery units. That's going to give us -- why did we do it, $100 million, plus or minus a few, well, instead of selling fugitive gas as to a reclaiming system, you're now getting $1 a gallon. So you start to amortize that over, okay, there's another $0.10 or $0.15 margin differential. The pretreatment system. People don't understand what I call the secret sauce. And the secret sauce is a lot of knowledge on our team's behalf and Valero's behalf of really of learning how to originate the fat. What I've told many people is not all fats are created equal. I know it sounds cliche, but what are you trying to do, much like in petroleum refinery, it's really run time or uptime, efficiency, catalyst life. And this product is less than pure, meaning animal fats. And at the end of the day, many have tried and many have killed catalysts trying to co-process it and use it. Why? The alkaline metals, the nitrogen content, et cetera, it polymerizes. and people go, what's polymerization? Well, if you've ever cooked anything and a skill it, you turn it over and it's got that brown on the bottom, you polymerize the fat on the metal. Same thing happens to catalyst. And you cope the catalyst. And so this is -- it's a tougher product to process than most people give credit to today. And then the final piece is we say it's just the outbound economics. Not only can you go out by ship, Jones Act, non-Jones Act, railcar, truck, pipeline, it just truly gives us really a competitive advantage coupled with the waste fat versus, as you said, the other competitors running some type of soybean oil, whether it's degummed or whether it's RBD. That advantage, when we couple all those together, I'm confident we have anywhere from $1.25 to $1.50 a gallon cost advantage over anybody else in the business today by where we located the CI scores, the pretreatment, the naphtha and the outbound economics.

Okay. Great. That's really helpful. I want to come back to some DGD and policy and renewable fuel questions in a little bit. But I want to pick up on something that you alluded to the news that you released last week, you did an acquisition in the base business, not a small one, $1.1 billion, Valley Proteins. Can you maybe just walk us through the business rationale? Help us think about the sizing of it? The details in the press release last week were fairly sparse. Help us think about kind of the fit the financial profile of the business and why you're the right owner for this versus somebody else?

Now I'd love to talk about it. The honest answer is why did I put sparse details in the press release? So I could be on camera with you and talk about it, Adam, and you know that. No, number one, Valley Proteins is a great company. There's 18 plants, 1 wet pet plant, 15 rendering plants on the East Coast and 2 in Texas. And at the end of the day, it's in the fairway. I mean I'm not talking talk and center the fairway, not towards the sand trap, doing exactly what we've done for 140 years. We listened to our shareholders, talk about feedstock security, and we thought that this was the right thing to do to add the Valley plants to our system. I've been working with the Smith Brothers for a number of years, trying to make sure that they and their employees shared our dreams, our values. And it's so important to me when we acquire a company that they share those values, makes integration so easy. It's why we've been so successful over the last 20 years. And we got this right. The value with for me was very simple. I looked at our margin structure, I looked at their margin structure, I looked at their tonnage. I looked at our tonnage, and I said, you know what, there's a lot of upside on this business to make it significantly accretive to our business. Now it's going to take us a year, maybe 2 years to get there. And so then the next question is, naturally, where is it going to come from? It's going to come through operating efficiencies. It's going to come through, if you will, specie-specific processing of different finished products that we can make in the value addition side. Sure, it gives us another 125 million gallons of feedstock that can, may go, may not go to Diamond Green Diesel. Ultimately, the plants are in the right location. They're with our customers and suppliers today. It was just such a natural fit that when I looked at it, it was about getting it done, finding a fair value. And we're going to be really, really happy with this deal.

Okay. And just to maybe try to fill in some of the gaps in that. Just from their public disclosure, it would seem to be roughly 1/3 of the size of your fee business today on a tonnage basis. Help us think about maybe just frame -- I can make my guess is on can share EBITDA revenue, just none of it was there. I think people were just trying to frame where this fits and thinking about the actual -- the financial profile of that once you close.

Yes. And I don't want to be remotely viewed as elusive on this. I think at the end of the day, the tonnage per week is about half of ours in the USA. And so at the end of the day, everybody can back into that. You can look at the old Darling numbers. And I think once we are able to put the Darling culture in and the Darling operating efficiencies and product mix in there, we can make the earnings mirror on a margin percentage of what we do today. So those are the optics that I want to put out there today. I absolutely don't want to be read as being elusive on it. We have a Hart-Scott filing out there that's going to happen here in the next 2 weeks. We're excited about that. We -- there is no geographic overlap. This is just another plug and play on the Eastern Shore that we didn't operate in. I think what's fun is if for the historians, anybody old enough, which you're probably isn't back to Darling Delaware, other than me is we sold half of this company in 1990 to the Smith family so we could stay afloat. So it was only natural for it to come home to roost with the family that started it. And so that's the opportunity is today. We'll see what happens. And anticipated closing, once Hart-Scott happens, if we're fortunate, which we believe we will be, then we should get clearance towards the end of February and close before the end of Q1.

All right. That's really helpful. So maybe kind of pivoting to the broader base business. I mean you talked about this a little bit, but one of the big strategic rationales for why Darling got into the renewable diesel business in the first place was to value-add to fats. And you had a lot of fats that didn't have a natural home other than the calories and animals feed. How did you value them up? How did you create a market? You've done that. With now low CI scoring in place, are you -- do you think we've finally reached the point where that you're getting the full value and the feedstock provider captures the value of that low CI feedstock appropriately, and you've really closed those discounts on UCO and tallow versus food-grade oil?

I don't think we're there yet. I think we've made great strides. I mean if you look at super degum, their degummed bean oil in the Gulf tonight, [ 600, 650 ] over, I don't know, a $0.59 board. So you're $0.655. Diamond Green Diesel's buying animal fats at $0.60 down there today. So at the end of the day, I'd still tell you there's still a nickel to go plus the CI premium, which would be another $0.03 to $0.05. So I don't think we've gotten the respect we deserve yet, but we've brought it a long way. I know that's hard for some to understand used cooking oil on the other hand, I think it's about $0.68 now. So it's at parity. So that's happened. Distillers corn oil is getting up there. But -- so it's really the hard-to-process animal fats that if they were still to go into an animal feed ration would be significantly discounted from where they're at today.

Okay. All right. That's really helpful. Maybe pivoting to the Food business a little bit, and this is kind of -- maybe it's a smaller business in the context of the total enterprise now, but it's got a nice growth story around. Can you talk about kind of how you see the growth opportunities for the Collagen business going forward and the capital investment you're putting behind that? And where we could see that business, not just this year, but over 2 to 3 years as you continue to move the value up of that product?

Yes, it's a fun business to talk about. And I always like to educate people about it. And they said, why are you in a Food business or Food Ingredient business? Well, when we send a truck to a slaughter house, you have a choice of declaring it as edible or inedible when you pick it up. And this is an edible bone or skin product that we then bring back and further process, degrease, if you will, take the fat off of it, and then we convert it into collagen. And so at the end of the day, it would either receive meat and bone meal value of, call it, $300 a ton or it can receive collagen value at $3,000 a ton. And so it's a very simple economic. What people have to understand is when you pick up a ton of raw material to go to the collagen business, 80% of that is actually animal feed or fat, the only 17% to 20% is the value-add piece. So always the rationale to help people understand why -- how you got from where you are to where you are. Now that's where it's at. The 10 plants operating around the world were 5 years ago, generic gelatin plants, gelatin acts an emulsifier, a thickening agent for confectionery, some goes into industrial, some goes to film, some goes to pharmaceutical for soft and hard gel caps. With the collagen peptide is a very special reaction that we have, I think, led the way on or been one of the pioneers in, been working on it for almost 10 years. And so when we entered it, it's a different way of taking a midstream product out of the same factory, doing an enzyme conversion and then a special drying process that then makes a product water-soluble versus thickening, very 2 different properties. So people get their mind around it. Everybody is out there watching the beautiful actress, Jennifer Aniston, sell vital proteins products. We're a significant part of that. We're actually the ingredients in most of those blue jars today. And so it's a product that we invented that has great health, beauty, joint, skin nutrition aspects. It goes into coffee creamers. You're now seeing it in power drinks, you're seeing in energy bars. The benefits are -- from the side are the very substantiated benefits out there. I would say, yes, it falls in that nutraceutical category. It's always subject potentially to fat versus reality. But at the end of the day, this one has great traction. What we love about it is that we backstopped the companies that wanted to enter the business in the U.S.A. And then it's now being launched in Europe today and a little bit in Asia. And so at the end of the day, COVID kind of screwed up our global launch on this and slowed it down, but it is picking up tremendous momentum now. And that's where we looked at the Food segment, and I don't know where we're going to finish out this year, $180 million, $180-something million. It's a $250 million to $300 million segment driven by the collagen peptide growth. When I get to talk about it, it's really exciting. We're now working on the next derivative of that product and taking that peptide into a what we call a low endotoxin product, which means that it can be used for suture repair or can be injected for wound healing. And that's our biomedical group. That's getting some traction right now. We are selling product. We're in the development stages there. We have a pilot plant in Ghent, Belgium. And then the next phase that when you say can be 2 to 3 years out, this is the 5 year out, but we are now growing biomedical devices. And yes, I had to sit in the room and learn what that was, we're growing pancreases. And so this is really exciting stuff that we're unleashing in that product line now. Not saying it's completely in the fairway to use my initial analysis, but it's close enough that we will find the right partners and the right relationships to capture some of that, if not all of that value going forward. So those are really exciting times in our Rousselot brand.

All right. That's really helpful. So maybe trying to tie this all together a little bit. You've got the base business, is performing well. Commodity environment is favorable. DGD Phase 3 is about a year, a little bit more away from coming on stream. How do we think about capital allocation? The answer to this is probably a little bit different than it would have been a week ago before you announced the Valley Proteins acquisition. But as an entity, you're going to be throwing off a tremendous amount of cash flow when Phase 3 is online. The JV is going to be debt free. How should we think about parameters for leverage at the parent capital return potential buyback and dividend? And/or your investment hurdles, both in the base business or incremental investments back at Diamond Green?

Okay. The way I like to think through this is we have been, number one, a defender of the Darling share price this year with buybacks. I think it will become apparent again. We obviously announced another $500 million authorization for 2 years. We have a fundamental belief that we have built just a wonderful platform that is not appreciated yet. As we come into '22, we're going to -- we're sitting here, the optics are, I gave you $1.550 billion as a total cash generation, that's $800 million base, $750 mil Diamond Green. Diamond Green at the entity level will produce $1.5 billion. We owe about $800 million to pay that off. That's the debt free. So Brad and I are thinking by late Q3, early Q4, assuming our margin assumptions are correct, we could start to pull a pretty significant dividend in '22. Now '23 gets to be a year of very interesting dynamics and transformation for us I like to think of it. We're 360 days away from having a free cash flow potentially in excess of $1 billion. And at that point in time, yes, we've got Valley proteins hopefully closed by then. We're going to run our debt ratio up to the 2s here with Valley Proteins. I think we should have sent a pretty strong signal when we put out the amended credit agreement and grew the revolver to $1.5 billion and put a deferred draw term loan A of $400 million down there. So it's -- if you essentially will, it's financed. We don't have to go to the market. We're going to go ahead and finish out #2 or #3 here. And then we're going to look at the cap structure long term for the company. We've got a couple of bonds that are callable out there. But at the end of the day, there'd be some improved pricing there. We're kind of that tweener. We've been unable to get in the S&P, Moody's and Fitch to give us investment grade yet. But once they see the dividend start to come, I think we'll get that. It's a goal of mine. I want to deliver on that. And then '23 becomes that transformational year. Do we find other M&A? Do we do a significant buyback? Do we finally put the dividend that I've always dreamed of putting underneath the company and making it an investment-grade income stock that has a platform. And as we look at it, and the pipeline, if we think of how capital allocation is, we think of dividends, we think of buybacks, we think of M&A and then we think of our current platform, which is potentially sustainable aviation fuel, growing out the collagen peptide business, investing in additional Green Energy businesses and then building out organic rendering businesses both here and around the world. So there's lots to do with it. But there's going to be a lot of cash. And I also like to always say, well, people -- the naysayers say, well, what if Diamond Green Diesel margins aren't what they say they are? Okay. So what, even if they go back to $1, you got 1.2 billion gallons, there's -- our share of $600 million. Our base business will still be solid because of fat demand. You still have an $800 million cash flow coming off of it. I don't see that we're trying to split the $50 million or $100 million hair here, directionally, because we're levered in the sense we're below $2.5 billion, we have lots of opportunities.

Okay. And we're running -- we're almost at the end of our time. I wanted to squeeze one more in and thinking about sustainable aviation fuel in kind of that next market. And maybe help us think about what you're watching and what you would need to see before you make a commitment for capacity and really pursue that in a more aggressive fashion?

Yes, I think we've been really consistent about this. Number one, we understand the technology to produce. We're engineering the plant to produce. Most likely, it could be one or two things, bolt-on module to #2 or #3 or a freestanding plant. The technology forces you to either make a road and jet, no -- it's not or. So it's road and jet and there's a split there, and let's call it, for a simple sakes, 50-50. So economically, Today, under the build back better, there's $1.25 incentive with $1.75 potential kicker up to $1.75 for CI intensity reductions. We think that given our feedstock blend the best we could do is $1.50, $1.55. Well, if you think about the model today, we have sufficient road demand and the road demand pays us the RIN, the LCFS credit and also the blenders tax credit. So under aviation fuel today, while we could ship and go make it once that $1.25 or $1.50 is there, it would have to be consumed in California to ultimately for that model to work. You wouldn't be able to ship it back across the country or whatever you be foregoing the LCFS credit, unless the carriers willing to compensate you for that. That's where the challenge comes in. While Mr. CEO of United wants to say he's going to buy 1.5 billion gallons, he'd love to buy 1.5 billion gallons, but -- I don't think today, I can't put words in his mouth, but at today, it's a premium to Jet A, a significant premium. They're going to have to work out their a la carte pricing system for seat economics against it. or because you're just not going to divert capacity from road diesel to aviation at the current economics. That could change. What could happen? Well, road diesel economics could it get overbuilt and they could come down and sustainable aviation fuels become parity. So we're watching it closely. But the first thing that has to happen is under the build back better, it has to go into some type of remuneration system and subsidy. Keep in mind that the fine print that's in that bill, and I won't debate whether it's going to happen or not happen is that it turns -- I think in 2030, or 2026 -- I'm sorry, it turns to a producer's tax credit, not a blender's tax. So at the end of the day, it would be very favorable for us then to attach a module or build another plant to do it. Today, if you ask me to flip a coin, I'd say, we're going to build flex capacity at #2 or #3 when those things all align for us.

Okay. Well, that's incredibly helpful. I think we're just about at the end of our scheduled time. So I think we'll stop it there. Randy, thank you so much for taking the time today, and thank you all for listening. I hope everybody has a great day.

Thanks Adam.