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

Good morning, folks. My name is Justin Jenkins, Energy Research Analyst here at Raymond James. Today, we've got Darling Ingredients. So Randy Stuewe, Chair and CEO of Darling Ingredients, is going to join me here for a fireside chat. So Randy, thank you very much for attending. For those of you who don't know, my coverage universe is a bit unique here at Raymond James. I cover refining, midstream, integrated majors and renewables. Darling has been the latest addition to our covered universe back in the summer of 2021 and one of my favorite stocks in my entire 42-company covered universe. So Randy, I appreciate you joining us today. Maybe just to start, if you would give a quick intro of what Darling is and a quick overview, and I'll hop into Q&A after that.

No, that's good. Thanks, Justin. First off, thanks for having us and love to show off the company and tell people about it. It's one of the great unknown, untold stories yet that needs to be understood, and we're celebrating our 140th year. I think we're 2 years older in Coca-Cola and not many know of us. And often, when I'm flying around the country and they say, Who do you work for? Darling. They don't know what the name is or means. And it's associated with a homebuilder in Texas to a lingerie company. So I kind of know which one I [ err ] to the homebuilder. But no, it's -- it was a company, originally founded by the Swift meatpacking family and the Darling family. And so it was the repurposing of slaughtered animal byproducts. And really, at the end of the day, it grew up as a company where you took the remnants out of the consumer protein business, and you took the fat, the bone, the guts, the hair, the feathers, not a real glamorous business. And you cook them. And so as I always tell people, you're all honorary [indiscernible]. That's the process. If you've ever fried bacon, hamburger sausage in a skillet, what have you done? You got rid of the moisture and separated the fat from the protein. We do that on an industrial scale. And today, we process about 12% of the world's slaughtered animal byproducts, 12%. 230 facilities, 5 continents, I think 20 countries now. And we put them in -- we make 2 things. We make fat or we make protein. Protein will touch your diet every day, either from your pet's diet, livestock feeds, proteins are also in the form of collagen. So if anybody is in the [ collagen kick ] now, that's us, the collagen peptides, vital proteins as part of our portfolio, not as a supplier to them, but we help found and build that business to where we improve health and nutrition every day. We try to take each of the products out of the -- whether it's fish, chicken, pork, beef, take them to the highest and best use, and that's on the protein side. And then on the fat side, we are the largest green energy company in the world. And then so that's why we're with an energy analyst now because about 10 years ago, I had a dream, and I convinced our team, so we had a dream then that we needed to find a better use for animal fats. And for the old people in the room, you might remember McDonald's French fries used to be cooked in beef tallow, but that was 1989. And since then, animal fats fell out of favor as you favored health and nutrition and vegetable oils. And so other than grandma making a pie at Thanksgiving with lard in the crust you've never really thought about them. But the only thing that they were was a calorie to feed animals. And so at the end of the day, as we wanted to look at growing our model and derisking our model, we wanted to create the arbitrage between feed and fuel. Same time as the renewables and climate change were picking up momentum. But at the end of the day, as you'll hear people talk about biodiesel is a wonderful product that some people make. We make renewable diesel, which is a true hydrocarbon, a drop in decarbonization solution for the world's heavy transportation system. And we ourselves in Neste are the largest producers in the world. While we hold the #2 position with Neste today, I think here in about 9 months, we're going to be tied with them, if not bigger than them. And so the story that we have to share with Justin and everybody is a business model that procures waste and converts it to human, animal proteins and then also green energy.

So Randy, as an energy analyst, I'm not used to standing-room only room, but it seems like somebody is telling a good story at your side. So I think maybe just to start, the obvious macro volatility, commodity price moves, geopolitical uncertainty. Maybe just talk about how that's impacting business, if at all, at this point, and what you're doing to respond to that theme? And then maybe also touch on inflation since that's a big theme too.

Yes. I mean there's clearly -- I recognize some people in here. There are students of this business that have watched for many, many years our delivery of earnings. And clearly, we do better in a higher commodity environment because of some of the products we make alternatives to the different grains, oilseeds and oils of the world. And so we get that benefit. We've started to pick up tailwinds I want to say in fourth quarter of 2020 -- or 2019 into 2020. And that was really the year that as we started to build out our second hydrocarbon unit. And at the end of the day, we saw a world that is built around the thesis that we operate is population growth, wealth creation, center of the plate dining. Yes, you get a lot of noise with Impossible Burger and Beyond Meat out there, but the world wants protein. Make no mistake on that. And it's in this order, fish, chicken, pork and beef. Beef is a luxury item. You pretty much need a Brink's truck to go to Whole Foods to get a steak any more. But -- it's -- but the world survives on it, and it's going to continue to grow. And so we are in the middle of that. We'll take more of that product and produce fats and proteins out of it. 2 years ago, we saw the curves cross. That was -- the demand was going to outstrip the supply of both protein and fat. Fat being accelerated by the climate change initiatives and decarbonization of the world and proteins just on whether it's pet food demand and whether it's just growing more animals to feed a growing population. So we said from that standpoint, there isn't enough corn, there isn't enough soybeans, there isn't enough palm oil to manage the demand of the world, which is very different because ag commodities ebb and flow, whether it's fertilizer prices, whether it's geopolitical, whether it's more land in production. But we kind of cross those lines now to where -- we're pretty much at a MAX production system. And that was pre-Ukraine. And now you throw in this very, very dangerous situation in the Ukraine, and you can go do your homework, but they're a major exporter of wheat, corn and sunflower seeds. The world doesn't have enough today, let alone to disrupt that. We got $14, $15 week this morning. I mean I grew up in Kansas and we barely got by on $3 a week. And now you're 5x higher 30 years later, but nonetheless, the price of a loaf of bread is headed way north and so is the price of pasta. And veg oil is now 3x higher than it used to be 2 years ago. And so at the end of the day, what's -- there's a lot -- what are you going to do for Thousand Island Dressing in a sense. But the commodity world is on fire. It's augmented by the continued push to decarbonize. And as we use the line, you've got a choice. You can either choose lithium, right, car battery or lipids, you can take fat, crack it and make a hydrocarbon. So the choice of the world, if you're going to choose from a tailpipe emission perspective is to take a drop-in solution, especially in heavy transportation and decarbonize the tailpipe.

So a lot of investors that I speak with tend to worry about the cyclicality of your business instead of maybe understanding the structural components of what's adding to the growth profile of what we would call your legacy business, the food and feed business. Maybe talk about those misunderstandings, if you will?

Yes. And if we like to think in a non-cliche way, we have the ultimate vertical. I mean, we're from the farm to whether it's food, feed or fuel. We control it 100%. There's no company out there in the world today in those sectors that can do that. And so the cyclicality, yes, our base earnings ebb and flow with the prices of alternatives. We've continued to try to derisk it, and I'm going to say derisk it and moving into higher-end nutraceutical supplements. That's our collagen peptides. We've derisked it by owning the arbitrage in the food, feed and fuel side with Diamond Green Diesel now and then we're making higher-end pet food ingredients. So we're spending time trying to de-commoditize it and you do it multiple ways. Location of factories, specie-specific and then products. And we see tremendous growth in everything. I mean, at the end of the day, that we've watched the model. If you look at the 5-year earnings track of $400 million base EBITDA to $500 million to $800 million will be $1 billion this year is a pretty tremendous story. Part of it's commodity lift, part of it was capacity, we added, and then part of it was changing the paradigm and the dynamic of the climate change market by providing a solution with Diamond Green Diesel added on to this unit that then creates more value for our base business.

So that's a great transition into renewable diesel itself. Maybe talk about the moving pieces of what you're seeing in that market today? How you're seeing renewable diesel evolve over the past couple of years and into the future here?

Yes. And so you've got to step back and think where does all of this stem from. You got to go back to 2007, a long time ago, that's called the Energy Independence and Security Act. It mandated renewable fuels. Most of you probably, some of you had investments in ethanol. You watch that plateau out and boom out. There was always hidden under there $1 billion gallon minimum called -- for biomass-based diesel, And that was to replace diesel in the combustion engine. And so at the end of the day, we've watched that grow to about 2.4 billion gallons through the different mandate growths over the last 13 years. And so that's the driver of the world today. It was renewable fuel standard. It's still there. It doesn't have any sunset provision for us. Along comes California, almost 10 years ago with leadership that wanted, under Jerry Brown even, to decarbonize. They have a health issue in their minds in the sense of particulate matter emissions in California. And of course, they were going to blame big oil for us, and they wanted to move to a climate change solution, which renewable diesel and biodiesel to a degree had that ability. So renewable diesel comes along as a solution to the California carbon issue. And what do I mean by that? Under labeling guidelines, you can put up to 5% biodiesel. This is a drop-in neat solution, neat meaning it can be 100% burned in an engine. And oh, by the way, it can go by pipeline. It just is a really fungible substitute. And then also, we can move around the cold flow property of it, so it can be burned in Winnipeg in January. And so at the end of the day, we built a product that the market wanted in the sense of a substitute. If they had a choice would they buy it? Hell, no. They don't want to Justin, but it's part of the legislation that has been put out there. So we saw it start at 1%. It was 11% about 3 years ago. 16%, 2 years ago. And I think we're 20% of the energy system for diesel in California. California is not the only market. We then see Washington, Oregon, New Mexico came within 1 [ row ] . And then now we're seeing New York go there. Canada has been there. Everybody wants to talk about the clean fuel standard, Well, that just nationalizes it. They're already a giant customer, so are the Scandinavian countries and so is a couple of countries in Europe. Decarbonization is an immediate solution. And I don't want to preach the ESG message, but we are the ESG message.

Randy, on that point, maybe talk about what sets Diamond Green Diesel apart from the competition. You mentioned that you're the #2 producer today. Probably next year, you might reach #1 global producer of renewable diesel. So maybe talk about the competitive advantages of what you bring to the table, what Valero brings to the table and what DGD is doing so well?

No -- it dates back, I always give a little history as when we try to build Diamond Green Diesel, this was serial #01 in 2009, '10. My CFO, Brad is here with me. We were in Washington, D.C., trying to get some of that department energy, free money, 8 year nonrecourse. It was a $423 million build I think that was pretty close to the market cap might have been $1 billion of Darling at that time. So it's kind of -- "Randy is going to bet his career on this one" and let's see if we can derisk this. And never been done. I mean the technology was black box at the time possessed by Honeywell UOP. Their subsidiary that is basically a catalyst supplier, but they had come up with the technology. And so we got very close with the Department of Energy on funding and then oh, by the way, that hopefully, none of you had money in Solyndra. But the Solyndra came along and then needless to say, it shut it down. Bill Klesse was Chairman at that time of Valero and Bill called me and said, "Hey, Randy, I really like this. I know it's high risk, we'll loan you the money." So I owe, incredible thanks to the Valero, confidence in us. Now what they see in us. They were scared of animal fats. They were scared of used cooking oil. I had no idea. They're used to buying Panamaxes and super Panamaxes, 50,000 barrels of this and that not 1 railcar or 1 truck. And oh, by the way, lipids or fats are catalyst killers. And as energy guys, the last thing that the ops guys want is they're incented off of the life of that catalyst in the yield they get and be honest with you, we've done it. We never broadcast. We killed catalyst in a month with this stuff before. So it's not easy to process. So we brought the technology to get the metals out of this stuff. You're now hearing the buzz word pretreat. But the secret sauce is pretreating, getting the nitrogen, the alkaline metals out and the impurities out, which extends catalyst life increase yield. So we brought that technology. That was my background. They brought the cracking technology, the distribution and what else do you get when you get -- put a lipid in a hydrogen or a super hydrogenation process, you produce water. And so you have to learn to handle a lot of water off of these things and water is corrosive in the sense the acidic water of it. And so it's part of -- I'm sneaking a little things, anybody that's kind of retrofitting out there is going to learn about how corrosive this process is. We learned the hard way. But -- so they bought that. We married up. We built a separate JV, 50-50, 100% independent of both companies. We provide technical resources, they provide technical resources and it's just been a huge success. 137 million gallons in 2012 to 160 million to 275 million to added another 450 million here in October, and we'll add another 450, 500 in the start of next year. And so it's a beautiful relationship. It's one -- most joint ventures don't work, and you have to share values. And so we're kind of the first marriage, I get in trouble with Joe Gorder when I call him big oil. He says, "No, we're a merchant refiner." They're big oil. And oh, by the way, "I'm a big ag." And so we get to have fun on that, but it's been a very special relationship that's created incredible returns for both shareholders. I pitch Valero here. They've got the most unbelievable green portfolio out there between their ethanol, their green diesel and their fossil solutions. So they're the whole deal and it's fun to be married to a visionary oil company, which they have been and continue to be.

As the energy analyst that covers Valero, I second that statement. But I think on this point, you've ramped up 2 different phases of the Diamond Green Diesel joint venture. We'll get a third phase of capacity in January of next year. Maybe talk about the investment process of what led you to sanction these and what we're thinking about next?

We -- number one, the hard part with the renewable diesel market is the transparency of the demand. There aren't any statistics out there. There are -- the EIA isn't reporting stocks. And so it was really customer-driven. And so before we brought #2 online, it was already sold out for 5 years. #3 is mostly sold out as we go forward. And why isn't it all sold out because the Europeans don't move as fast forward. And so it will. The demand is out there, and that's just road fuel. And you start to look at these tertiary markets that haven't even really been [ exploited ] yet. I mean we launched Arctic grade last year. So now we have the flexibility in our Unit 1 to make a very, I think, plus 4 [indiscernible] point versus a plus 15, so we can ship Canada. And so we can flex between that. And so -- and then we set up Unit 2 and 3 now to have Jet modules added to them. We're not there yet. We're engineered. We're confident we know how to make the product. We know the yields. We know the economics, but we don't have the remuneration or the subsidy yet to make it and the kind of the dirty little secret there is, you still have to make road if you make Jet, you can't make all Jet. So if you're going to make road or if you're going to make Jet, it's got to be at the same economics and it's not. It's probably -- I don't know -- the numbers are all over the map they use -- they move around daily. So I don't want to say it's 30% less or whatever, but it doesn't equal it yet. When it gets there, we are more than happy to make it. And then that's going to -- if you think about the Jet market, and this is why you got to get bullish Darling, is the Jet market is 25 billion, 29 billion gallons. You're not going to go 100%. But maybe it's kind of like a lead building out there, the little green sticker. United Airlines said, he's going to buy 1.5 billion gallons of it. Amazon said they buy our entire production. They want to buy it at Jet A. They've got to move to where they're going to pay what it takes to produce. And that one's consumer driven. We'll see if they truly get there. But at the end of the day, the rest is mandate-driven, so it's very solid.

So on that point, sustainable aviation fuel is obviously the buzzword of kind of what's next. Maybe talk about what you've learned in the start-up process of all of this new capacity and what's yet to come? And you touched on this a little bit with the competition that you alluded to. What are others not seeing this that might break later this year as new competition starts up?

Yes. And so you kind of have to frame the world a little bit. There's -- I'm going to call it 3 or 4 of us that really know how to make this product. Ourselves, Neste was the pioneer. They do a great job, different technology than we're using. REGI has a little tiny plant. They were just bought out by Chevron, so you ought to do that valuation. And then you really like Darling. And then you look at Total in Europe, they're using the technology. So those are really -- the rest are late come to the party guys. And really, at the end of the day, they're trying to repurpose stranded assets. And what we know from the business is it is not as easy to crack the molecule as it is on a spreadsheet. It's a corrosive process. So old carbon steel doesn't really work. And then at the end of the day, only 30% of this process is related to the hydrotreater cracker unit. The rest of it is wastewater, it's gases, it's pretreatment. So there's a lot of money that goes into it to make it the right product. So you've got today, you've got Sinclair trying to run their asset. You got BP up in Cherry Point, and you've got P66 out in Rodeo trying to run 6,000 barrels a day, all using food oils, soybean oil. You guys better get used to olive oil and vinegar in your salads because you're not getting any Thousand Island Dressing if these guys all start up. You won't be able to afford it. The difference with Darling is we -- it's the waste supply system that we have, operating, as I said, in all those countries, and all those continents and we bring the fat to the system. So we're a waste converter to green energy that makes us very different. The new capacity, it's hard to say how much of it really gets built. I mean I can get some guys that get pretty negative on it. The economics don't work. And that's the thing, go run the -- the spreadsheet looked pretty good 2 years ago. The spreadsheet doesn't look very good because feedstocks. There's not enough feedstock. I'll give you an example. If P66 wants to convert the Rodeo facility to 800 million gallons, whatever...

Just a number?

Yes. Times 8.25 pounds a gallon. There's what is that, 7 billion pounds of lipids or fats. That's 1/3 of the U.S. soybean supply. 1/3. I mean it didn't work. Common sense. This isn't fossil fuel processing here. So there's only going to be so many of them built. And really, at the end of the day, you have HollyFrontier coming online here later this year. They've got to learn to operate it. You've got the Seaboard Hugoton, Kansas facility done and trying to start up right now, they didn't get pretreatment right. And then REGI is years out, like worth about a 2-year call option on a facility that's not built. And -- then nothing else is real out there.

Randy, one of the points you made in there is, I think, inherently, my thesis on your stock, which is the vertical integration that you bring to the table here is maybe the most underappreciated aspect, right? Renewable diesel margins can be volatile and core, to be frank, but the other side of your business probably is doing really, right? Do you think that's still the most misunderstood aspect of your business overall?

Yes. It's a hard company to value. Number one, there's no comp. Number two, it has some commodity exposure, why we invested in the hydrocarbon system was to derisk it. And so even if commodities go back down and our base earnings go from our guidance this year of the $1 billion, we were $850 million last year, we were $540 million the year before. Okay, what did Diamond Green Diesel make 2 years ago. Well, it made [ 226 ] gallon. Why? Cheaper input cost. So instead of $1.25 this year, and now we're bigger in Diamond Green Diesel. So we built a model that is more sustainable and robust, at least in my eyes, not in yours yet. I got to get you there. But -- and you will get there, but the reason we asked our shareholders today in many different one-on-ones, they said, what inter narrative isn't resonating. "well, your base business is complex." I said, not really. We just make fats and proteins and grind up dead animals. I mean anybody can get their mind around that. And we got a hydrocarbon business married to it that's pretty well protected by mandates. And so -- and they said, well, but we've never seen any cash come out of Diamond Green. We are 9 months from being 1.2 billion gallons. Pick your margin. I don't care whether it's $1 a gallon or $2 a gallon. We're going to start repatriating free cash out of it. It's debt-free anywhere from, I don't know, $600 million to $800 million a year on top of a base business, then that produces $300 million of free cash. So there's $1 billion of free cash, 1 year from today for sale.

Randy, you're doing a really good job of segueing my topics because we're going to go to capital allocation here to finish the last 4 minutes that we've got. So on that point, what's the process of starting a dividend from Diamond Green Diesel? What's your base case in terms of timing of when we might see that formula developed and then I'll get to the Darling specific ones after that.

Yes. No. And really, at the end of the day, I think '22, I'm not going to say never on a dividend out of it, it will just depend on margins. I mean, obviously, with the volatility of oil right now, it's kind of hard to predict. But '23, for sure, there is, call it, $1 billion of cash. We announced an acquisition of feedstock supply once again, kind of insulating and building more robust the supply chain that gives us another 150 million gallons of production availability, and that's $1 billion. So I got to pay down $1 billion there. We're going to maintain, as I told people, 2 things, Brad and I haven't done in our careers. We haven't made Darling investment grade yet. We're levered at 1.5x today. I guess we are, but the rating agency said, "Gee, you're too small." And then we haven't put a dividend out. And so for the really old folks in here, which you're not just, I got 1 last special dividend. What year, Brad?

1989.

1989, we were Mike Milligan's last junk bond. So you can have some fun with Darling Delaware, if you're really bored on a Saturday night and want to read about it. But I want to be the guy that puts a legitimate dividend out there and makes it consistent that brings in a long-term growth shareholder. The piece we -- and so it's going to be a combination of buybacks and dividends. It's clearly a high-class problem that the Board is going to have to wrestle with, and then I'm going to leave you with 1 note, and that you're going to see a continued repositioning of the narrative of the ESG story. I was on Jim Cramer, the dumbest thing I ever did in 2003, and he started on one of his rants and I got all flusters and I said, "Well, we're green before green was cool, Jim." And 20 years later. That's the story. We've got to get that. We'll find out what the true value is of ESG. But if you're an e-person, this is going to be a big G for you.

Randy, on that note, you've shown a pretty opportunistic ability to repurchase stock between the $60 and $70 range. Is that the area where you see the most value in terms of stock? Or how do you think about the buyback process here, too?

I'm authorized for $500 million opportunistically. And so I'm trying to balance it against growth that we see out there and reinvestment, I kind, of believe putting the floor in it at $65 to $70 was a fair value. I sit there and say, I've given you guidance. I gave you $1.235 billion last year. I gave you a range, $1.225 billion to $1.250 billion, not bad to get within 2% on a commodity company. And I'm saying $1.5 billion to $1.6 billion this year. If you take anybody's multiple, whether you're going to be ADM or Bunge. And give me a 10, give me a 15 Neste multiple, they might worth, give me a 15 multiple that you just paid. And at the end of the day, you sit there and say, this is somewhere between $110 and $150 stock as things play out. The thing that people say, well, why isn't it there today? Well, they're bearish carbon. How can you be bearish carbon when Mike were -- he's an obligated party. He could have on a piece of paper and bought hard assets. How Marathon putting money in P66, they're not bearish carbon. So that's what keeps it profitable and keeps us different today as the carbon markets of the world.

Randy, I'm glad you tell him the same story I am. So that makes me feel better.

You haven't even read yourself.

Thanks for joining us. We'll be in [ Cordova One ] for the breakout session with Randy after this.