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

I am very happy to have Randy Stuewe from Darling Ingredients here today. Darling, I think, is going to face a golden era. And what we saw in the last year was not a golden era. That was just good times. I am a big believer that there is going to be a feedstock war for the 15 renewable diesel facilities that are either officially announced or rumored. At least half of those are going to get built, and there's not enough feedstock to go around. So Randy's company is the largest producer of that feedstock and it trades at a big discount to the CI value, and that's the opportunity in my mind.

So my question for you, Randy, to start this off. Diamond II, Port Arthur, how much of the available feedstock in North America are you going to be using once you have Port Arthur online?

So Craig, it's always -- it's great to see you again. Thank you for writing on us again today, and you were one of the original believers in the story. And I think back in 2013 when we started up our first renewable diesel factory with serial #01. And essentially, I had bet my -- the market cap of the company and my personal career on the technology of being able to marry a technology to produce a hydrocarbon out of a lipid. In today's world, you guys have to choose between lipids and lithium. So you think -- remember that when you leave here today. So -- but we were successful at it. And so -- and we went for it for a whole different reason because the business platform that we built around the world and where we're at today is we process about 12% of the world's slaughtered animal byproducts, not the most glamorous business in the world. If you're meeting me in the bar later for a drink, don't ask me what I do, I grind up dead animals for a living. And I'm a used cow dealer. And so I was caught in this agriculture vertical on valuation. We were the biggest, we were the best, most diversified model, ebbed and flowed around the world, but we couldn't participate in the fuel segment because animal fats, and if some of you are old enough, remember, grandma making pies out of lard, animal fats get hard. When they get cold, they don't make a very good fuel unless you can break them apart, pull out the water, which essentially makes a hydrocarbon. And so we wanted to own the -- if you will, the animal feed alternative because when you stopped eating McDonald's French fries with animal fats in '89, animal fats had no respect left in the world. And so they became a very large discount as a feed source in the world. And so we wanted to own that opportunity for that arbitrage, no different from a long short -- many of you in here. And so that's when we built it. So here we are today. We've operated. We've been at it for 10 years, been under construction for 12. We continue to reinvest in it. Today, we're the second largest hydrocarbon from animal fat renewable diesel producer in the world, second to Neste, but we're very different than Neste because we own the entire supply chain from farm to fuel. Notice, I didn't say food to fuel. We'll talk about that later. I'm sure Craig will get into that. But -- so farm-to-fuel, today, when we started, I don't know, 10 years ago, we were using 5% of the U.S. or North American animal fat waste, fat supply, then we went to about 10%, 11%. Now we're using 40% and we're originating it without any issues. A lot of it comes from our own factories. We own the -- like I said, we own the arbitrage. So we're net long into our system today. And so we can -- whatever we need, we bring in or we logistically sell out. And it's a global market. We operate in 18 countries. We operate on all 5 continents. And so we can see what no one else can see. So we move fat from Brazil, Paraguay, Colombia, Ecuador, Australia into Diamond Green Diesel today. So it's 40% today, 9 months from today, 66%. Maybe it's 67%, maybe it's 65%, I don't know.

That's a really chunky number.

I think -- as I joke in our boardroom, I think the only person that beats us with the fundamental use of their own supply is Saudi Aramco.

That's probably -- well, you're sitting on a green oil field up there.

Thank you.

So -- wow. So the other thing that I would say is, I think Darling is actually one of the oldest sustainability companies in the world. Isn't that right?

Yes. I laugh and I get to share with people because now I'm having to pick up all the cliche and buzzwords around ESG and formalize it. And I think we've done a really good job there. But our world dates back to 2003 when I took over this little tiny $200 million revenue company with 21 factories located predominantly in the Midwest, and I was dumb enough to go on Mad Money with Jim Cramer. And I would say that's the second biggest mistake I ever made in my life. Ask me about the first one later. But Jim, all of a sudden, we'd scripted it, and he said, okay, I'm going to ask you this, blah, blah, blah. Music comes on. He goes into one of his horrifying rants. And the only thing that could come out of my mouth, tell me about Darling, I said, we were green before green was cool. Little did I know, 20 years later, we were the leading edge of it. We are the original repurposer, recycler, renewer of products. We make -- we are the largest producer of sustainable ingredients and decarbonization hydrocarbons in the world today, 20 years later. So got a great story to tell. We have not touched on where we're going with the story. You're going to see us kind of rebrand a lot of different things, not spend a lot of money to get there, tell the story differently and to make sure that people know that the organic fertilizers I make. And if you watch the U.S. Open, I don't know, was it 3 or 4 years ago, Johnny Miller goes, I wonder whose fertilizer they used on those roughs. It was ours. We didn't brand it. It's called Nature Safe, but we're not out there in the forefront. We like to tell you, we touch each of your lives every day, your kids or your pets. And I think you can only think of another company in the world that maybe follows that would be BASF. And we just kind of sit out there. If you were hung over from last night's party and you took a little gel cap this morning, Advil or Tylenol, that's our gelatin. If you're a runner and you took -- you're under this collagen movement now, that's us. And then you get into the pet foods, Nestlé and Mars, that's us. And then into the green hydrocarbon area. So chances are we touched your lives somewhere along the way today. And it's just really fun to know that we're participating in kind of what's good for the people, what's good for the planet. And hopefully, I can give you what's good for profit for you, too, at the same time.

So the commodity cycle we're in. It's a pretty nice thing, right? But the real benefit of green diesel is only just kind of taken in a little bit, or am I wrong, right? It's just starting.

Yes. I mean commodity cycles are really fascinating. They make some look smarter than they should be, which would be us at times. And then they also go the other way and you actually work a lot harder in those things. And when we took the company and I took it over out of a restructuring in 2002, 2003, the first thing that we had to do was to put a structure in place that derisked the commodity cycles because the only thing, as I tell people, that you really control in this business is the balance sheet. The rest of it, somebody else is in control of. And so -- but what's different right now in the world is about almost 1.5 years ago, Q4 2019, we started to see demand exceed supply of really the products, grains, oilseeds, palm oil, energy in the world. And it's a function of the underlying thesis of why I still get so excited about the business, Craig, is it's -- we believe in population growth is going to continue, maybe not as fast, but it will. Creation of wealth, center of the plate dining. 2 things, a bigger population needs, more energy, more food. And we're right in the middle of that. And it just really gets us excited. So here we are watching the cycle finally turn for the last -- from 2015 to 2018, '19, we dropped about $1 billion, $1.5 billion into expanding our processing footprint for the production of fats and proteins. We believe that long term, you don't stay under the 10-year average. It's very simple. You can model this thing and you look -- if you go back and look at our investments at the 10-year average, they were 15% to 20% cash returns. At these levels, they're 70%, 80% return. So we got the cycle right. So now the question as we look forward is how long does it last? And trying to predict your crystal ball in commodities, as I always tell people, I've never made a bad trade. I've lost a fortune in timing. This one is different. And the demand side is there. It's driven by China. It's exacerbated by a drought in South America now. And now we've got the Ukrainian issue. And while I don't profess to be an expert on the exact production of Ukraine, I work in some businesses on a different private company that have seed businesses there. And so I have a pretty good transparency to the challenges ahead in agriculture in that part of the world. And that's the #3 and 4 exporter of corn, wheat and sunflower oil in the world. And so this cycle feels longer than shorter. Four months ago, I would have sat next to you and said, I think, Craig, we're on the back half of it. We're in the last quartile of the cycle. Production will catch up again. But now with the Ukrainian issue, I think we've got another 2 years ahead of us. The only thing you can ever be wrong on is trying to be here. But it feels wonderful. And then you put on our business and our demand from renewable diesel. And you talked about the 15 wannabe factories. Some will be built, some won't. It's a fascinating time. There is not enough feedstock in the world to go around. And it's just going to -- some of those won't be built. You're going to enter -- I said earlier, we are waste fats to fuel. We are a repurposer and a recycler and we give you green hydrocarbon. We're not competing with the food companies for making salad dressing or Cisco to take their product and put it in fuel today. So we're not a food fuel. And I think that's a very powerful statement as we look at this world moves forward.

Yes. No, I like the fact that you take the stuff at the back end that doesn't get used and make money with it. And I'm sure your feedstock partners really like that, too. It improves their economics. So one of the things I tried to do was try to sort of approximate how the balance swings back. I know it's next to impossible. But when the world is consuming more feedstocks to make renewable fuels, it's going to have a very interesting and positive impact on commodities prices. Squeeze profit maybe just a little bit on the production of green diesel. Is it fair to look at a ratio of sort of a give back across the platform, your core platform versus your Diamond Green Diesel joint venture? Is there a fair -- is that a fair assessment, a fair way to try and split the baby?

Yes. It's a fascinating thing because when we married Valero and Valero married us, I mean, we were going into uncharted water. We were as distrustful as Valero as they were as distrustful as us and -- in the sense that -- I can tell you when we started engineering the plant in New Orleans, their engineers were scared the alligators were going to come out of the swamp once they started unloading animal fats there. I mean, so really not a lot of knowledge in a humorous sense. On the same side, we didn't understand the value proposition of fuels and how it really works, and it's really -- it's the oil companies and then the distributors that really have all the power and pricing power there. So at the end of the day, we got into it for a very different reason than most people think. We got in it to have as a hedge or an offset to our core business against commodity cycles. So we own that arbitrage. But also we went into it, and we modeled. And this is what's interesting. When we do -- we looked at the 10 years prior, 2000 to 2009, and we said, what's the diesel price? What's the animal fat price times the yield minus the co-products minus $0.50 a gallon to make it. And at the end of the day, that margin was $0.79 a gallon. So when we built into the business, we looked at it from a very pragmatic standpoint. We said we didn't expect to make $2, $3 a gallon at this. Well, we also didn't know what the word low carbon fuel standard, didn't know what carbon intensity meant at the time. So you get a little lucky in this thing. So at that time, as we go forward, we're happy, Valero is happy. I mean we're making $1.25, that's our guidance this year. It came down a little quicker than we hoped. But at the end of the day, here comes feedstock prices and then you got all the volatility in the oil and you still got all this noise with these government programs where what is the RVO. And so I don't think we've ever hit really straightened level at 30,000 feet here, but we're casting it out at $1.25, $1.50 right now as we go forward. Okay, is that a good return? That's $3.20 to build, $3.20 a gallon to build a greenfield plant, all right? I think most of you in your portfolios would like 40% returns on them. So I think it's a pretty good use. Mr. Gorder is happy at Valero with those returns, our shareholders, we're actually making the price, I mean, cheaper because we're able to pay the livestock producer more for their material. So long term, we're creating value on both sides, and I get to smile about that.

And I think the people at CARB here in California also smile because if it wasn't for the success of that product, the LCFS and the State really would not have been in existence, would had -- have gone through another negative revision.

Yes, it really is. And you look at it, and the first thing I like to tell people is thank you, CARB, LCFS, but it's not an American phenomenon. I mean this is a global program. Because we're an American company and we receive American subsidies, we don't like to stand out and say, oh, by the way, a lot of our product is leaving the country. But the fact of the matter is California has their program. Europe, the Scandinavian countries, Canada all have their programs. And they're just as big, if not bigger, and growing faster. I mean, I think the question that I know that I ask myself is what makes this go away. And I don't think there is. And as I shared with people, and I've had a lot of one-on-ones today, I wake up working for you guys trying to make you as much money as I can and give you perfect execution when possible. But we're -- I have a 25 and a 28 year old now, and I sit there and my daughter said to me one day, and I cannot get it off my mind, she said, Dad, it's okay to make less money now if you're better for the planet. And that's a generational thing. And I struggle with it, and I'm not telling you I'm signing in blood on that one by any means. But there's a generation out there starting to think that way. And how long that lasts, I don't know. But we have an obligation, and I won't get on my soapbox on my responsibility to the environment and the planet. But if you can provide a solution, it's the funnest thing in life. And this is a drop-in solution that is so ready right now to grow around the world.

So I got a question for you on Valley, right? I remember years ago, your explanation where you did VION, you did Griffin. You buy the property when it's available, right? When you court these really interesting targets for many, many years. And then usually, when market conditions are spectacular and there's a risk of something going wrong, that's when they really want to sell. And you just have to buy it or else you're never going to see it. Someone else is going to own it, you're going to miss your chance. This acquisition looks like it's going down a little bit different. It looks like maybe they see the golden era that I'm looking at, and they want a way to handle liquidity. I mean, how on earth did that come together?

It's always fun and -- to talk about it because -- the first thing I let people know is that I've been in the turnaround business for 35 years. I don't want to ever be in it again. And so I only buy good businesses with great management teams. And then I want to make sure -- the price is the price, as we always say. And then you want to put a no-fail capital structure in place because once you screw up and you start laying off and terminating employees, that is so damaging to culture. And we've built a culture at Darling built around entrepreneurship. You get to run your own company. There's no surprise, as we call that, transparency. And then the brand is the brand, that's called integrity. And I know that all sounds cliche, but it's how we operate. It's how we've operated for 20 years. I know what's going on in China today, and I get woke up at 2:00 in the morning by my Chinese country manager telling me, we got a problem. And so at the end of the day, we try to find people to fit our culture. The Smith Brothers, known for 20 years, been courting them. As I always tell people, I take you on a first date, I buy you dinner, I buy you a drink. Next time, the second date is about 3 bottles of wine. About 1.5, 2 years later, I get you to the altar. Now I don't want to talk about a mistake I made at the altar once. But at the end of the day, this was courting a family. These are all -- we are the only public company in the world, in this business. And we now -- with the Smith family, it will push us up closer to 15% of the world's processing. And so bringing them into the fold, but most importantly, selling them on the culture and meeting with J.J.'s wife [ Kay ] and asking her, what's important to the legacy of the family. You grew up in Winchester, Virginia, your name is on the church, your name is here, your name is on the school, that's what's so important, and that's what I love about agriculture and food today is it just has such family roots to it that makes it so special. This one is -- right now, the Hart-Scott filing has been made. We're in that wait-and-see mode. I can tell you that -- I won't call us collateral damage, but I would call us guilt by association. And guilt by association is with the chicken industry because 15 of the 18 plants are chicken by-product processing plants, and they've had the price fixing issues. And so it's getting extra scrutiny and by our scale. Obviously, the Biden Administration is against anybody getting bigger. So end of the day, we remotely aren't close to them, 250 miles in most cases is our nearest factory. These are perishable items that it's a sell-it-or-smell-it business, and you can't truck it that far. 50% water. So I think it will get through or I guess I'm confident to get through. I wouldn't be spending your money if I didn't think it would get through. I think it will take a little longer to get the government there. But nonetheless, we're so happy with it. And then, Craig, we're looking for other feedstock around the world. We want to keep derisking these assets.

So then last question, if I may. I remember in the first, I don't know, 7, 8, 9 years that I followed your company, you built something like 36 facilities to keep EBITDA flat in a negative commodity cycle, right? There was a tremendous amount of investment, real growth in your partnership with your feedstock suppliers, and sophistication that you brought to your processing capability. How does that play out in a positive commodity cycle? We're just -- we've passed the prior peak on the assets, but nowhere near what the capability of the platform is. How -- can you kind of unpack that for us a little?

Yes. I mean you transition from operation moron to operation genius here. As we said, when we model out businesses, we say, what's the 10-year average. And as the Sanderson Farms has various people, Peco Foods, Case Farms were all trying to grow in the country, they did not want to put their capital in. They'd rather put it into the food side. This is the dirty side, highly regulated by the government. And so at the end of the day, when we snapshot at it, at the tenure, it looked like a great investment. We spent 7 years under the 10-year average. So we've come out of that now. And so now it's got unbelievable returns to it. And oh, by the way, it's running full. We are at capacity. Kind of fun in North America. We're now 50% larger than we were per week in tonnage than we were back in 2010 when we bought Griffin. So that's the growth that we've been able to unpack. And that's the -- if you will, that's the low CI feedstock now that we operate with and can ship and convert to a higher-value product.

So collagen and everything else is additive on top of that, too, of course.

And so people say, where does these other businesses fit in? Our proposition to the slaughterhouse is really, you separate it, we'll process it, we'll create a value for you rather than dumping it all in one truck. So specie-specific, put the feathers over here, put the blood over here, put the bones over here, put the softs over here. Each one has a different fundamental value and use versus other smaller, little competitors that dump it all in one barrel and process it all together and make just a protein byproduct and a little bit of fat. So we've been able then to create just substantial value in the supply chain for the livestock producer in the slaughterhouse. And so it's an unparalleled offering that we have. Kind of paraphrased, a one-stop shop. It's a little challenging at times, but we do it all over the world. The only place we don't do it today is in China. They eat everything.

That's a great place to leave it, Randy.

Thank you, everybody.

Thanks, everyone.