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

How can I forget Mr. Randall Stuewe, our next guest, Chairman and CEO of Darling. Darling is based in Irving, Texas. So the global sustainable leader in feed, food, fuel. Randy joined Darling in 2003 as a Chief Executive Officer. Darling has 160 million shares, trades around $80 for a $13 billion market cap and $1.5 billion of net debt. Please forgive me again, Randy, for -- how can I forget you? You're such a dynamic speaker Well, welcome, and it's good to see everyone. Brad, I'm sorry. Brad, it is good to see you. Suann, good to see you. Got Brad Phillips and Suann Guthrie. Maybe we could start off with telling us a little bit more about your company, Randy.

Okay. Tony, it's great to see you in [indiscernible] Ohio. I can't wait for to get back out on the road and see people and share the story. It's been kind of an interesting 2 years and I would say it's been a transformative 2 years for the company. So really, as we share with people today, you're getting now to witness a 140-year-old company that is transforming itself into the largest sustainable ingredients player in the world. And so as we've met with the many investors over the whole month of March just this year, we continue to tell a story that Darling is a company founded in 1982, but really created in the last 10 years, by the low-carbon fuel revolution, the decarbonization of the world. So our business model is pretty simple for people. We collect remains from slaughterhouses, butcher shops or abattoirs, grocery stores, commissaries, and we take the product that was destined to go into the landfill and create greenhouse gases and methane, and convert it back into sustainable ingredients that can be used in different food products, different feed products, and then ultimately it can be turned into a hydrocarbon. In the simplest sense is we are essentially a business that separates fat from protein after the water is removed. And so when we look at our facilities, as most people know, we have about 230 of them around the world. We operate on 5 continents with about 11,000 people. And we process around 10% to 12% of the world's, what we call or refer to, slaughtered animal byproducts. And so not what people -- when they hear the word Darling, I don't know that they would think that the sentence finishes well these guys grind up dead animals. So -- but at the end of the day, we're the biggest in the world. I think we're 1 of the best or the leaders in the world, and we're now on the forefront with our co-investment in joint venture with Valero, started in 2009, in leading the world of providing a drop in low-carbon fuel for heavy transportation, making us the #1 producer in North America and pretty much tied in the world to here with our third plant coming online in about 9 months. So it's really a fascinating business for me with great people. Financially, if you look at it over the last three years, we've grown from $500 million plus of consolidated EBITDA to $840 million to $1.235 billion last year, and then we've given guidance of around $1.5 billion to $1.6 billion this year. We had and hosted a group of investors yesterday as we shared, many of them are shareholders, as we took them on plant tours and talked to them, we said we're not done growing. And I don't know that there's many 140-year-old companies that can boast that. But we've got plans to continue to expand around the globe based on basically 4 core principles. One, we're going to continue to expand in green energy in Europe. We're 1 of the leading digesters in the world of producing green electricity. We are exploring and ready to complete the construction of sustainable aviation fuel modules here in the U.S., if the economics come to fruition. Maybe there's some that, I would say, leg #2 is our collagen peptide business. That probably doesn't mean much to many in the room other than I would say the word vital proteins. We're an ingredient underneath that successful brand and collagen peptides are an innovation product that we started working on about 9 years ago, that are great for skin, beauty, health and around the world in joint health. The other pieces as we look around the world are really our innovation businesses. We continue to develop the technology of insect [indiscernible] of waste streams that were headed towards the landfill that we think we can make proteins and other items for. And then the final piece is really just the growth of our core rendering business or as we talk about in the decarbonization world, the supply chain business for supporting our green energy business, which we announced here in December, the acquisition of Valley Proteins, an 18-plant system here in the U.S. that will provide additional feedstock for our Diamond Green Diesel venture plus protein for our value added proteins business. So we're having lots of fun around the world. As you know, and I'm sure you've heard from the world is a pretty complex and complicated world right now with many supply chains disrupted, but I can just say with a smile on my face, that we're having another record year at Darling around the world, and it's really great to be part of the chain that makes the planet at a better place, gives great opportunities for people around the world, and we're finally delivering the earnings that our shareholders have been waiting for, for many years.

That's a great overview, Randy. And along that line, maybe you could give us a brief -- just take a couple of minutes to talk about your different businesses and the current market. Also, I think, explain the complexity of your business, where you source from and how those business -- the mechanics of those businesses?

Yes. It's kind of -- it's a really interesting business model. And it's evolved over the last 10 years. But essentially, a process or a meat process or a grocery store, a commissary as a choice. And that choice is, I can put the material in somebody's dumpster and have it taken to the landfill. I can provide it to a composter or I can put it -- Darling can pick it up and bring it back and transform it into an ingredient and create value and share that value with the raw material supplier. I think globally, we have around 200,000 plus suppliers. They would range from very large suppliers that are well-known brand names around the industry and the world, to very small mom-and-pop restaurants and grocery stores. So the model is essentially identifying the raw material that's available, figuring out then what species it is, meaning is it beef, pork, chicken or fish, and then what's its highest and best use, and then segregating and separating the protein. And we like to think of the model from 3 different avenues. The first 1 is, in the food production business, if it comes out of a food processing line that is declared edible, we can then produce edible products from it. The edible products that you would know would be collagen or gelatin. Gelatin would be the emulsifier that would go in as a thickening agent in yogurts and confectionary items, probably top of mind for people, gummy bears and gel caps for medicine. And then our collagen peptides are a water-soluble form of that product. And we're the largest in the world of that. And then the second thing would be edible fats that can be used for frying chips in the U.K., predominantly in the food service business and then our sausage casings business. So we're taking all products from the animals. And once they're inspected and they're declared food, if we can move into the food chain, that's the highest and best use. If they're not allowed for human consumption, they will be then deemed edible for pet food or livestock feed, and that's our Feed segment. So the Food segment, we're a $1 billion food ingredients company. We're a $3 billion Feed ingredient company, because that's the majority of the material that comes out of the raw material supply chain, is really doomed inedible. And that's where we separate the fat and the protein. The proteins, you would know in all the major pet food companies. You're seeing Blue Buffalo, you're seeing Hill's, you're seeing Science Diet, all of them out -- on Nestle, advertised meat as the #1 ingredient. That's 1 of our businesses where we are deboning meat and processing it for them and then they're allowed to put it into pet foods. That's our wet pet business. The drive -- when it gets dried down, it would go into aquaculture feed to feed fish around -- fish and shrimp around the world. And then you would get into, what I would call, livestock feed, predominantly poultry feeds after that with what are not deemed to be really the high-end value-added proteins. And then if they can't go into either of those, but it's still been deemed inedible, in the sense it can go to then organic fertilizer. And that's a very fast-growing category for us as the world searches for nitrogen sources to grow organic vegetables and fruits. And so that's -- you got the food, you got the feed. And then if you can't eat it, you can't feed it, you got to burn it. And so that would be our fuel segment, and that's where we then take all of the products that can't go into either 2 categories and convert them back into a Btu in the form of digesting. We're 1 of the largest green energy producers in Europe today on digestion. And then we produce other ingredients that can be burned in cement kilns and boilers around the world. And then you would have that being our Diamond Green Diesel asset in there, which are 2 plants today [indiscernible] and then 1 plant coming online at the first of next year in Port Arthur, Texas, where we produce or will produce 1.2 billion gallons of renewable diesel or green diesel. And making us the largest in the world of producing a drop-in solution for tailpipe reductions from heavy transportation. So all of those businesses are a procurement business that are managed on a spread basis, such that we can have some level of prosperity, meaning recover the trucking cost, the processing costs and a profit margin in it. And then we've created a business model that shares that with the raw material supplier such that when markets move up, we share, they're more competitive. When markets move down, we're protected. And at the end of the day, we help them grow, they help us grow. So that's the model today. It's been very favorable for us.

Pretty amazing stuff. Maybe you alluded to before, but talked about the Ukraine crisis and how it's impacting your businesses around the world. Could you sort of talk through maybe on a high level of what's -- how that is impacting all of your different markets?

Yes. And I will back up even a little further. If you go back to about mid-2019, and I know that seems a long time ago. The world population growth and world's appetite for animal production, what was growing rapidly, and it was augmented by the fact that China had been predicted for many years, was dealing with massive animal disease issues that we're killing off the hogs called African swine fever, and bird flu, culling off chicken. So China had a huge appetite, not only for grains to feed their people and feed animals and oilseeds, but they also had -- they were buying up every type of protein in the world that they can get their hands on to feed their people. That started in late '19. So you started to see the global meat markets, the global oilseed and grain markets move up in 2020. Boom, February, here comes COVID, shuts down the world. But there's 1 thing that people had to do, and that was eat. Even though they were home, they continued to eat. And so protein and grain demand continued to grow rapidly during that time frame. And it's really when the lines cross into what I was going to call a demand-driven market versus prior commodity run-ups in grains and oilseeds, which would be supply-constrained markets. And that would be a weather event in North America, South America and the Ukraine. Ukraine now, as we transition there, we're in the midst of a demand-driven market with strong economies around the world, no matter what kind of news you want to read out there. People -- GDP's high around the world if the world is growing, people are eating and they want center-of-the-plate dining that includes protein. So that's the world we were in. It adjusted the COVID, supply chain is a little bit messed up, but not really on the food side. And then here comes Ukraine. The Russia-Ukraine conflict, and that's the #3 or 4 exporter of wheat, corn and sunflower oil in the world. And so that has been rapidly disrupted to the point that people are scrambling right now for shipments from what they thought was going to come from the Ukraine, that are being moved back to Europe or moved to South America. And so at the end of the day, the Ukraine helps feed the world and they're very important part of the world today. So any future disruption in the Ukraine from where it's at, will only carry this demand-driven cycle of higher grains inputs and food prices forward. What we can say today is at least today, the Russians have not disrupted the Odessa port or the demolished it. If Odessa gets destroyed, then that even extends the longevity of the next cycle here that we're in. But overall, your question relative to our business, the Ukraine and Russia are consumers of some of our products. Of course, with sanctions, we could no longer sell into there, but it's such a minor piece. We would say our total exposure to them was less than a couple of million dollars. And so the only thing I can look back and say what the smile was 2 years ago before COVID, I was headed to the Ukraine to make Darling's first investment and I passed on the trip. So it seems like a good decision at that time, but I still look long term on the Ukraine, great people, and a great agriculture production area in the world. But right now, it has a limited impact to us other than it's going to keep prices high for the products that we compete against.

Sure. And yes, you did a good job of backing it up and talking about COVID, so what is the impact of COVID on your business? How do you foresee the long-term impacts of COVID on your business? Where do you see all 3 businesses 5 years from now, have things changed materially for you? Or is the world just going to keep going the way it was with the demand side?

Yes. I mean, if I think of just kind of COVID impacts, the first thing was in the 2020 time frame and forward, we got deemed an essential service. And so that was both here in Europe and Canada and South America and China. So at the end of the day, we could operate while others were being locked down. So that was the good news for us. It taught us a lot about our workforce. It taught us a lot about how brave our people were and how important they felt that it was their obligation to take care of the food supply system while people were at home. What we've seen now in the business around the world and the impact, that's both direct and indirect, is obviously labor shortages. Our business is ancillary to the slaughter house business that typically operated on a 5-day work week, other than during barbecue season, kind of makes sense. But they're being forced to run 6 and 7 days now, because they don't have enough staff, labor, to finish the processing in the normal 5-day, 2-shift work week. That spills over to our business. And at the end of the day, we have to run longer and it's harder on our plants, harder on our people. So I don't see the labor issue correcting itself really in any near term. And then now we've got inflation in the world. I don't know that there's anybody out there in the industrial world that didn't have to give pretty significant raises to both attract and retain labor, and I'm talking nonsalaried labor. And so in the end, it's a good thing. We've got great people and better wages. And now -- but we've seen inflation move up to where a lot of that paychecks just going back to the gas station or the grocery store. So those are the big impacts of COVID, but really no disruption around the world other than some minor issues. I would say just kind of news to the world today is Beijing and Shanghai and other big cities are on lockdown. Northern China is short chemicals for food processing now, they -- because they can't be transported. They shut borders again. So the COVID situation is not over yet around the world. You're going to have to be reactionary to it. I think the bigger impact on our business, as we look around the world, is the cost of energy. We lived in a world here where energy was cheap for, I don't know, 7 or 10 years, you didn't even think about it. And at the end of the day, we're able to pass it along through our processing agreements. And as we look at Europe today, though, Europe has always been about 3x higher in energy costs than North America on a per unit or a like-on-like basis. Europe is really struggling right now, and we saw Germany this morning come out and talk about potential gas rationing. At the end of the day, it takes diesel to move our material, it takes electricity to convey it and gas to cook it. And so we're highly reliant on energy and the recovery of that. So -- but that's the real thing. And then the final piece on COVID to your question is really we've had to be flexible from a social perspective and learn to work from home. Like we're doing a call right now, I hope and pray that I never do another Zoom call in my life, but I don't think that's real. But it's not -- for us, it was really challenging, and I share personally with people to the culture. I spend or spent pre-COVID 200 nights a year on the road with our people around the world. And so trying to be that person virtually now has been a real adjustment. But we've done just fine. Work from home is something that we're all going to have to adjust to. I don't know that I put myself in a category of endorsing it, but it's reality in some cases. But at the end of the day, it's made us a more efficient business model here.

When I came to visit you in -- I guess I'm trying to think now -- I'm trying to think when I went down to visit the opening of Diamond Green Diesel. But I remember looking at the plant and just seeing how -- seeing this so outlandish and unbelievable. And then how many over years later, it's probably 1 of the biggest success stories in my gamut of investing. Could you give us an update on Diamond Green Diesel II and that plant opening soon? I mean you've doubled -- you tripled capacity. I mean, it's just wildly successful.

Yes. And it's something -- I always like to give a little bit of quick background on it. Why is a guy that grinds up animals, burn animals for a living in the hydrocarbon business? And the answer was, because animal fats, after they kind of lost favor for their saturation in the food chain, and then they're really -- they were destined to only assist in livestock production in as a calorie substitute in livestock production. And so we went after a technology to convert an animal fat into a hydrocarbon, meaning you take the oxygen and the water molecule, if you will, out of it, and thus, you have a true hydrocarbon. Because once you're deemed a hydrocarbon, then you're able to be transported within the incredible infrastructure in this country that moves energy. And all of this stuff, I know it's probably all kindergarten stuff for your listeners and investors, but it was really new to us. And in 2013, when we started the plant, it was serial #01. It had been done on a bench scale, but it's never been commercialized. And we learned a lot. We learned that animal fats, whether they come from fish, chicken, pork, beef, fresh animals, dead animals, everything is different. There was nothing homogeneous about any of the products. And if you think about the technology that was employed, it's not dissimilar to basic hydrocracking that exists within petroleum refineries today. But it's at a higher pressure and a higher temperature and a deeper saturation to break the molecule apart. So we started up on July 13 of 2013, I believe, and from that on, that was 137 million gallons. About 1.5 years later, we took the plant for debottlenecking to 160 million gallons. Two years later, we added the next train or 3 years later, to make it 275 million gallons. And then last year, in October 22, we started up plant #2 for another 450 million gallons, putting us at 750 million gallons, and we're 9 months away now from starting up #3, that would be about another 450 million to 500 million, putting us around that 1.2 billion to 1.3 billion gallon mark on a technology that from a market cap perspective, if you go back and look at it in 2010 when we started construction, it was a [ career batch ]. And we happened to hit the trend right, better lucky than good, I guess, in the world, as I always share with people. I've never made a bad trade. I've just lost a fortune in timing. But in this case, we got it right. And then we've hit the incredible decarbonization movement driven by the recognition that climate change is real, and we have an obligation to do something about it. And Darling and Valero are positioned right in the center of the fairway to really address it right now. And oh, by the way, what's it done? It's taken a product that was an orphan, dirty animal fats that were a discount to any other fat in the world by anywhere up to 50%, and created -- and made them now parity with their brothers and sisters. And so what's that done for the base model of Darling? Well, we were -- 2 years ago, we were a $500 million EBITDA business. This year, our base business will be $1 billion. And it's driven off of the demand that we created with the new market for Diamond Green Diesel and the decarbonization movement in the world. And so end of the day, that's the asset. Let's talk quickly about the returns. It's costing us low $3, $3.25 a gallon to build these facilities. They take special technology and special metallurgical demands. And the returns on them are somewhere around 35% to 45% cash returns on them. So not only are we happy as Darling shareholder, Valero is happy as a co-investor and partner in this, they've been incredible. And they're having incredible returns in the business, too. So it's a business when you combine the 2, we'll make $1 billion on this side of the ledger. This year, we're predicting 750 million gallons at $1.25 a gallon, which would then put another $1 billion, $1.1 billion on that side of the ledger, which half of ours, and that's where we get to $1.550 billion, $1.6 billion guidance for our business this year.

The actor in Castaway going to long -- on island and he's missing coming down and visiting with you and I think we all do. So that's the impact of Zoom on our team. What's the economic -- how much -- do you have any change in the put call on the Valero deal with Darling, DGD? And secondly, what kind of cash are you taking out? And are you liable -- refresh for us on any incremental CapEx or the balance sheet?

Yes. No, great question. So the relationship with Valero. I always give a little bit of history. This is all public out there. If you're a bored on a Saturday, you can go in the SEC documents and read them. But Valero was scared in 2009 and '10, we were putting the deal together that Darling will be acquired by ADM or Cargill or Bunge or somebody or private equity. And we were scared that we wake up and if you go Chavez, be our partner. And so essentially, what we put into the agreement was, well, for each of us to either sell our half, we had to have mutual agreement. And at the end of the day, that agreement rolls forward for 20 years. And then it has tag-along rights. We can't go build another hydrocarbon plant without Valero, at least getting the opportunity to participate, and they can't go build 1 without us having the same opportunity to participate. And so, it's a great marriage. To a degree, I know some people say, well, that sounds like a poison pill. It kind of is, but it doesn't mean Darling couldn't be bought. You're just going to be partners with Valero and you can't sell your half of Diamond Green unless Valero blesses it. So that's how the deal works. We are completing #3. The second question is cash. We're going to spend about $800 million of internal cash flow and we're able to fund a little cash out of both parents right now, as we accelerate the completion of Diamond Green Diesel 3. But it will be operational at the end of the year, and it will be paid for at the end of the year. So then in 2023, we would say, and as we're sharing with all our investors, we expect to have a free cash flow out of both businesses combined of right around $1 billion. And that's using the $1.25 a gallon that would come out of -- we're going to guess for 2023 at 1.2 billion gallons. So you got $1.5 billion cash generation, leave $100 million in for catalysts and turnaround. So you've got 1/4 split between the partners, $700 million into the mother ship here, and then plus $300 million or $400 million out of our base business, depending on where markets are. So when I said we're at a transformative inflection point for Darling, we will be in a position in '23 to make some really high-class opportunities and decisions. And I suspect that the Board is going to wrestle with repatriation of cash to shareholders from a 140-year-old company that takes forms and opportunistic buybacks, additional acquisitions and most likely, what I would say, to put in a meaningful dividend for our shareholders for the future, because...

I put some new meaning on Texas draw in terms of how you're pricing that deal up. Tony? Well, thank you so much Randy, Brad and Suann for being here. Hope to have you back next year. You did a great job, as always, love the conversation. And I hope to see Top Gun 3 is coming out in 58 days, not anybody's counting. I hope to see Top Gun 4 be Diamond Green dog fighting with sustainable aviation fuel. I'm sure you guys will have to do it.

All right, guys, thank you.

Thank you. Bye-bye.