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

Good morning, and welcome to the Darling Ingredients Inc. conference call to discuss the company's first quarter 2022 results. [Operator Instructions] Today's call is being recorded. I would now like to turn the call over to Ms. Suann Guthrie. Please go ahead.

Welcome to the Darling Ingredients First Quarter 2022 Earnings Call. Participants this morning are Mr. Randall C. Stuewe, Chairman and Chief Executive Officer; Mr. Brad Phillips, Chief Financial Officer; Mr. John Bullock, Chief Strategy Officer; and Ms. Sandra Dudley, Executive Vice President of Renewables and U.S. Specialty Operations. There is a slide presentation available on the Investors page under the Events and Presentations on our corporate website. During this call, we'll be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's press release and the comments made during this conference call and in the Risk Factors section of our Form 10-K, 10-Q and other reported filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. Now I would like to hand the call over to Randy.

Thanks, Suann. Good morning, everyone. Thanks for joining us for our first quarter 2022 earnings call. We kicked off the year with a very strong first quarter earnings of $330.7 million in combined adjusted EBITDA. Our global ingredients business had a record quarter at $244.1 million in EBITDA. Our food business earned $57.7 million in EBITDA, and our fuel segment ended the quarter with $110 million in EBITDA with $86.6 million coming out of Diamond Green Diesel. We are carrying solid momentum into 2022. Global supply chain challenges remain, while increased labor and energy costs are being addressed by our formula and spread pricing, and finished products pricing remains robust around the world. Starting with our feed segment. Globally, raw material volumes are up year-over-year, and we are not seeing any indication of livestock or herd reduction. Fat prices continued to escalate throughout the quarter. Protein prices improved during the quarter and grew sequentially. However, logistical disruptions due to container shortages have kept our prices lower year-over-year. Additionally, we saw some margin compression relative to Q1 in 2021, which reflects procurement process lags due to rising prices. We are working diligently to maintain margin structure in a higher energy cost environment, especially in Europe. Turning to our food segment. Performance grew year-over-year driven by our Peptan business, and our product mix shift from commodity gelatins to hydrolyzed specialty collagens. The changes we made in late 2021 have helped improve margins. I am confident we will see improvement in the food segment for the balance of the year despite supply chain challenges. In our fuel segment, escalating energy prices in Europe supported stronger earnings in our green energy electricity business. Our previously announced acquisition of Op de Beeck is contributing nicely and is under expansion. Now turning to Diamond Green Diesel. We successfully completed the turnaround of DGD1 during the first quarter. Q1 earnings for DGD were $1.11 per gallon in EBITDA. This is lower than our full year estimate of $1.25 per gallon, and it's attributed to rapidly escalating feedstock prices, while heating oil, RINs and LCFS did not have adequate time to react. As we head into Q2, margins are on the rebound. We are seeing higher RINs and steady LCFS prices. DGD1 and 2 are running wide open, and optimization programs are in place to increase gallons. Given these factors, combined with the start-up of DGD3 in Q4, we maintain our forecast of at least 750 million gallons at $1.25 per gallon EBITDA for the full year 2022. Last week, we announced 2 key strategic acquisitions to grow our base business: the completion of the Valley Proteins acquisition and our signing of a definitive agreement to purchase the FASA Group in Brazil. With these announcements, we will process more than 15 million metric tons of the world's available slaughtered animal by-products or about 15% of the world's supply. Valley Proteins, which closed on May 2 for $1.1 billion, plus or minus various closing adjustments, includes 18 new plants that process about 2.4 million metric tons of raw material per year and enough fat to produce approximately 125 million gallons of renewable diesel. This is a great acquisition and will be immediately accretive. For 2022, we expect contribution of $60 million to $70 million of new EBITDA. And under current market conditions, I anticipate the business contribution to be more than $150 million in EBITDA in 2023 as we address operational synergies. On May 5, we announced the signing of a definitive agreement to purchase FASA Group for BRL 2.8 billion or approximately USD 560 million at the current exchange rate. FASA Group processes more than 1.3 million metric tons of beef, pork and chicken annually through 14 rendering plants with an additional 2 plants under construction and has approximately 2,400 employees. FASA will augment our supply of low-carbon feedstocks to Diamond Green Diesel and will also be immediately accretive upon closing. We expect to close by the end of the year. The current operating EBITDA of this business is approximately BRL 500 million per year. Now I'd like to hand it over to Brad to take us through the financials, and then I'll come back with a little bit of an outlook for the balance of 2022. Brad?

Okay. Thanks, Randy. Net income for the first quarter 2022 totaled $188.1 million or $1.14 per diluted share compared to net income of $151.8 million or $0.90 per diluted share for the 2021 first quarter. Net sales were $1.37 billion for the first quarter 2022 as compared to $1 billion for the first quarter 2021 or a 30.5% increase in net sales. Operating income was $232.9 million for the first quarter of 2022 compared to $199.5 million for the first quarter of 2021. The 16.7% increase in operating income was primarily due to the gross margin increasing $71.9 million or a 26.2% improvement on higher volumes and record-high fat prices in our global ingredients businesses, while our share of the earnings from the Diamond Green Diesel joint venture declined $30.4 million to $71.8 million from $102.2 million the previous year. Additionally, the first quarter of 2022 included $3.8 million of acquisition and integration costs, primarily related to our acquisitions of Op de Beeck, Valley Proteins and FASA Group, as well as $4.6 million increase in SG&A. Now turning to income taxes. The company recorded income tax expense of $26.1 million for the 3 months ended April 2, 2022. The effective tax rate for the first quarter is 12%, which differs from the federal statutory rate of 21%, due primarily to biofuel tax incentives, the relative mix of earnings among jurisdictions with different tax rates and excess tax benefits from stock-based compensation. The company also paid $41.4 million of income taxes in the first quarter. For 2022, we are projecting an effective tax rate of 18% and cash taxes of approximately $60 million for the remainder of the year. Total debt outstanding at the end of the first quarter 2022 was $1.7 billion as compared to $1.5 billion at year-end 2021, and the bank covenant leverage ratio ended the quarter at 1.69x. The increase in debt was primarily a result of the acquisition of Op de Beeck and contributions to Diamond Green Diesel 2 due to the project's acceleration. Capital expenditures totaled $71.6 million in the first quarter, and the company repurchased $17.2 million of common stock. Lastly, you will note we added a $500 million delayed draw term loan A, which was undrawn at the end of the first quarter. With that, I'll turn it back over to you, Randy.

Thanks, Brad. Looking ahead, the business environment remains very favorable for Darling Ingredients. Rendering volumes are robust and growing with no sign of depopulating or herd reductions. Despite global supply chain concerns, we are optimistic as we have seen some improvement and better raw material availability. While European energy prices were up 250% year-over-year, we are working hard to minimize the impact and protect our margin. Darling Ingredients continues to lead the way in creating renewable and bioenergy solutions to combat rapidly rising energy prices and satisfy the world's demand for low-carbon fuels and decarbonization. We expect our green energy business in Europe to continue to flourish as we expand capacity to meet this increased demand. Diversifying our feedstock supply to support DGD from a multi-continent arbitrage has been our focus. Darling's access to low-carbon intensity feedstock is unparalleled in the industry. DGD's ideal location with access to multiple transportation options, our pretreatment expertise, our experienced team make DGD the lowest-cost producer of renewable diesel in the world, and our best is yet to come. Our global ingredients business run rate supports earnings of $1 billion to $1.050 billion EBITDA for the year without Valley Proteins. Valley Proteins is expected to contribute about $60 million to $70 million of running EBITDA in 2022. Adding in at least 750 million gallons of renewable diesel at $1.25 per gallon EBITDA, we believe a combined adjusted EBITDA of $1.55 to $1.60 is very achievable. This does not include any additional gallons that may even be produced at Diamond Green Diesel 3 in Q4. With that, let's open it up to Q&A now.

[Operator Instructions] Our first question will come from Manav Gupta with Credit Suisse.

So Randy, somehow you guys are always ahead of the curve. You figured out renewable diesel before everybody else did. Your facilities are now coming on. DGD 3 is coming on soon. and world is like -- your competitors are still figuring out permitting and stuff. So somehow, you're always ahead of the curve. And my question here is when we see the next leg of growth for Darling here, it appears between Valley Proteins and FASA and the deals you're signing with Chick-fil-A and stuff that the next leg of growth for Darling is going to be coming from the feed side of the business. I mean, you have DGD3 coming on. But when we look at DAR, the next leg of growth for the next 3 or 5 years is going to be on the feed side. So if you could comment a little bit on that, sir.

Yes. I think -- thanks, Manav. I appreciate the comments. And I got to say hats off to the global Darling team on bringing these acquisitions home. The Brazilian one, we worked on for almost 8 years. And the Valley Proteins one, we've been working with the Smith family for a number of years to bring that one home as well. I think we talk very openly about kind of a 4-legged approach to growth. And we, in this room, with the management team still view Darling as really an excellent growth vehicle around the world. We don't see our growth anywhere near done in the near future. And so I'm going to talk about 4 paths of growth here. Number one, that's our green electricity business in Europe. We continue to see the opportunities to add digestion capacity. Op de Beeck, an example, that's going to grow substantially in volume given energy prices in Europe. It's a very lucrative investment. But most importantly, it allows us to arbitrage different raw material streams that typically could go to landfill or can go to landfill and make energy out of them. So it's a very, very good investment. So that's the green energy side. You got to move to Diamond Green Diesel. We're not done there yet. I mean, jet fuel. I mean, you saw the United announcement here this week. I mean, we are not, by any means, discounting the fact that we won't be making SAF here in the next couple of years. We're just going to let the policy evolve before the CapEx is spent here, and we believe there's just adequate gallons there eventually when the policy supports that. So that's number two. Number three, you will see the food segment accelerate for the balance of the year and next year. We've built a special product and a product line there, and it's expanding into our biomedical area now. That gives us really a neat opportunity to add significant earnings without volatility. And that's a very different business in the sense it uses slaughtered animal by-products raw materials. But at the end of the day, it's more of a specialty ingredients business than anything else we're in. And we've got a great team there that's moving it forward. So as we look, we've got the green energy. We've got Diamond Green Diesel expansion, SAF. We've got the Peptan business that we're working on growing. And then the fourth leg is clearly the -- what we would call our global ingredients business, our core rendering business. Valley Proteins was the #2 independent processor in the United States. It is a great team, great locations where we're not at, basically 50% the size of Darling USA rendering operations and volume per week. And I think it's very easy to look back historically what Darling post National By-Products, post Griffin in the 2011, '12 can make. And then we're almost -- we're about 60% bigger now in North America or the U.S.A. than we were at that time. So that's where we're trying to telegraph that Valley Proteins will be incredibly accretive to this company once we get it integrated and once we get the margin structure, the operations and get it to look like the business that we have. Moving south to Brazil. We've talked openly about Brazil for a number of years. We are a very successful company in Brazil today. Adding these factories to our Brazil management group and our team and our structure just made a lot of sense. Brazil will feed the world. And we absolutely believe that animal agriculture, while it may come under challenges in Europe and maybe to a degree at times in Canada or the U.S., Brazil is still the Wild, Wild West relative to growth in animal agriculture. And we have 14 factories and 2 more under construction. They're spread out throughout Brazil to allow for growth from the south to the north as Brazil expands. And so I think the thing that's interesting, and I'm sure Sandy will comment later today, but we're already importing fats from Brazil into Diamond Green Diesel. That goes with the logistics that we've always talked about of location, location, location for Norco or St. Charles and Port Arthur. So the FASA Group was an immediately just a very simple idea that we've been working on for a lot of years. It's being procured or bought from a private family that we know very well. The management team is going to stay in place for 3 years to help us continue to grow. So those are the 4 paths: green electricity, DGD, Peptan and core ingredients growth. We continue to see many, many opportunities still around the world in the core ingredients growth, including additional factories that will be put under construction here in the U.S. once the agreements are signed. So we just still see Darling as a growth vehicle, Manav.

Perfect, sir. My quick follow-up here is sometimes, as analysts, we focus too much on fat prices, RINs prices, LCFS, and we sometimes don't give enough credit to the fact that Darling, at the end of the day, is a technology innovation company. You spent so much time on collagen peptides and figured it all out, and it's doing very well. So can you talk a little bit about your R&D efforts, R&D pipeline? What's that looking like? And when -- where could the next leg of R&D take you? And I'll leave it there, sir.

Thanks, Manav. This is John. At the end of the day, we have tremendous expertise in taking the by-product material from the meat industry around the world and turning it into a variety of different products. What Darling, I believe, has been really good at is we focus on the value of the finished products. We're always out there trying to figure out where our customers and the world is going to take us for demand for our products. And then we work backward from there, trying to figure out how to create the most efficient and best supply chains around those great products. And what you see inside of Darling today is we've got rock star, and I mean rock star low-carbon products across the spectrum of biofuels as well as into fixed energy and electric and gas in Europe. We have rock star products on the Peptan side. And when you start with what's the value of the product, where is the marketplace going from the demand of the product, and you listen to your customers, then you are able to rebuild the innovation. Our innovation pipeline today is tremendous. We're working on a variety of new products that our customers are coming to us and saying, "This is the future. This is where we would like to see you bring us products." And we're really good at going back in because it's just such a broad range of expertise along different product lines around the world, different geographies. We understand various cultures around the world very well. We have an ability to internalize those products and design that structure backwards. And I will tell you today, the pipeline is more robust internally than it's ever been. We have a very exciting platform of products that we are working on now developing with our customers, but it's all about the finished products. It's all about creating a product that the market wants.

Our next question will come from Ben Kallo with Baird.

Congrats on all the work. Maybe a boring question. But just on the leverage, how do you view that, Randy or Brad, when we look for -- I think you ticked up in the Q I saw up to 5x, and you've been there before. But maybe just remind us about the cash flow DGD splits out and how you think about the leverage going forward.

Yes. Ben, this is Brad. So you followed us for a while, and what we've tended to do is certainly delever down to where we've recently been. And as Randy just articulated and John, we have been, we still view ourselves as a growth company. Having said that -- and we lever up after Valley, if we're a bit over 2x, with FASA, we will delever the -- we're in the process already delevering. Our cash flows are tremendous. DGD coming online now in the fourth quarter this year. So having said all of that, we still have the big picture from a leverage perspective of staying after the dust settles from acquisitions each time you see what we've done, we've gotten below 3x, well below 3x. And that's really still our mantra and our strategy.

And Randy, you said we're not finished with the DGD, and you talked about -- is there -- as you make acquisitions to underpin feedstock, is there -- what's the thought about what's next? I hate to ask that question. But what's next in terms of a new plant?

Yes. Ben, so this is Sandy Dudley. I think we're right now working on initially trying to complete DGD3. But that said, while there's not an investment decision on the table, we purposefully left space at Port Arthur that would work well for a DGD4 or SAF if the marketing conditions are right. And I think if you look at both us and our partner, it would be a huge underestimation to say that DGD3 is the limit for us. I mean, if you look at our partners, they've done a whole lot beyond just petroleum. And then you look at what we've done as Darling, we are a great low-carbon feedstock business, a tremendous food business. And then we have an unparalleled renewables business. And then if you look at what we did together, we created DGD. So I think that there's a lot more for us. I think we purposefully positioned ourselves within the market and how we built DGD3 to take advantage of whatever opportunities make sense for us going forward.

Our next question will come from Adam Samuelson with Goldman Sachs.

Yes. Randy, I was hoping maybe, first, if we could just think about the updated view on the base business for the year. And I think in your prepared remarks, you said $1 billion to $1.05 billion for the base and then another $60 million, $70 million or so of EBITDA for Valley. Could you help us just frame kind of how the key moving pieces of how that's changed relative to where you were at the end of February? And specifically, is that just assuming forward curves on fats and oils from here? And then I have a follow-up on Valley.

Yes. No. Adam, what -- essentially, it's a bit dynamic and a bit crystal ball-ish here a little bit. But we're looking at the Q1 run rate, and then I'm looking at April now and basically doing -- rendering math, divided by 4 times 13 and then extrapolate now. So it's very simple as we look at the run rate. And we have not seen the higher fat prices flow through the business. Remember, we're 60 days sold out in front at most times now relative to the supply chain to Diamond Green Diesel, so you get a bit of a lag. So you're going to see Q2 much higher in the global ingredients business than Q1 because of the fat prices flowing through. Protein prices, while better sequentially, lower year-over-year, a whole bunch of different reasons going into that. But still, at the end of the day, somewhat at or near in many places to soybean mill. And as long as soybean mill doesn't crash, we should be good there. The Rousselot and the food ingredients business is really just starting to ramp up as sales move forward here, and so we feel pretty good there about it. So it's a pretty simple math of extrapolating the first quarter and then take in April, divide it by 4 times 13. And that will put you at the -- basically the $1.050 billion run rate. And then Valley we believe will run at about $8.5 million, maybe up to $10 million a month here for the balance of the year, and there are 7 months left. And so that's not added in there yet. We're still -- we're really on day #8 of Valley, so it'd be kind of hard to tell you. Remember, while it was in Hart-Scott filing, in today's world, you didn't get to do a lot of deep dive into people, places and pricing, if you will. And so now we're just getting into it. The benchmark for next year there is just simply saying we should be able to get the similar margins out of that business operationally and marketing-wise and product mix-wise that we have in our base business. So that's how that's all extrapolated. And then Sandy's numbers are 750 million times $1.25, divided by 2. And that's how the -- that's the magic math. I don't know that, that works in Goldman Sachs quantum physics class, but that's rendering Randy's math.

I'm no quantum physician, so I appreciate that. But on the Valley Proteins for next year and just thinking about getting that business to more in line with your legacy U.S. business, can you talk about where the bigger opportunities were? Is it product mix on some of the -- moving some of the poultry by-product into pet food markets? Where was the gap in terms of their performance and their operations and their mix that you're so excited about?

It's a little bit of everything. And number one, when a business goes for sale and management teams and operating teams find out they're going to have a new owner, it becomes a bit of a challenge to keep momentum. And I would say they lost a little bit of focus and momentum around the business. There's a little bit of capital. It's not giant numbers that have to go back into this to bring it up to our standards. But you start to look at specie-specific, moving different products around. We look at what we're selling product for versus what they have sold product for and saying if they would have only sold the product at the same price we did or near, that's a significant number. There's 1,900 people in 18 factories. I mean, simple math again, 105, 110 people. There's a lot of people that we got to figure out what they're doing. And then you look at it from a yield standpoint, from an energy operating cost standpoint. And we see significant opportunity there to teach the organization how we do it. I don't want to ever say we're the best of the best, but I think we're pretty darn good at what we do. And when we benchmark ourselves against them, if we can get them to where we're at, it is very easily the achievable $150 million number next year that we're throwing out there.

And if I could just squeeze one more follow-up. Where are spot margins in DGD today? And how is the backward-dated kind of diesel curve kind of impacting kind of your margin capture?

You want to take that, Sandy?

Yes. So diesel spot margins today are well above where they were for Q1. They're getting closer to the $1.50 to $2 level. It just kind of depends on the day where the RINs prices, feedstock prices, et cetera. It's so well above what we saw the last quarter. So that's positive. And I think that -- if you look at where we're estimating for the year to end up at $1.25, that probably looks like a pretty conservative estimate at this point in time. So we're really happy about that. In terms of the backward-dated curve, the backward-dated curve for us, what we do is we don't necessarily hedge our volumes out to the front month. They're going out to further months, and so we're not capturing that full front month value that you're seeing.

Our next question will come from Ben Bienvenu with Stephens.

I want to ask about your acquisition strategy around continuing to build out your feed ingredients business. Strategically, it makes all the sense in the world, and I think you guys are in a relatively unique position in that your vertically integrated renewable diesel production positions you to acquire these assets. I would think without a lot of relative competition for these assets, the multiples you're paying suggest that. Can you talk about the potential, though it seems remote for the competition, for these types of assets grow and when you think about the value that you can add to these businesses when you buy them, given your long history of running and operating these types of businesses efficiently, how that positions you competitively relative to potential other suitors for these types?

Yes. This is John. I mean, first of all, thank you for asking that question. This is something we sit around all the time and wonder especially, quite frankly, when we see the multiples that others are valued in the marketplace. The reality is this, the feedstock supply position that we've established around the world in today's marketplace would cost an insurmountable amount of money for anybody else to come in and try to replace. But more importantly than that, the supply system associated with low-carbon fats is a complicated supply chain. These are complicated supply chains to our plants. Our plants are complicated to run. And the sale of the product in the marketplace and the supply chain is a complex mechanism to operate. So if somebody went in today's market, which basically what we've seen in recent acquisitions with others, if you look at what you've heard in the marketplace in relationship to other acquisitions that have occurred out there that we haven't been engaged in, you would see multiples in the 12 to 18x range. If you went out to try to replace the size and scope of our system at those types of multiples today, you would have to break a bank to come up with enough money to do that. So the reality is we're hard to duplicate. In fact, were impossible to duplicate. Now it's pretty easy to set up a trading desk and put a guy at a desk with a telephone and say that you've got procurement expertise on fats. You've got the ability to call us up to try to buy fat and others like us, but you don't really have the ability to source fat from its origin source, which is what we do. We go out to restaurants and pick up the fat. We go to slaughter facilities and pick up the process and -- material and bring it in process. We go out and pick up the food plate waste and come in and turn that into bioenergy. The reality is that system is very, very difficult. Nobody else has that. Nobody else has the vertically integrated position in this marketplace, and it seems to be the best-kept secret in the entire industry.

Yes. I would add, Ben. I mean, it's a very special business that we put together over the last 20 years. Clearly, the marketplace is still trying to understand what we have and what the competitive advantages are, I mean, scale, geographic, people, expertise, product line. When a meat processor around the world, whether it's in Brazil or China or Australia, thinks about it, the first call is to us now because they know we can derive maximum value for them with the product line that we can convert their by-products into and thus essentially pay them more, make them more competitive and help them grow at the same time, meeting our shareholder requirements growing. Like I said, we still see the world as our oyster. John was talking about it. I always like to give a little joke about it. I mean, RTI traded out there at 15, 16x. You got 200 million pounds of fat. Well, that's great. Well, we got that with Valley. And, oh, by the way, we got the 18 other rendering plants for free. So it's really how do you look at this stuff. And this is really a very special platform around the world that has -- it always has competition, but we have such a position now. I think it's very defensible, and it will continue to grow.

That's great. Yes, definitely an enviable position to be in. My second question relates to cash flow and less looking for a direct answer and more helping -- hoping that you can help us think about calibrating strategically. And the question is I think we've certainly been guilty of this, focusing a lot on what might the distribution of cash flow from the joint venture be back up to Darling in 2023 or beyond. And I'm kind of stepping back and seeing -- or thinking now that you're making acquisitions across the feed ingredients business. You're investing into organic growth of the business. You're buying back stock, talking about potentially SAF down the road, if the economics line up. And I guess it sounds more like you've got a lot of opportunities that you might pursue, and the returns will dictate where you put the capital to work. But as we get closer to what's likely to be a very sizable amount of free cash flow coming back to the business, have you considered setting up a framework or structure to create some predictability in our expectation of where that cash might go? Or is it truly going to be variable depending on the environment?

No. I think, Ben, I mean, you articulated about 6 hours of the Board meeting the last couple of days there. And to be honest with you, yes, I mean, we will be articulating that. I mean, number one, we will maintain and our goal is to become investment grade and maintain sub-3.0 leverage. So if you say $1.1 gets you to the trajectory of delevering after the growth that we've done here, that's very simple to do given the massive amount of cash it's generated. Number two, John Bullock has projects that will compete for capital. And number three, we'll continue our share buyback on an opportunistic basis, just like we've done. We're committed to that. And fourth, if there's any shuttles left in the cigar box, then the Board will have the opportunity to put a dividend under it in '23 to be meaningful. So there's going to be a balancing act of all 4 items with the number one being maintain the leverage at investment-grade levels or below; number two, fund the growth as we see it out there that has reasonable returns; number three, buy back stock when it makes sense, when that is the best investment and it makes sure we don't dilute anybody at any time; and four, consider a dividend when it makes sense here. And so I think that's exactly what you're going to see us do, and we'll be -- we're going to be committed to it.

Our next question will come from Thomas Palmer with JPMorgan.

Maybe follow up on Adam's question on DGD's economics and dig into some of the factors that maybe could cause DGD to vary from the spot rates you cited. So I'm just going to list a couple of things. So first, I saw you have an approved pathway in California for renewable naphtha. Have you started selling into LCFS markets with that? Second, the derivative losses were pretty sizable last quarter. At this point, should we expect additional losses in the second quarter? Or is it mainly going to be isolated to that first quarter? And then third, to what extent should we factor in start-up costs at Port Arthur as we look at the fourth quarter?

Sandy?

Yes. Okay. So I guess I'm going to start with our feedstocks or hedge loss because you brought that up. So typically, what we do at DGD is we buy our feedstock months in advance. And when we do that, generally, what we try to do is we try to hedge the spread between the feedstock price and the diesel price. That means that we're putting on hedges in the months in which we plan to sell the diesel. That's typically not the front month. So that's, in part, an answer to your first question why we don't realize the front-month margin. So basically then -- and because we're putting those hedges on and specifically within Q1, what we saw is we saw that, that diesel price continued to climb all quarter long. And what that meant then is it meant that we were buying our hedge back at a higher price than what we put it on at. That's what created the hedge loss. And in terms of what we expect going forward, we don't know where diesel prices are going to go. We're not going to spec the spread. We have a normal hedging policy that we're planning to maintain, and so where that falls out is where it falls out. In terms of Port Arthur and margins and where we think things are going to go, we think that there's a lot of support within the market. What we've seen recently that was different than what we saw really in Q4 as we saw that RINs really responded as well, and we continue to think that RINs will respond in order to incent the marginal producer. And we are not the marginal producer. So we do think that we'll have good values when Port Arthur comes online. We have very low carbon feedstocks that we utilize, and we're fortunate for that. And so I don't necessarily anticipate anything different with regard to Port Arthur, but we'll see. We'll see how the market reacts to that. We do see -- we're also seeing some movement in sort of LCFS prices, which is a good sign. We've recently seen those kind of pop back up. I know that CARB recently came out with their report on the Scoping Plan or there was some initial discussion with regard to the Scoping Plan where they were talking about considering increasing the targets both before and after 2030. So that's very positive. And I don't know if that's what's driving the increase in the LCFS prices, but I think that those will continue to strengthen there. So I think that the market looks very positive going our way, and that's again why we're seeing better margins going into the future than we did in Q1.

Maybe just to follow up on the FASA acquisition, what's the structure of the rendering market in South America? Is its formula contract similar to the U.S. or structured differently?

This is John. There's a combination of formula contracts and then also some just contracts where we're pricing versus the marketplace. I think the critical issue that we see in Brazil with FASA that we see in all of our rendering operations is that we have the right locations in relationship to where the slaughtered by-products are being created. So we've got the really good economics. We can give a really great deal back to our raw material suppliers because of how we're positioned in those marketplaces. And kind of the form and substance of whether you're doing it on a long-term contract or whether or not you're just buying them what the current market is and passing along that value back to your raw material suppliers, I think it's sometimes overestimated. We operate very different models in every continent that we operate in. But the fundamental thing is this: Are you in the right location with the right processing capability to support the people that are providing you with the raw material products? And if you are, then you've got a great business model.

Our next question will come from Ken Zaslow with Bank of Montreal.

I'm going to try and do some Bank of Montreal math, maybe not that complicated, but let me just try this out. If you're guiding this year to $1.1 billion for the rendering, and you have another $150 million of incremental profits coming from Valley, that seems to add up to about $1.25 billion for next year without any changes. And then if I think about the Diamond Green Diesel going to about 1.3 billion gallons next year, holding margin at $1.25, that's kind of close to about $800 million. Is there anything wrong with Bank of Montreal math?

I would say, okay, we're guiding $1 billion, $1.50 billion in the base business, add $50 million to $60 million for accretion from Valley this year, so you could say up to $1.1 billion there, the increment -- so I call it -- that's an incremental $100 million over the $50 million this year. So if prices hold, volumes hold, then yes, you could go $1.1 billion to $1.2 billion next year. And then I'm looking at Sandy, if $1.2 billion is what we're saying, you're rounding up to $1.3 billion now. I'm not allowed to do that, although I kind of believe it will do that. And you're right. I mean, that is Bank of Montreal math, and I love it.

And that also excludes FASA. Is that also true?

Yes. And like I said, it's at a $500 million or up. Divide it by 5 on the real, plus or minus a couple of bps there. So it's on a USD 100 million run rate right now.

Okay. And then also just to make sure I fully understand this, what new capacity for you guys is coming online this year on the food side? And does that add incremental profitability?

We have one unit coming on to expand our Peptan capability later this year. And that's the...

So that's also -- so that would also be marginally incremental as well. Is that fair?

In '23 as it comes on. It's supporting the growth in the hydrolyzed collagen business for next year.

Okay. All right. I was just trying to just do BMO math. And then the second question I have, just to double-check on this. Next year, when you -- from the Diamond Green Diesel business, if you pay a dividend back to yourself, that could be used to deleverage the balance sheet. So leverage is really not an issue that I should know about? Or I know, Brad, when you discussed the leverage, you're talking about generating tons of cash flow, but you also have this Diamond Green Diesel dividend that might be coming back next year. So that also provides a little likelihood of deleveraging or am I misunderstanding that as well?

No. I mean, using the math that you generated there, yes. I mean, if we snapshot the world as of May 2 or whatever, Brad, we're what, 2.88 levered with something like that, plus with Valley in there now?

With Valley.

So I mean, we're where we want to be right now. And then if we start pulling dividends of $400 million to $600 million out of Diamond Green next year, on top of a core run rate that has $1 billion number in it, they're somewhere between $700 million and $1 billion of free cash to, like I said, do 1 of the 4 things that we're going to do.

Okay. And then my last question is when I think about SAF, what is the pathway to that? And what will be the key milestones for you to be aware of that? And then I'll leave it there.

I think the big milestone for us really is to get a tax credit put in place. That's really the main holdup, so we need to see what that looks like and see if it makes economic sense before we want to make an investment decision on that.

Our next question will come from Matthew Blair with Tudor, Pickering, Holt.

Randy, you mentioned that DGD is pulling some feedstocks from Brazil today. What percent of DGD's feed is imported now? And looking forward, do you expect the U.S. to pull an increasing amount of global feedstocks to support all this R&D growth? And if so, it seems like your Gulf Coast location could be pretty ideal. So I was hoping you could comment on that.

I'll comment a little bit and let Sandy put her thoughts together. I mean, clearly, we have the arbitrage flexibility. We're bringing stuff from all over the world today into Diamond Green Diesel 1 and 2, and obviously, we will at 3. I mean, that's the beauty of those locations, receive by water, can ship by water. And as long as the U.S. is really the leader in low-carbon markets and as long as the capacity is here, not in Europe, then yes, we'll continue to originate. Sandy, you want to comment a little bit?

Yes. I think as we have expanded our capacity, then we've drawn more international feedstock into the mix. I would expect that we would do the same once DGD3 comes online, and I think we want to do that because we have the unit that can run the cheapest fats. And so we want to do that so we can create the highest margins. And so we're fortunate that we sit in the Gulf of Mexico and where we do and that we have the capabilities that we do with our unit that we have the pretreater that we have just tremendous logistics and that we can bring in whatever the cheapest fat is from wherever that is in the world.

Great. And then thinking about the $1.25 EBITDA guidance for 2022, I was curious if you view that as somewhat of a floor, just considering that some of your competitors seem to be struggling even to stay like cash breakeven in this environment. So is that $1.25 a floor in your mind? And then also, does that $1.25, is that enough for you to support additional R&D investment?

Yes. I'll try to answer that a little bit, and maybe John will want to pipe in. Number one, as Sandy said, we look at the ability of the feedstocks we can run and originate from around the world that gives us an incredible competitive advantage. You heard about the pathway on naphtha now that's out there, the CI scores that we have, the supply chain between us. No one ever talks about Valero's supply of corn oil. I mean, that's important into this facility. So $1.25, I always hate to use as a floor. But right now, with what we see, obviously, with the inverse or the backwardation, I had to learn what that word meant in the market. Clearly, as we go forward here, it looks like it's conservative with what we see. And going forward, nearby spot margins are quite a bit above that. But as we work through the volatility and then the world dealing with renewable demand -- rather with the higher oil prices, we'll see. Keep in mind, $1.25 against the $3.30, whatever, a gallon investment is still an incredible return for us as we go forward. Sandy, John, anything you want to add?

Yes. I think the only thing that I would add to it, and we've talked about this a lot in the past. We have built a machine that is the right machine in the right location with the right expertise and the right capabilities. And essentially, what we have is a Swiss watch. We are fully capable to maximize margins in the environments that we'll develop in the future. We have a lot of folks out there that are not building Swiss watches. They're trying to come out with the cheapest knockoffs they possibly can to try to participate in what looks like a massively lucrative business. This is a very good business if you're in the right location with the right machine with the right logistics with the right people. If you're not, it's not so much fun, and we're starting to see that from some of these other guys. So margins will go up and down over time at Diamond. We're fully confident that we built the right machine with the right partners, and we're prepared to compete for the long haul. And we think that margin structure is going to be solid for us. And as Randy said, at $1.25, it remains the best investment that you could possibly have in ag or energy in the world.

Our next question will come from Sam Margolin with Wolfe Research.

Quick one on this green energy initiative. Maybe you could elaborate. I guess we're talking about RNG digester gas. And I was just wondering, given it makes sense, right, given where energy costs are in Europe, is this a business that you imagine as kind of an internal, almost like a cogen business? Or are you planning to distribute what you produce to third parties?

No. This is John. We've been engaged in digestion in Europe now for a very long period of time. We ran one of the largest digesters for -- since we bought VION and our Son facility in the Netherlands. We recognize this. It's interesting. Low carbon -- everybody has been focused on just low-carbon biofuels, and that's a very important marketplace. However, in Europe, you have a fundamentally different pricing structure. The price for fixed power is so much more expensive. This is before Vladimir Putin invaded Ukraine. It's much more so today. But even before, fundamentally, they had high natural gas prices, and that led to an extremely lucrative market. They have also developed policies that support fixed power generation, similar to what we've talked about as a renewable electric credit in the United States that's never been fully baked into the regulatory scheme in the U.S. It is in Europe. And so we have the expertise -- again, running digesters is a tricky proposition. We have great internal expertise. We've expanded Son over the years. We've put a unit into our Denderleeuw facility in Belgium a few years ago, expanded that. Just recently bought Op de Beeck. And we continue to look to expand that business because we just think, fundamentally, it's a great place in Europe to take advantage of the low-carbon fixed power market because the marketplace is structured such that it makes a lot of sense to be engaged there, and the regulatory scheme is extremely friendly to being able to be in that industry. So again, we're in the right place at the right time, but we've not sat on our laurels. We've rapidly expanded that with an absolutely fabulous European team we have working on this.

Yes. Sam, the supply chain there is obviously we can divert different streams from plate waste that has to be recycled to manure. We're in partnership with a Dutch farming community to a different animal by-product streams that are not allowed to go back into feed. And clearly -- then from there, you obviously make the gas. We convert the gas to electricity through the turbines, and we make bio-phosphate fertilizers then that go back into the marketplace. And so it's just a natural for us. As John said, we operate the largest facility in the Netherlands and Son. We built and have doubled and tripled the size of our Denderleeuw Belgium facility, and now we added Op de Beeck. And we still see 3 or 4 different opportunities throughout Europe from Poland on to Germany that allow the same thing because of the -- if you think of it, it's the logistical supply chain. You got to have the trucks to collect the material. It's no different in a sense from the used cooking oil business in North America. We're just picking up different streams. And instead of settling or purifying used cooking oil, we're converting it back into green electricity. So it's a very natural fit.

Got it. And then -- just a quick one on food. I mean, if I kind of look at the margin progression and I overlay that with the way you talk about the segment in terms of mix benefits and new products, it looks like we are almost at the finish line of the new product contribution kind of overwhelming and making up for the energy cost headwind that was hitting margins earlier. Do you think that -- is that a fair assessment? And then on the margin side, is that just going to keep going where now that business has essentially fully absorbed the energy cost impact, and now you're just sort of banking the mix benefit on the collagen side and...

Yes. I'm not totally sure that I understand the question. Let me comment generally about the segment. We have seen tremendous margin improvement in our food segment because we were an early adopter into the Peptan space and have been able to divert a lot of products towards that much higher-margin product marketplace because -- and the demand in that marketplace, I have to tell you, is absolutely stellar. And we don't think that, that stops. So we still think there's plenty of opportunity for us to grow in that space, and we work hard on that every day to take advantage of opportunities to grow. I'm not quite sure I understand the energy cost component of what you were asking us.

Well, the question is so you had margin benefits accruing from product mix on the Peptan side, but it wasn't accumulating to full segment margin gains, right? Year-over-year, you have a little bit of a decremental margin in food, so -- and I'm attributing that to energy costs. And so I'm just wondering if now that energy costs -- maybe plateaued, we're sort of through that process. And you'll start to see food margins expand because there's nothing interfering with that.

Yes. I think -- Sam, I think there were multiple things, obviously from COVID disruptions, container freight disruptions, energy price escalation, raw material price escalation, that all impacted that food segment really. Instead of going into hyper speed, it stayed back on cruise control last year. We're starting to see that now accelerate in first quarter, and we think it will continue through 2022, and then we bring on some more capacity in '23. So I think you'll see an improvement there. I think -- is that fair enough, John?

No, that's exactly right. Energy was part of it, obviously. But there are, as Randy said, a variety of factors that just kind of flush together that kind of delayed what we thought was going to be the impact coming out of this. But now we're starting to see it, and then it looks like it has an excellent growth curve to it.

Our next question will come from Bill Baldwin with Baldwin Anthony Securities.

Okay. I wanted to see what insights you could offer regarding your rendering volumes in Europe. You indicated you're going to have roughly around 15 million metric tons globally with the acquisitions that you made. Where do we stand in Europe in terms of those volumes? And what are the trends there? Are they static? Are they growing? Are they declining? Kind of what -- can you give us a feel for that?

Well, I think, Bill, we had about 11.5 million tons, added 2.5 million, a little under, with Valley and another, a little under $1.5 million with FASA. So that's where the 14-something million, rounding to 15 million comes from. Never really broke out Europe. But what I can tell you in Europe today, the volumes are actually up year-over-year right now, pretty steady. Animal agriculture is under attack a little bit in Europe today, really what climate change and what's to do with the manure. We've seen some animal disease issues in Europe. ASF, up in Poland, a little bit into Germany. And then we've seen some bird flu issues. Now remember that while the bird flu side depopulates in Europe, anything that does with animal disease gets brought into 1 of our 7 Rendac plants to be disposed of. So we benefit on both sides there. But really no material changes, I mean, yet today in animal production or demand in Europe. John, Brad, anything that you...

No, I think one of the interesting things that we've seen, and it was interesting when COVID started, we sit around and worried about what was going to happen to our volume, and it didn't go down, and it went up. And then as we've seen supply chain disruptions around the world, we sit around and worry that our volume is going to go down, and it goes up. The reality is the demand consumption by the world now, while everybody complains about prices, people are still buying. And so we see tremendous volumes continuing to flow through our facilities. And that's part because we keep bringing on additional production capability all the time to be able to handle that. So it's great right now.

Yes. And I think, more importantly, in North America, we're still running plants around to run 6 days to make 5 days of production in the meat business because of labor shortages. I mean, it's just universal. So I mean, clearly, the demand is there, and they could run more if they add more people. So it's -- we're optimistic for the year that volumes will remain robust, and they're up 3.6% year-over-year right now during Q1.

Yes. That's been -- but we expected volumes will be pretty good here in the early part of the year. I think kind of felt like they might trail off a little bit in the beef as you got out towards the latter part of the year, but it sounds like you're not really expecting that, Randy.

Not seeing it yet.

Right. Last question. Can you -- as far as the European rendering, can you offer a little bit of a species breakdown as to percentage of beef, pork and poultry that you process through your rendering plants there? How does that kind of stack up?

Well, this is John. There's less cows in Europe. There's a whole lot of chickens, and there's a whole lot of pigs, but we're both -- we're engaged heavily in both of those.

Yes. I mean, Germany is clearly a beef country. Holland is a lot of pigs, and Poland is a lot of chicken. So it's pretty much -- it's a pretty similar mix to what we have in North America here. So it's just a differential which country because you've got more pasture land, obviously, in Germany.

This concludes our question-and-answer session. I would like to turn the conference back over to Randy Stuewe for any closing remarks.

All right. Once again, thank you, everybody. Appreciate everyone's time today. Hope you stay safe. I look forward to seeing you some time at any upcoming events. Next week, we'll be at BMO presenting there, and I look forward to everybody catching up and staying healthy and being safe. Talk to you soon.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.