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

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

Thank you for joining the Darling Ingredients special investor call to discuss the acquisition of Gelnex. Here with me today are Mr. Randall C. Stuewe, Chairman and Chief Executive Officer; and Mr. Brad Phillips, Chief Financial Officer. During this call, we will 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 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 statements. Now I will hand the call.

Thanks, Suann. Good morning, everybody in the U.S. and good afternoon to all our shareholders and colleagues and friends in Europe. We're broadcasting live from one of our latest acquisitions last spring at the Antwerp Belgium at UPA Quebec, one of our new green energy investments where we take a lot of 250,000 to 350,000 tons of plate waste, leftovers from grocery stores, delis, commissaries and turn it into green electricity and organic biophosphate fertilizer. So it's great to see the team here and see the facility that is now part of the Darling family. Today, we wanted to get together and kind of remind everybody what we're doing and why we're doing it. I think as we've been on the speaking network and both in Europe and the U.S. and South America. We've always talked about 4 pillars of growth. And the pillars of growth were sustainable aviation fuel. We'll continue to keep you up to date as we evaluate those economics. Additional basic specialty ingredient to processing the core rendering business, that would be Valley proteins. That would be the FASA Group in Brazil. We talked about all kinds of different things, but one of them that was very near and dear to us was the collagen business as an expansion mode for us as we look forward. Today, we wanted to talk to you a little bit about a deal that we had been working on for some time. I think we've been very open with people that if opportunities come through the space that we will continue to look at them and take opportunities to grow when they can be done in a friendly, accretive manner. In this way, the Gelnex acquisition once again meets the 3 criteria near and dear to the success of our management team. And that is we're buying a great business with a great management team. We're paying a fair price for it, and Brad and I'll talk to you more about the capital structure that is going under it. I know there'll be lots of questions there, but I think as you've seen or if you were connecting the dots over the last 3 months, you would be able to then know that the delayed draw of loans that were put out there were being put in place in case we were successful on this. So today, Darling entered into a definitive agreement, as we said, to acquire all the shares of Gelnex. I would refer to them as a top 4 leading global producer of collagen products. That's both gelatin and collagen peptides for approximately $1.2 billion, and that's U.S. dollars. The transaction is really the same as all of our deals. It's subject to customary regulatory approvals. And we are hopeful that we can get this done through the Brazilian authorities sometime during the first quarter of 2023. It's headquartered in Brazil, in Santa Catarina. It has 5 facilities in South America, but more importantly, it has one in Paraguay. So once again, we're growing the Darling footprint to another country. It produces a little under half of what we do today of 46,000 metric tons of collagen products and it exports about the same as we do into 60 countries around the world, and they have 1,200 wonderful employees that we welcome to the Darling family as we build the Rousselot brand to serve our global and worldwide customers. So the brand we're talking about is Rousselot. We refer to Rousselot as a leading manufacturer of collagen and a worldwide supplier of hundreds of collagen products made from bovine, porcine and fish today. To remind you, we operate 11 facilities, 3 of them are in China today. Four of them are in Europe, 2 in South America, plus the other 5 we just acquired, and then we have 2 in the U.S.A. today. So we will move our number of facilities up from 11 to 17. And we're also adding one in the U.S., so there'll now be 3 in the U.S. There will be 6 in South America, Brazil, and there'll be one in Paraguay. So we're expecting, as we would be shared with you, the reason we've done the deal is we have been incredibly bullish and optimistic on collagen peptides as a growth vehicle for the Darling platform. We believe, and fundamentally, we have studied it and studied it through different consulting groups and different trade associations. We believe that the collagen peptides and their applications will nearly double, if not exceed that in the next 5 years. And so as we look at growing out and I know everybody always likes to spend about 80% of our time, 90% of our time on Diamond Green diesel and renewable diesel and sustainable aviation fuel, we happen to really believe in the food segment as another linkage that once again, brings us closer to the slaughtered animal byproducts. As I tell people, today, around 15% of the slaughtered animal byproducts in the world goes through one of our factories. That's about 1 in every 7 animals. And so we segment those between inspected and food grade stuff that can't be fed to a human, but can be fed to an animal, that's our feed segment. And then the third category would be converted into green energy, and that's our fuel segment. So as we said, we expect that segment to grow maybe 50%, maybe a little more over the next couple of years as we integrate in Gelnex into it. We've been given the open guidance in the segment for 2022 and that $220 million to $230 million EBITDA range, that's U.S. dollars. So let's quickly talk about collagen and what it is, and then we'll kind of open it up to Q&A here in a minute. But collagen is the most abundant protein found in the human body. It plays a really interesting and increasing role in both health and nutrition and consumers are continuing to seek benefits for their hair and nail skin, joints, bones, muscles. And I think that's true with the aging demographic of the world. Collagen, as a supplement has now been proven to be very effective in improving hair growth, nail quality, skin, joint, bone and muscle behavior. And so our -- we've built a portfolio that started here over the last 9 years, and it started with one little collagen conversion unit in Brazil, and it's now grown to 2 or 3 in Brazil now, 1 in Ghent Belgium and 1 in Angelon plants. And so we continue to see incredible demand for this product because of the breadth of applications that it can go into. It can go into powders, it can go into capsules. It can go into tablets, nutritional bars, drinks, dairy, confectionary, it can go into cosmetics. You're starting to see it. You see it on TV advertised by Jennifer Anderson and the Vital Proteins brand. You're seeing it with Gatorade Bolt now. You're seeing it with, I believe, L'Oreal and some of the other cosmetic companies, you're seeing it in PediaSure. So it's a product that has numerous applications, which I would say are -- tend to be even broader than straight gelatin, which is an emulsifier and encapsulation agent, and we see it as a way to once again grow the base of Darling around the world. We can grow our earnings, we can grow our customer participation around the world with a product that's once again good for the population. So with that, I'd like to go ahead and turn it over to Q&A, and we'll do our best to answer what we can. I would ask you to be respectful that we are in a regulatory filing period. So if we are shutting down a question or not answering it as bigly as you'd like to, it's because we're being advised until we get clearance to not do that. So with that, let's go ahead, Sarah and open it up, please.

[Operator Instructions] Our first question comes from Derrick with Stifel. Please go ahead.

Congrats on your acquisition.

Thank you.

I want to start with if you could then ask, if you could just share the earnings power of Gelnex's business today and what are the potential synergies you see with the business?

Yes. I mean, number one, it's being purchased at around a 10 multiple today. I don't -- I think you could back into that with the 50% of the Food segment growth earnings there. So no real surprises there. We look at it, as we looked at our system around the world, Derrick, we've added splay dryers and hydrolization units and reactors where we can, and we've maxed out our capacity that we have available to produce the product today. And you have multiple choices, if you will, in these factories. You can either produce gelatin or you can produce collagen and through 2 different processes. But the basic front-end extraction unit is the same. And so we've maxed it out where we had access to the raw material that the world prefers and that would be Bovine Grass-fed, high Gelatin. So at the end of the day, it will integrate nicely into our management structure that exists down in Brazil. It will give us additional extraction capacity to add additional hydrolization and splay drying units where it makes sense as the market grows over time. So it's really a transitioning of product mix. And as we said, it's immediately accretive, and we believe it will even be more -- even a growth vehicle for the next 5-plus years for us.

Terrific. And as my follow-up, I wanted to maybe ask if you could, for the benefit of investors speak to the value of Grass-fed Bovine Collagen versus Grain-fed Bovine Collagen and the consumer markets and not if there's a noticeable margin difference between the two?

Yes. It's -- clearly, it deals back, I would say this is way above my pay grade in that space. But as I looked at it, once again, it's the clean label and you get the clean label organic versus the -- who knows what it was fed. So it is clearly the growth category, the consumer has spoken, and they're willing to pay a premium for that product.

Great. Thanks for your time and congrats on the transaction.

Thank you.

Our next question comes from Tom Palmer with JPMorgan.

Good morning and congrats on the third acquisition, the larger one of the year.I wanted to ask, I guess, on maybe to start off just on the bandwidth. So it is the third larger one, I guess, fourth if you include the fuel one. How do you think about bandwidth both from a balance sheet and personnel standpoint? Might we expect a pause to pay down some debt and integrate these businesses? Or are there still more captive M&A opportunities in the pipeline?

Yes, this is Randy, and I'll tag team this with Brad. Bandwidth, we're done. I know that can be many thanks to people listening on the call right now. But from an internal resource standpoint, we're going to focus on integrating. We're making great strides in integrating the Valley Proteins acquisition. The FASA group is a very well render group in Brazil and Diamond Green Diesel III is in process of commissioning here over the next 2 weeks. So bandwidth-wise, people-wise, we're done. We've got to spend some time putting in the control systems, both from a SOX timing, from IT, from banking, treasury, FX, risk management, all those things that have to happen here. So I think as Brad will comment on leverage ratios and how he's going to pay for my buying binge again, he'll sit there and make you comfortable, Brad.

Yes. Tom, Brad. So we paid for earlier in the year, Valley proteins, now FASA back in August. And after that, obviously, we're not at our Q3 call yet, but ballpark, somewhere in that 2.5x -- you've had FX, of course, moving around 2%. So subsequent to that, depending on when Gelnex closes, right, we're looking at some time, hopefully earlier part of 2023. And depending on the base business, we've been saying the guidance around $1.6 million. So given that, we'll probably be a little over -- pro forma a little over 3x. And then as Randy said, we're going to pause and delever like we've always done before. We've said before, we want to stay consistently down below 2.5x. So that leaves us more than a turn of availability. We have delayed Draw Term Loan A. That were put in place. We did an upsize on our bond that freed up our revolving facility backed several months ago. And so it leaves us with very adequate liquidity, availability and then we'll be looking to pay down debt in 2023, which will be supplemented, of course, by the Diamond Green Diesel startup and the JV being debt free.

Okay. Great. And maybe I can just quickly follow up on the funding. I think you've both in the prepared remarks and just now you referenced it, but I just want to confirm. So you've got the 2 delayed Draw Term Loans, that's $800 million. You upsized the prior offering in mid-August by about $250 million. And then the balance, if there is any, would just be the revolver. Is that right?

Right. The balance in excess of the term loans will be all available cash last revolver. Another reason I mentioned the upsize on the bond, that freed up revolver availability. So you'll see that clearly here at Q3.

Our next question comes from Ben Bienvenu with Stephens Inc.

I want to ask first a question just following up on some details of the Gelnex business and then a second kind of a higher level strategic question. The first is you gave the facility breakdown. But if you think about the split of revenue of the business or EBITDA, however you want to look at it, how much of it is U.S.-based versus South America, if you can provide it?

Yes. I mean what I can tell you there is there's one facility in Portage, Indiana, the fiber in Brazil. But I don't know that, that's relevant because remember, all of our hydrolyzed collagen peptides that are bovine in nature come out of Brazil today. So that's the backdrop or the strategic investment decision was where is the home of the most affordable and most available hide in the world. And fundamentally, as we've said, which is reflected in our files investment, we believe that Brazil -- and to a degree, let's say, Paraguay–Uruguay, Argentina are going to feed the world. They have the land. They have grains. They have the water. They have the people. And from a food security standpoint, we believe in significant protein in the form of chicken, pork, beef in that part of the world over the next decade. So we wanted to be there. This is just another rate furtherance of that investment thesis.

Okay. Great. My second question is just related to those composition of the capital you spent around M&A and how you think about kind of balancing the overall earnings contribution across all the different businesses and what you participate. Obviously, the feed ingredients business is benefiting from higher fats, oils and grains, protein environment, which there are some clear structural demand drivers for. But when you think about balancing across all the different business segments, more cyclical earnings streams versus more secularly growing earnings streams with more stable margins like this business, the collagen, you noted the long-term growth profile of the business. How should we be thinking about where your head is in terms of the type of business that you want to build over the long term?

Yes. And those are really great, I mean, deep think questions, and we do spend a lot of time thinking about it. Clearly, the Food segment, as we've talked about the parts of the slaughterhouse inspected, et cetera, we're able to provide a superior economic proposition to the slaughterhouses of the world with our access to value-added products that we can create. And when we look back at the Food segment, that came 100% from the VION acquisition back in 2014, '15. And if you go back and look at it for the last 7 years, I think we've grown at somewhere between 13% and 15% every year. And so it's got nice margins. It's attracting capital, and it has the thing that's so important to us, and that is it has the lack of cyclicality, seasonality, whatever you want to call it, of commodities here. Now I 100% agree with you. We have structurally figured out a way now to change the world dynamic of fats in the form of animal fats, used cooking oil and distillers corn oil. But at the end of the day, value-adding proteins was the next thing we wanted to do. And so once again, you see us doing that here. Like I said, we're coming to you live from Antwerp Belgium and one of the coolest facilities I've ever been in that where we're segregating plate waste and grocery store waste, and we're making biogas, and we're making biophosphate fertilizer and we're recapturing nitrogen. And so both of them, what do they have in common? They're both part of the food supply chain, but they're also both very much annuitized and very predictable earning power businesses. So we all know that, that feed segment has had some volatility in it over the years. And so anything we can do to balance the portfolio that meets our return standards and growth opportunities or beliefs is something we will continue to do.

Our next question comes from Ken Zaslow with Bank of Montreal.

A couple of questions I had. One is, when you think about the 330 to 350 days once you combine everything together, what will the growth rate be from there? How do you think about that? Just what's the longer-term view on how you're going to grow off that 330 to 350 basis?

I would use right now, Ken, 5% to 7% I mean, clearly, we've seen the collagen product line grow rapidly the last couple of years as the -- and it's really a U.S.-dominated demand point at this time. We were bringing on all the 3 spray dryers in Brazil when COVID hit, and so that really -- this is a -- somewhat -- it is B2B, but it's B2C also. And there were some really some supply chain challenges, there was some consumer not getting to the store challenges that happened here. And so only now are the products really coming out with big brand support behind them. And only now are they being launched in Europe. So as we look forward, there's an immediate success story here once we're integrated. And then as we go forward, it will be converting capacity to make the products that we think will trade in the world. And in Angelon plants today, we make fish collagen and that's great for skin beauty. We in Ghent Belgium, we make porcine and so at the end of the day, this is an expansion into not only gelatin, but also gives us an expansion in the collagen business for the hydro, the bovine and Grass Fed materials. So I think long-winded answer, somewhere 5% to 7%, 2 to 3 years out. These products, you will saturate at some point. But I think it's still a ways out and the applications are only beginning to become -- be unveiled out there. we've not talked about some other consumer products. We're talking health, nutrition and wellness here. And yet at the end of the day, you're not -- you're starting to tick see coffee creamers salad dressings. There's a whole bunch of application areas. I mean, I think it's safe to say that the product has a pretty good following of believers in the health benefits of it for an aging population. So I'll kind of leave it at that. Brad or anything?

Okay. When you think about your leverage, just to make sure -- what is the rate would you expect to be delevering. Does this change your ability to provide a dividend? Does that delay the year? Or how do you think about that and is there a line in the sand limit your debt to EBITDA just going forward in that -- this is -- I know you said this is the end of making sure that, that is without hesitation, no change to that.

And with numbers with DGD III coming on, Ken, and with the level that ballpark that I mentioned earlier that will be at Q3 and with the JV debt free. And with the base business performing as it is. No. I mean we see ourselves at the end of '23 being -- we go to the rating agencies here in a few weeks and see ourselves being -- Well, at our target. I'll just kind of put it at that by the end of next year. so sometime in '23. So it leaves us really with -- as we've been saying for over a year, really the -- and I think this one was on the M&A side, what we've said before, we can do some of all of the above, we'll still be in a position for that discussion in '23 for consideration in '24. Randy, do you?

Yes. I mean, number one, we're committed to maintaining a strong balance sheet, 2.5x, first dollars are going to go there to get that done. We've got a couple of bonds coming due in the next 3 years. And ultimately, we're going to add I'm hopeful and confident that we're going to add an investment-grade rating here. And so that's our focus. And then as you were correct with our prediction on Diamond Green Diesel performance, and the sustainability of the core business earnings. And clearly, as Brad says, there'll be enough to do a little bit of everything. We've continued to buy back stock opportunistically as we can. And we're not going to go out and announce any giant buyback to that. But at the end of the day, delever, buy back opportunistically and then we'll be in a position to evaluate a meaningful dividend.

And you alluded to the rendering business, obviously doing well. Is that what you're implying by being able to do this that it's actually at least in line, if not better than your expectation that you're going to be able to delever. I can't do the math that quickly in my head, but it seems like that's what you're implying. Is that a fair assessment?

You're trying to put words in my mouth, but that's okay. No, it can -- protein prices and fat prices have continued to maintain. If you look at protein prices around the world, they're pretty close to the 10-year average, maybe a little over a couple of products. Fat prices kind of fell off here a little bit but not much. But we are in process of starting up #3. There's just a ton of demand for HVO or R&D projects or potential projects out there. So I think the core business stays at where it's at, and we'll just kind of see. I mean, clearly, I think you always have to take a little downside, you know that I've always tried to be conservative, Ken with it. I mean after spending I've been in Europe now for a week. And yesterday, I was in Poland, and we had fighter jets fly over us. And so this place is a bit crazy. I watched my Polish team put a slide up to say that energy prices are up 500% year-over-year. So I mean, clearly, we've got some challenges here. We're doing what we know how to do in maintaining margin. But that we're signaling a very strong core business for this year and next year. There's no change in our voice. There's some moving parts here, but we're bigger. And I think that will do a lot of the offset.

Our next question comes from Paul Cheng with Scotiabank.

Randall, just 2 questions. First, you mentioned that your negative or existing plan is already running at full capacity. And so you're adding this new set of assets and what is the asset current utilization rate? Or in other words, that, how much of the business that you can improve on in missing at ease and we are trying to expand the bottleneck and what the bottleneck opportunities that is there. And the second question is that, just curious, when you buying this business that is it primarily you're buying the capacity or you are buying the relationship with the smaller house and all that. In other words, that if you don't buy this and if you're trying to go in and trying to build the this facility yourself? Is it a feasible option at all? And what kind of the economics between to buy or to acquire.

Great questions, Paul. I think pretty simple to answer, to be honest. Number one, this is a very well-run business. These are excellently constructed and managed plants with a great management team, sales team, commercial team, et cetera. The alternative, as we evaluated it was to go build 1 or 2 plants to add the extraction capacity we needed. And the timing of that was 3 to 5 years and between equipment delays, design, permitting, location. And so we kind of believe, as we've said, we've been growing at 15% 13% to 15% for the last 7 years. We think that those rates can be attained and it just made sense to jump start this by adding a well-run business that was seeking a new owner so it just met all of the criteria as far as operating efficiencies, I'm going to challenge the Darling team. I think they can teach us something. And I know those might be words that I'm going to hear back from my colleagues and team members. But no, this is a well-run business. I can't wait to put them together. And I think that clearly 1 plus 1 is a very solid 2-plus here. And so not only geographically, but globally and our ability to service our customers we're at a point here where we were out of capacity and unable to take additional orders to meet the demand that our customers were bringing us. So this is something that we really -- the team worked hard on and then we look forward to getting to the regulatory agencies.