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

I think we're going to get started with our next session today. My name is Adam Samuelson. I'm the agribusiness analyst here at Goldman Sachs, usually not presenting at the Global Energy Conference, but we're very happy today to have Darling Ingredients who does a fair amount of energy-related biofuels work. And so I think this is a very natural audience for it. Today we have Randy Stuewe, our Chairman and CEO, here with us. It's going to be a fireside chat. But there's -- our microphones in the room. So as we get later on, I'm happy to take questions from the audience as we get going. But maybe [indiscernible], thank you for being here.

So maybe to start, let's just level set just talk about the business, and we've just finished calendar 2022. Maybe just provide just general business update on both the Diamond Green Diesel business where you've been kind of ramping up and expansion as well as the parent base business, and can you use that as a jumping off point for discussion.

All right. Always, Adam, thank you for having us and always a great chance to tell the Darling story. We're 140 years old, and we're a growth company. I don't think anybody else can say that today. Today, for those, I see some friends and investors and shareholders and stakeholders in the room and others are new. And for those who don't know the Darling story, it dates back to 1882. We were the original byproducts processing unit of the Swift meatpacking family based out of Chicago. And over the years, the business grew. Today, Darling is the largest slaughtered animal byproducts processor in the world, and you're saying what does that have to do with energy? And it's a fascinating piece of how we kind of intertwined into the decarbonization story. So if you think about it, 1 out of every 6.5 animals in the world passes through 1 of our 270 factories in 22 countries and 16,000 employees, and I don't know, a top 20 or 30 trucking fleet in the world today for -- to support the business. And really, at the end of the day, the company produces 2 products, fats and proteins. Proteins, you would know for any of those that had a little too much to drink last night, you'd know is a gel cap, that's collagen. For those that have joint issues and skin and beauty and health, you know that as collagen peptides predominantly under the leading brand Vital Proteins. And then we produce feed ingredients and fuel ingredients. And so animal fats, historically, out to 1989, the largest consumer of animal fats in the world was McDonald's, and I don't remember it's Formula 40 something to fry french fries. And then you convince them that frying in hydrogenated soybean oil was a better idea. And animal fats fell out of favor. And so as the world evolved, Adam, in the sense of seeking a decarbonization solution, we figured out how to basically make a hydrocarbon out of animal fats. And so we've now entered the -- we are 10 years old this year in the hydrocarbon business, we are the 1 -- if not the 1 or 2 largest producer of animal fat-based hydrocarbons in the world with our partner, Valero. We seeked out Valero 10 years ago to bring an expertise in the engineering and optimization and processing side while we brought the supply chain. And so we've built this incredible business now that people should take note of. We're also in the -- we're I think the top 3 largest green energy producer in Europe today in the bio digesting, biomethane business. And then we're also the largest processor of green energy from the rendering disposal business in Europe today. But -- so the business or back to your question, now that we've educated everybody and they are all experts. The business has continued to evolve. The last year, we would say, was a transformative year. Everybody gets nervous when you say that. But at the end of the day, we've now balanced the world with our green energy business of Diamond Green Diesel 1, 2 and 3. We now process or have the capability of processing 65% of North America's waste fats and greases into the -- probably the lowest CI carbon intensity scoring, tailpipe emission reducing hydrocarbon in the world. We just finished up the year. It's a record year. We're maintaining guidance that we've given at [ 1550 ] for the year, even though I have not seen December yet. I'm hoping I'm right there. And we're going to step out today and give a guidance of another 20% growth next year. And that's just on bringing up Diamond Green Diesel 3 now in Port Arthur.

Okay. So maybe let's unpack that near-term environment between Diamond Green Diesel and the parent business. So maybe a Diamond Green Diesel, just talk about the start-up of the DGD III in Port Arthur? Kind of where we are in terms of that getting to full rate? Where that product is going as you think about having -- not having a pathway into California at the outset? And the feeds -- what that's done to the feedstock markets as it's ramped up and significantly increased the feedstock?

Yes. It's been kind of an incredible journey. The engineering and construction group actually brought this facility online 6, 8 months earlier than we had anticipated. We got ahead of the cost curve of any inflation. We are ready to come online here in about mid-November. And we've been really debottlenecking some of the issues that happen when you start up a facility. This is the largest facility of its kind in North America today. As people start to try to run the math, and while we call the boiler plate 470 million gallons, it's north of that. And it takes, I don't know, 4.5 billion pounds of fat to run it. And if you take a 200,000-pound railcar, you can start to do the math that the logistics to support 1 of these facilities is rather incredible. And so we've been online now. We've been operational for 30-something days. Obviously, the cold weather that the Arctic blast that flew through Texas didn't make a startup in December [indiscernible] very easy. But it looks like the team is ready to it, if you will, push the pedal to the metal and take it on up to full rate. We've got a sales ledger around the world that is very meaningful and, if you will, committed. The opportunity that kind of makes us different than others is because we have boiler plate, I don't know, 670 million gallons over in St. Charles or Norco, Louisiana, 700 million gallons, we can arbitrage those sales. So even though we don't have a pathway at #3 today because of California, we can apply #3 sales to #1 and 2 and put #1 and 2 into the California market without any margin disruption. So things are going good. It's always the team as a learning curve that amazes me. The vessel sizes are bigger than #2 here, pretty much similar technology, but it's -- it is rocking and rolling. I think it's pretty safe to say that we'll step out at -- we'll make 1.2 billion gallons this year and margin structure remains very robust.

Got it. And as you think about -- I think previously, you talked about $1.10 a gallon is the kind of framing margin that really did not assume getting any sales to California or getting -- having that DGD III pathway. So if you're actually able to export out of Texas that could be additive to that framework? Is that -- if you actually are able to realize that, is that correct?

Yes. It's been -- it's fascinating to watch the -- understanding and learning and participating in the carbon markets around the world. They're evolving. And if I said to you, we were shipping product to Texas today, would you believe that? It's being blended. If you -- if I said we're shipping products to the East Coast today to be blended without mandates? It's happening. So decarbonization is happening all over the country. It's growing rapidly here, Canada, Europe. When we take the dart board and throw a margin guess for the year, it is a guess. And so what we try to rely on is we say, "Okay, what is our competitive advantage on labor, yield, location, feedstock and customer shipments," and add it up and everybody goes, okay, let's pick $1.10. It's right now margins are north of that even after what -- as we've met with, I don't know, 50 investors today and they called the renewable volume obligation a disappointment, I'm going, well, it really hasn't hit margins much. So life is pretty good.

Okay. Well, you just brought -- I was on my question list, so you just brought that up. Market had a pretty to the RVO that was issued at the beginning of December. I mean, how does that change your view of the domestic market for renewable diesel, biodiesel, renewable fuels?

I think we -- as I tell people, I -- for 20 years, I woke up in the chair of optimism and feel pretty good about things, and I still feel good about them. And at the end of the day, I think the farm community and the different alliances that are out there, we're optimistic that -- and maybe overly optimistic that they had made their case to the EPA through their trade associations, lobbyists, and they were expecting a bigger number. So the disappointment was that it wasn't as big as they'd hoped. It was larger. That's 1 thing. But I think as I -- you'll never know the internal workings of the sausage grinder at the EPA. But at the end of the day, clearly, they were weighing the view -- they had the -- the Biden administration clearly believes electrifying everything is the solution. So they weighed to that. You've got the weighting to food versus fuel. So they were hearing that if we grow the RVO, it's going to use food oils and consumer prices for ranch dressing was going to go up. And then -- and then the farm community, we got $13, $14 soybeans, $5.50, $6 corn, they're in good shape. And so the easy button was the 1 they pushed. And so at the end of the day, I think we're out for public comment now. I'm sure it's going to be a pretty robust set of comments. And it would not surprise me to see them edge up maybe not '23, but '24, '25 quite a bit more as we go forward. And so end of the day, I don't really see anything here as disappointing by any means. I think it also signals the administration's view that they really want to see growth in SAF versus road fuel.

Okay. So on SAF, I mean, it kind of ties into the Inflation Reduction Act and some of the incentives there. Is SAF viable at current economics with the policies that are actually in place today?

It is very close. And it's something that, as a partner with Joe Gorder and team, we've been studying, trying to get the right technology. So if you think about it, what's the difference between road fuel and then high altitude fuel, it can't freeze. So you've got to take some waxes out. And so at the end of the day, we were trying to figure out how to make this work. We lobbied hard as trade associations and to -- for a bigger subsidy in the Inflation Reduction Act. We didn't receive it. We got about 80% of what we wanted, but that's okay. The economics now are much closer. The challenge with SAF is, if you are an airline and out there, the numbers that are lobbed out there, I don't know, 20% of their operating costs or fuel, and if all of a sudden, you're going to buy Jet A at $4 a gallon or you got to buy SAF at $8 a gallon, that's a big, big number for them. And so trying to make it viable without a mandate is challenging. So the question ultimately will become does that leave meaningful, is that absolutely meaningful to us because it will give us the chance to arbitrage between road and air as the margins move around. Today, they're close to parity to answer your question, but we'll be -- if we make the decision here in the '23 to go ahead and commence construction, it's a '24, '25 type of build-out spend out, and we would be then the largest producer of that and on the optionality, and that's really, for me, from a derisking of the model here, then by owning that optionality, you've really created an opportunity. And whether or not the SAF stays in private aviation here, commercial aviation, cargo or it gets exported, it really won't matter. But it's a -- any new gallons is great gallons.

Okay. And maybe in that vein, let's talk the other kind of key regulatory piece, there's many, but is California and the Low Carbon Fuel Standard, LCFS credits now are about $70 a ton well off where they were 18 months ago. You've had CARB looking at advancing and taking -- increasing the carbon reduction targets. What can happen out of the California market to change that calculus and really be additive to the market today, especially one that's already pretty saturated with renewable diesel or it's already a pretty significant part of the Pacific Coast diesel pool?

Yes. I mean, California, I think you can step back pragmatically and look at it and said, I don't know, was it 2 years ago, 2.5 -- time just flies for me as an old guy now, but carbon was $206 a ton. That is a signal to New York and Washington, Oregon, New Mexico, Pennsylvania, New Jersey that maybe the cap and trade program there didn't really work. At this price, now they say, "Wow, this does work because it incents production and the system is efficient." Now the current price, I think, is kind of caught the California Air Resource Board, maybe a bit off guard here and has now given them the courage now to accelerate their reduction targets or blending targets. You still have California that's slowly returning to 2019 miles. You've got a myriad of RNG investments going on in the dairies. You got electric forklifts. You got electric cars. And so the program is truly working, and so we're excited that we think California, they just completed their, whatever, rescoping. They're going to public comment now. Sometime in '23, they're going to tell you what that trajectory is. And I will tell you that the deficit in credit bank is, while it's tipped to the credits right now, with an acceleration, will quickly turn to the deficit side again, and will move back on up. At the end of the day, as it impacted margins a little bit? Yes, but not really for waste fat or low CI producers. And then the other piece that's contemplated right now is maybe a mandatorium California SAF program. And any gallons there, once again, become really, really positive to the S&D.

Okay. I want to switch over to the parent business and done a bunch of acquisitions over the course of the last year, 1 is still pending, and would love to just maybe think about kind of where the platform is today and been operating and where it can go once you get these deals properly integrated and at their full margin potential?

Yes. It's -- for those as we look at where the business has come from in 2003, there were 20 plants, 600 employees, and we processed, I don't know I can't even remember now, 48 or 60 million pounds a week. I can't even think of that in tons. Today, we'll process somewhere between almost 17 million tons of slaughtered animal byproducts. And essentially, we have successfully, not declaring victory yet, rolled up family companies from around the world to build the new platform. And so yes, we've had some challenges in some factories we bought. You always ask, why do people exit businesses? And it's either a, the time to sell, b, there's a succession issue, or c, they're in trouble. And so we always try to buy good businesses with great management teams and you pay a fair price and then you make sure that whoever built that spreadsheet if they're 100% wrong, you've not lost your company. And so we've done that this year. It's kind of interesting. We look back when we had a Board meeting in 2005, we doubled the company. In 2010 we doubled the company. In 2015 we doubled the company, became global, and then we had a little COVID interruption here. But in 2022, we almost doubled the company again. So we still look at the world now as -- if you think of China today, and this is really what I always share with people, a couple of points here. China, 1 out of 3 people have access to protein today. Center of the plate dining is still part of people's goals in life. If you think of the world, you've got population growth, wealth creation, you eat a little better and then you buy better clothes and then you ultimately move to a better neighborhood, I mean, it's pretty simple. And when you look at the world, it is absolutely still craving fish, chicken, pork and beef. And while we may have had a myriad, in the boardroom in 2021, all I had to deal with was, are we going out of business because of plant-based proteins? And so 1 day I brought in a group of whatever the plant-based whoppers or whatever they were, cut them up into quarters and served them to the Board and watch them say, never serve that to me again. I said, okay, don't ask me the question if we're going out of business again. And so the world craves protein. Nigeria will be the third most populous country in the world and 1 out of 3, 1 out of 4 have access to protein there. So we continue to see an incredible trajectory for myself for the next years and then the next management team after that for -- to grow this thing. It's just -- and really the value that I always share with people, and I don't mean to get on my soap boxes is we wake up in the morning trying to figure out how to make more money, not only for you, the stakeholders, shareholder, but how to present to the livestock producer, the slaughterhouse more money such that they can grow and we can make food more affordable in the world. And I don't know that people understand that's how we think. And as the world evolved into -- and everybody is like ESG, ESG. 20 years ago, we were about the people, the planet and profit. And so that's the world we operate in today. The companies we bought over the last year, Valley Proteins for, I don't know, $1.1 billion, Gelnex for $1.1 billion, Miropasz for a $100 million. What else I buy, Brad?

FASA.

Is it enough? Oh FASA for I don't know, $567 million with the real at 5.23, it was a buying spree.

So -- and I guess that kind of a capital allocation question in there, and I want to then open up to the audience anything. But how do we -- how are you measuring -- talk about the return thresholds that you're targeting, balancing kind of that inorganic investment versus the returns you're targeting on organic plant investment versus potential increases in shareholder returns down the road?

Yes. And we can go to specifics here. I mean when you think about how we look at the world, we look at it and said, we want to stay in the fairway of what we're good at, and that's converting, transporting, removing water and separating fat and protein. And that's what we do for a living and then trying to create value-added products. We benchmark ourselves against 28 public companies. You guys would know all of them from ADM, Bunge, Tyson, Celanese, FMC, Mosaic, Corteva. And we have a view that we said if we can operate in the top quartile annually of return on gross investment, we will attract both premier shareholders and we'll have a shareholder return that is admirable. And so we wake up in the morning, looking at that. So everything that we invest in, we say, how will this in fact affect our return on gross investment in our peer group? And that says that everything that we do has to have between a 15% and 20% return. Now there's going to be years, it's going to be lower, there's going to be years it's going to be higher. So we look at the world both on a 10-year and a 5-year average. And then we say, okay, over 5 years, would it achieve those returns, over 10 years would it? And so there was a period of time between 2015 and 2019 that it was subpar, it was like 11%. And people we're really questioning both my leadership and the view of the company. But now -- all of a sudden now we're at 25%. So it comes and goes, and you just have to have a long-term view. We're absolutely blessed with a Board with a long-term view that buys into that. And so all of these businesses have been bought and acquired between 7.5 and maybe 8.5, 9 multiples pre-synergies that will then meet those targets.