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

All right, folks. Good afternoon. My name is Justin Jenkins, research analyst here at Raymond James. On my left is Randy Stuewe. He's the Chairman and CEO of Darling Ingredients. Darling has been one of our favorite companies since launching coverage about 1.5 years ago now. So Randy, thank you again for joining us here in Orlando. If you would, maybe give a 5-minute intro on who Darling is and what the story is looking like.

Well, first off, Justin, thanks for having us back. I mean, last year, obviously, it was the first year post-COVID. It was just -- it was fun to be back with everybody in-person to get to tell the story. I mean, Darling for many of you that I recognize here, you know the story well. For many of you that don't, Darling is a very unique company, 141 years old, but a growth company. It's a company that today processes about 1 out of every 6 animals in the world after the meats removed and converts it and repurposes the products into different food ingredients, different feed ingredients and then fuel ingredients. It's a business that, today, we have 270 factories, 16,000 people worldwide operate in 22 countries. On February 3, I celebrated 20 years and never thought we would be where we are together as a team. I started with $600 million revenue -- or 600 people, $300 million revenue, 20 factories. And we had a vision. We had a vision that the world population will continue to grow , that wealth creation will drive center-of-the-plate dining and protein predominantly animal proteins will be part of it. And then we looked at an industry that was very family held, very old and worn out, and it takes a lot of capital to stay in the business. And we said this is going to do nothing but explode and grow over the next 20 years. We're not at the end of our journey. We're at the start of our journey as we built this thing today. So if you think about the business, we collect, we transport, we cook or evaporate and we separate fats from proteins on a global scale, about 17 million tons, 17% of the world's supply today. What we did about 10 years ago, this July is very unique. It dominates every conversation I'm in. And the conversation is we decided what could we do to create a new market for animal fats. For the old people in here with me, believe it or not, my claim to fame was I helped formulate McDonald's out of animal fats in 1989. And replaced it with vegetable oil. So in order to make all of you live longer. I didn't know that I was going to create a monster on the other side with no demand for animal fat ever again. And little did I know that God would get back at me and say, now fix it. And so 20 years later, we've created this new product, a hydrocarbon out of, you can call it, a lipid, a triglyceride, I call it animal fats, the market calls it waste fats. We've created one of the greatest solutions for decarbonizing the world, especially heavy transportation. And today, we operate 3 factories on the Gulf Coast with our partner, Valero. They've been incredible partners for 10 years. And today, I think we're 1 or 2 with Neste in the world and where we convert animal fats in a sense, my goal in the world was to create additional value for animal fat by creating a new market. And one may say, why? Well, for the shareholders, it's to create value for you. For me, it was to create value also for the slaughterhouses, the livestock producer in the world because if we create more value for the slaughterhouse, it creates more value for the livestock producer, it creates more meat in the world that makes meat more economical to feed a growing population. So it becomes a win-win around the world. Many of you have heard me speak over the years. I used the line, I coined the line back in like 2008 that we were green before green was cool. I didn't ever know Justin that, that would haunt me 15 years later, Cramer reminded me of that on Mad Money the other day, but it really is. We are -- if you are an ESG investor, we are the true ESG story in the world. Our stands for earnings and sustainable growth along with the standard ESG story. And so it's a great company. I'm very proud of the team that's helped build it. And let me share a little more as you want to learn more.

Beautiful. I think maybe let's start on the Diamond Green Diesel side of things. Randy, you just brought up the third facility here recently. Maybe talk us through how operations have gone at all 3 plants and what the forward outlook is for the renewable diesel business.

Yes. I mean clearly, we'll mark 10 years at it. So number one, we learned. We had to change some metallurgy along the way, which is a unique part of one of these processes, and I'm not sure most understand today because it's a very -- triglycerides or fat, lipids what everyone call them, are heavy in chlorides. And when you hydrogenate in the form of the process that we do in hydrotreating, you create hydrochloric acid in a very, very severe -- extreme process here that can really eat up metal very quickly. So clearly, there's a learning there. Number two, we brought online October of 2021. It's at capacity and then some. So number 1 and 2 now make -- I always have to my Valero colleagues, who are here in the building, and I never know if they're out there right now, but they like to talk nameplate and I like to talk reality. It can run 750 million to 800 million gallons. It's operating today. Number three was brought online 6 months early. It's a clone of number 2, but bigger, better and better. We are still ramping up the full rate. We'll be there. I believe this on March 8 was what I saw in the report this week. We've been constrained by one of the fears that we had. Can you unload enough fat quick enough to support the rate of one of these facilities. And when I look back at number 1, we put in the most sophisticated rail unloading system that's built in the United States or even the world today for unloading a product that goes solid at 55 degrees. And so obviously requires steam. Then as we built out number 1 and took it from 135 million to 275 million gallons, we had to expand the capacity there. And then as we went to 750, 800, we had to use an outside terminal across the river to not only support inbound logistics, but support outbound logistics of the product flows. And it took a little bit of a learning, but it's working very, very well. Number three is tied in Port Arthur to about a mile away is the Howard Energy terminal, 1,100 acres with a big 100-car loop track that we can unload 100 rail cars a day, looks great on paper. We've just not been able to do it effectively and efficiently yet. Anybody that's a student of the railroads knows that we have 4 railroads embargoing us in the United States right now. And ultimately, we're making progress, like I said, we'll be at the full rate here on March 8. And then after that, we'll see what we can do. And we're excited. Just a big learning curve there of handling a product that when people are used to unloading liquids, whether it's ethanol or whether it's other petroleum distillates, that's very easy, but a product that requires heating and has some challenges. And if you all remember, the giant, whatever they called it, the bomb cyclone or whatever they went through the south, it froze us up hard. Railcars coming out of Central Nebraska turned into bricks. And it just took longer than we hope, but we're there now.

And maybe also give us an update on sustainable aviation fuel. I think DGD just announced investment in that production capacity for the next couple of years here?

Yes. The sustainable aviation, let's talk about it. In the world today, I mean, clearly, no matter where your head is on climate change and decarbonization, clearly the market and the world is moving in that direction. And they're looking for economic solutions to accomplish that. And clearly, the markets embraced electrification. It's going to come in heavy transportation, but it's not there yet. I don't know if it's 3, 5 or 10 years out and whether it's an infrastructure. You've got a lot of dreams in the hydrogen area. And then ultimately, you've got a drop in fuel, which we make that drops makes to 85% reduction of tailpipe emissions immediate through animal fats. So very exciting on that standpoint. As we looked at the world out there, we said, the untapped universe that's out there today. And we've got to give some clarity to it, is sustainable aviation fuel. And people go, well, yes, but it's going to be more expensive. Yes, but look at the world today, the dirty little secret in the airline industry today is their level of emissions. Like I said, no matter where you subscribe along the curve, they can adapt and adopt and adjust. And at the end of the day, sustainable aviation fuel is a giant market. And I'll give you the numbers in -- between Europe and U.S. transcontinental flights and total flights, 45, 46 billion gallons of aviation fuel. Today, in North America, there is about 2.5 million to 2.7 billion gallons of renewable diesel capacity. It's not producing that yet, but that's what's there today. You take a 3%, 4%, 5% blend just in the mix there, and it can dwarf anything that we do today. So as we looked at our portfolio and we said, okay, if you're going to look at Darling equity today, I'm a significant shareholder. I personally is the only CEO will ever get in front of you until our equity is undervalued. But you look at the world and you sit there and say, why have we not been able to untap the value of Darling? And so we looked at it and said, well, many of you subscribed to the fact that renewable diesel is now in the ethanol 2.0 arena, where they're going to overbuild and there won't be demand. And we would tell you, we don't believe any of that or we wouldn't have put our money in it. But if you believe that, okay, then we're going to change the paradigm. Let's go to SAF. It is a much larger market. It is rapidly developing. And between Neste out of Finland and ourselves, there'll be, I don't know, 700 million gallons. Do you know how many gallons have been pledged in the U.S. in North America alone by 2025? 11 billion gallons. You can go to the big airlines. They're all out there saying, we're going to buy $1.5 billion, $1.8 billion. So I just tell people, I said, there is a day of reckoning [ coming in ], and we have the gallons. They're going to buy it, and we're going to be in great shape. If Port Arthur works as we plan it to be online sometime in early '25, I hope, we're still waiting on permits. You can't ever control that. Then number 1 and 2, will go back and will add another 300 million, 400 million gallons there of aviation fuel. But we see the transition aviation fuel is something that is not if, it's just absolutely happening in front of you. There is a game of roulette, Liar's Poker going on right now. And I kind of just fundamentally believe there's going to be a first mover, if you have the gallons, who's going to buy them? I don't know if it will be cargo or passenger but somebody is going to flinch and buy them, and we're going to lock it up and have a really great time for the joint venture and for Darling.

That's a good segue to the Feed segment maybe here. Can you talk about the dynamics that have impacted that business over the past couple of quarters and what your outlook is for 2023?

Yes, I like for the audience, I always like to say, so we don't dive too deep in the weeds. So the Darling proposition is, like I said, 17% of the world's slaughtered animal byproducts. We go into a slaughterhouse and we say, if you will separate the blood from the feathers, from the [ hosts ], from the heads, from the horns, from the skins, from the bones, we can come up with an aggregate value that no one else in the world can pay you for because we have so many different processes not to [indiscernible] into the highest and best use. So today, as we look at the slaughterhouses, we look at separating the most valuable piece on that slaughterhouse is anything that can be deemed food-grade or edible. That would be our collagen business that many of you would know. While we're not branded, we backstopped many of the collagen peptide companies out there, one that we love dearly is Vital Proteins and help build that brand. And we -- in the collagen business, we will possess here about 1/3 of the global capacity here as we get clearance on a Brazilian acquisition. A little bit of animal fat is left, edible animal fats left in the food segment, as we call it. That fries chips in the U.K., still the best French fries ever, a little tiny retail brand attached to it, and then there's a sausage casings business that comes out of the porcine or the pork side. So if you can't eat it, but it's still deemed edible in the sense, but not for human, it's for feed. And that becomes the Feed segment. And that's predominantly pet foods, aquaculture, organic fertilizers, all kinds of different things. 11 million tons of the 17 end up there, as you can imagine, because the slaughterhouses want to keep the valuable piece and then they give us whatever is left over. And that segment is the one, as we look back over the time frame had the most volatility. And what we mean by that is, it was clearly collect, transport, evaporate, separate fat from protein. Proteins, if you say, what do they trade against? Predominantly soybean meal in the world. They go to animal feed or pet food or aquaculture. Proteins vary maybe $50 to $100 a ton in any given year, driven by supply constraint or demand expansion predominantly in China today in the world. But animal fats, that other 50% of that would move just wildly around. And so the feed segment had this giant volatility in it before we brought on Diamond Green Diesel to create value there. So that's kind of what's driving that now. Today, Diamond Green Diesel system can procure up to 2/3 of the U.S. waste fats and oils production. As I joke with people, I think that makes us kind of there with ExxonMobil, Saudi Aramco in that world, if you want to be king of that world. And then the other piece of the model that we talk about is, if you can't eat it, you can't feed it, you got to burn it. And that's the Energy segment, and that's our green energy businesses in Europe. Classically, our timing was impeccable as we started to build out our biomethane business in Europe for converting organic food waste. If you think about it, we're one of the largest trucking companies in the world today are stuff because -- our raw materials because of the way it is categorized in different parts of the world is near hazardous by definition. And so it has to be dedicated trucking and we've got to, looking at it and said, Americans take for granted. You throw out -- you roll out your garbage container and then you've got your little blue box and you're throwing some newspapers, some aluminum cans and whatever, some glass. In Europe today, there's -- industrial organic waste cannot go to the landfill. They say what landfill? And so we've built out a model there in green energy that's been very, very lucrative. I give the benchmark out there, there's kind of fun is, Shell just bought the Danish assets for $2.2 billion. I don't know if it was dollars or euros, but we'll call it dollars and then just say that's about 45% -- we're 45% the size of those guys. So we're a large biomethane green energy producer in Europe in the model. Those are the 3 models that are built up today.

Randy, you've been fairly busy over the past, call it, 15 months with M&A. Maybe talk to us about what's been the strategy on the M&A side for you recently?

Yes. I know for the analyst world, it caused a bit of chaos. So as always, I apologize. But if you look back at the business, 2005, we doubled the company; 2010, we doubled it again; 2015, a Canadian and European platform acquisition. And then here comes COVID on the birthday of 2020. So it took till 2022 to get the next opportunity. And really, if you think back to my first comments, we talk about businesses, these are family-held businesses. In most cases, they're not public companies or they're private. And typically, they're event-driven opportunities that are a succession plan, a death, a health issue or if they're part of another company, they're being liquidated for growth of another opportunity. So this last year, we had the chance to buy the #1 competitor left in the U.S., the Valley Proteins, the Smith family, 2 great brothers been -- my job is 30% as Chairman of the Board with my directors, the other 70% is running around the world, developing growth opportunities and the Smiths were on the radar screen for 8 years. And so finally, the 2 brothers made a decision post-COVID after one almost died in COVID that it was time to go have some fun. And so we reached a deal there. It's been a big challenge as always, in bringing in family-held businesses and converting them to a public company, but we're making great progress. Also, 8 years ago, we started on trying to buy the #1 independent processing of rendering company in Brazil, had it bought 3 times. It makes for great barroom discussion. Sometime what happened? [ Guy ] turned 60 at midnight in Italy, and he [ breaks out ] the, I don't know, [ Black Soldier ] or whatever it was, I don't know. We didn't get the deal done, but it was about $200 million cheaper last time I had it bought, but it's great. We have the #1 position there. And then here comes Miropasz. That's a 3-plant system in Poland, family situation. Again, the patriarchies moving on. And then Gelnex is the other one that hopefully will give you a good news on closing here shortly on that, and that was a 6 -- plant gelatin business, 4 in Brazil, 1 in Paraguay, 1 in Portage, Indiana and the patriarch that I had been working with for many years, unfortunately, his health declined rapidly, 2 children not in the business and said, liquidate for the trust. And so that came a year earlier than we wanted it, Justin, but you take it when it comes. So next time, it will be now what is this? It will be 2027, 2028. I'll be 65 and I'll buy something else again.

So on that point, maybe, Randy, talk to us about the balance sheet as it sits today and how you think about capital returns over the next couple of years?

Many that bear with me and listened to me, which they probably shouldn't have over the years. But I said there's really only one thing you can manage in the business, and that's the balance sheet. I mean the rest of this is supply-demand driven, regulatory-driven, mandate-driven, macro policy, macroeconomic-driven. But the balance sheet, we've always looked at. When we acquire businesses, we've always said we want to buy good businesses with good management teams, put a fair valuation on it and then put a no fail capital structure. That's code for -- if every assumption in your Excel spreadsheet is wrong, you haven't lost your job or your company. And so we've done that again. I mean for little old people that have been around Darling long enough to sit there and say, we've got to -- we'll have $3 billion, $3.5 billion of debt here in another couple of weeks. It's a big number. And so people are looking at that and saying, well, we've seen this business cycle before. And I would say, yes, you're right, you have, and I've lived through it, and we've lived through it. But this time, it's very different because of the, if you will, the countercyclical play in the renewable fuel area. So a very different company, will be levered 3, 3.3x here in a couple of weeks, and we'll be down sub-investment grade by the end of the year. We've got such incredible cash generation. So where we're looking at right now is we've got a big CapEx program for this year, $565 million. About 20% of that, maybe 25% is headed towards growth projects. We always build out additional factories, additional capacity for the plants that we've acquired to optimize and integrate them. And then at the end of the day, we'll pay down the debt. We'll be $2.7 million, $2.8 million by the end of the year and we'll go from there. So it puts us in '24 then in a different world than a free cash flow that should range between $800 million and $1 billion. We don't -- we'll be -- we're debt free at Diamond Green Diesel. We'll have our big CapEx program behind us. We'll be integrating with the new company, and it's just really going to transform, I hope people's view of this company going forward.

Folks, any questions in the audience here? Please.

Yes. So Vital Proteins, Nestle is your biggest customer. And I'd like to know how much of Vital Proteins business is Nestle and then are there any other big customers that are...

Yes. It's fascinating. I'll talk to you in the degree I can. But in the sense of, number one, collagen peptides, I don't think are fat out there. I don't know how many people take them today in the form of vital proteins, garnering the whole bunch of other products. They're Gatorade Bolt, L'Oreal and the face creams now has collagen in it. The concept was that Kirk came to us about 8, 9 years ago and said he was a NASA scientist, and he was running or jogging with one of our salespeople that were friends. And Kirk joins her, he did his own research and said, "Hey, can you get me -- can you guys make this stuff? I heard you were. He started being a consumer of his dream, and that's where Vital Proteins was born. Kirk is now in Aspen. I'm still working. And it's interesting. And then about 2 years ago, I think Nestle came in and acquired a significant portion. I don't know the exact percentage. It's not public. And they are now wanting to take the product globally. We have been limited to really serving vital because of their growth has been so fabulous. For us, it was a product mix from gelatin, which is really a commodity. If you think of what's the difference between gelatin and collagen peptides, they're all collagen. So you start at the top of the pyramid is collagen. If you use one process and dry it, you get gelatin. What's gelatin? It's an emulsifier or a thickening agent. Most of you would know it in 2 forms today. If you took a gummy bear today, let's call it -- that's gelatin. And if you took that Advil for the hangover from last night, the gel cap around it, that's gelatin. So that's how you would know the business. Collagen peptides by nature have been hydrolyzed, meaning smaller particles spray-dried. Ultimately, the molecule has been flipped a little bit, but it becomes water soluble. So the application breadth, depth becomes really huge compared to a thickening agent. So what's it replaced in a lot of cases in Sports and Nutrition today, whey, dairy whey. And it's been linked to hair growth, nail growth, skin, beauty, joint lubricity. You're seeing the big food companies and even the pet food companies now pick it up and put it on the label. We're excited. Obviously, when you do business with Nestle, it's a global giant, probably one of the -- that in Unilever and Mondelez is the big powerful marketing networks of the world. They have a dream for it. And that's what drove our Gelnex acquisition because we were out of capacity to meet their current needs, let alone their dreams.

Any others?

When do you...

We do. We're excited about it. And that's part of the Gelnex acquisitions that there's a half dozen other companies that we want to diversify with. When you -- we have pretty good exposure to a company that likes to have 2 suppliers, and we have a very unique position with them and given the product qualities that we've been able to create that really work well on their products. But I'll also share with you that the exciting part of the collagen business is, what I'm going to call the Phase II and Phase III. We now have under patent different biomedical processes and products, meaning wound injection. Collagen helps wounds heal quicker. It allows for different other attributes in the body. We're seeing a product that can replace insulin now possibly. We're doing research at the University of Berlin. We've grown, believe it or not, of a collagen, we've grown pancreases for diabetes research. So really, we think in the collagen peptide world, I always get screwed up. I think there's 28 amino acids within the peptide, we have 27. We don't have tryptophan in there. Otherwise, we'd be the full deal out there. So it's really an exciting world as we go forward. Don't want to leave anybody with the belief we're going down the pharmaceutical, biomedical route. We're an ingredient company, and we will find somebody to help us commercialize it.

Randall, please...

You're going to speak up.

[indiscernible] identified a key issue.

So I'm the one that I started on, and I said we were green before green was cool. The mantra for the global team has always been, it's got to be good for the planet. It's got to be good for the people doing it for the planet and you got to make a profit. So we always called it the 3 P's. You guys renamed it ESG. So as we look at the world -- we look at the world differently and very simply. And the governance side, we've always been 1.0 with ISS and Glass Lewis. We're just a well-run boarded company today. The [indiscernible] side, clearly in the biodiversity side, and trying to, as a global team, we've got a lot of work to do there. We've left 270 cities in the world. You kind of leave kind of the local community relations to the local team. We've got to pick that up a little bit. We're making lots of progress in that area because we have to be a great citizen. These are businesses that may do some great things, but if they're not run properly, you really don't want us to be in your neighbor. We don't smell very good. So we always have to be honest, and we have to be on the offense before we're playing defense, especially from that side. The environmental side is really fun for me. And I'm going to give you 3 different or 4 different perspectives on it. One, we -- what do we do for living? We create water. If I'm in a bar and they say, "Hey, what's the #1 product Darling makes?" I say water. We transport water. We evaporate water, we treat water and then we pay somebody else to get rid of it, kind of a stupid model. But -- so we've got to figure out how to reduce the water intensity in our business today. My dream before I'm head to the club house one day is that my water becomes deemed potable. There's no reason through all the technology today, I can't use that water back in human processes. So other than regulation. What's the regulation? The municipality wants my clean water to dilute your dirty water and charge me for it. So it's an economic circular here that we've got to change the paradigm. Energy. We've got to figure out how to take energy out of this. I mean, obviously, I've lived through 3 or 4 cycles in natural gas and energy in the world. The Ukraine situation, again, made people realize that energy intensity is something that you have to pay attention to. For Americans, we -- energy is so cheap, we never pay attention to it until it spikes up and then all of a sudden, it gets a little attention. And then, oh, by the way, natural gas is back to 2020 levels, $2 in MMBtu again. But as we look at the world and environmentally, our world, and I was telling Justin this the other day, we look at a couple of things. If you want to say, what's the other dream? I want our shareholders to be credited for carbon avoidance. And if you think about it, we have an option. I can take 17 million tons -- 17 million tons of bones, guts, feathers blood and dump in the landfill and I can get paid for it. I probably have a better return as an ROIC than I do today. That's not the right decision. But I don't get a carbon credit for it. I don't even get credit for it. Because it's under the Additionality Principle, we haven't done anything new. We've been doing this for 141 years. The other piece is we -- 1.2 billion gallons of Diamond Green Diesel renewable diesel or will be whatever it is, 950 gallons of renewable diesel, 250 of SAF, guess who gets the credit for that, the oil companies, even though we made it, they distribute it. So under the way the world is defined a day, we don't get credited for the carbon handprint. In that case, as I call it, nor do we get the carbon avoidance. So as I look at it, we've got the water issue I want to deal with. We've got the carbon avoidance and the carbon handprint that I hope we can be that company when you look at the ESG world and say, that's really a company that does right things and can make money at it and fair returns for their shareholders or track capital.

Folks, please join me in thanking Randy for coming here today, and we'll be downstairs in the breakout session.