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

Okay. I think we're going to go ahead and get started with our next presentation here, which is Darling. Over the last decade, Darling has transitioned from a U.S.-based rendering company to a global leader in rendering renewable diesel and food ingredients. It's integrated platform of rendering and renewable diesel, creates a competitively advantaged model while mix improvements and capacity expansions are enabling the Food segment to emerge as a greater contributor to the EBITDA outlook. CEO, Randall Stuewe has been the architect of Darling's transformation, and we're very appreciative Randy that you're here with us today. So welcome.

Thanks, Andrew.

So maybe I'll kick it off with this. And this is kind of a longer-term earnings power growth type of question. So how do you think about that building that over time? Can you frame kind of the framework that you use to think about it?

Yes. Number one, it's great to be here. It's -- I'm passing year 20 getting to sit in the seat, which is very rare for a CEO from the description of an architect to more of a founder of transitioning and transforming the company. Where we're at today was a dream that we had 20 years ago and it's a playbook that is really very obvious. I mean it's really not hard to figure out who Randy is or where Randy is going with this thing. And today, we've assembled -- I don't know, 270. I lose track, 280 factories. I think I added 4,500 employees this year in 22 countries. I don't know. It's a lot. And we process 17% of the world's animal byproducts today, and we're the -- either tied or the second place largest renewable diesel supplier in the world. And so our more of the same playbook is pretty simple. We love core animal byproduct process, and we use the word rendering. We love it. We know how to do it. We're the biggest, the best, the baddest around the world today. And at the end of the day, we -- our thesis is so simple. There's going to be more of you, you're going to have more money. And best I can tell, unless you visited a little booth over there on all those weird products of vegan plant-based, you're going to eat me. That's such horrible. Makes you lose your hair, look at Andrew. But at the end of the day, we think the meat will be a center of the plate item going forward. 3 years from now, Nigeria will be the third largest country in the world. One out of 3, maybe 1 out of 4 have access to protein. India, the same. There's 1 billion people in China that still don't. So meat, it's not going away. We'll take the other half that isn't sold to the consumer and transform it. The fun part of our business, and this is the part that people -- I don't know if you say give credit to Darling or don't recognize. We try to create value for the slaughterhouse, for the abattoir, the processor, such that, that value ultimately increases the total cutout value of the system, ultimately creating a chance to grow for that slaughterhouse and making meat more economical in the world. And it's really -- when our employees learn, listen and understand, not only the green side of the company because in the new ESG world, we were green before green was cool. And we cared about the people, the planet and profits before now people are trying to make it really fancy. But the world we're going to grow in is core rendering, green energy. I think Pat said it so well. Pat and I've been friends for 40 years, and it's always fun to hear him talk and I learned from him. But green energy is -- we're in the biodigestion, biomethane, whatever you want to call it, business organic food waste. And we're the second largest in Europe. No one knows that about Darling. Number three, collagen peptides. And we're the -- we have 1/3 of the global capacity in collagen today, producing products that range from gelatins. So anybody had a gummy bear, hopefully, no edibles in here. And then also maybe an Advil for that hangover from last night because that was really bad wine that you guys had. But -- and then you ultimately look at the collagen peptide market. And if anybody takes Vital Proteins, I'm a customer of it. It's a great product. We're now separating activated peptides, concentrating them. You're going to see us more in the world of -- in the nutritional and health world. I've seen -- we're in clinical trials now on glucose in the sense of insulin reduction and dementia. And it's really cool stuff that we're creating out of a molecule. We've grown biomedical devices. We've grown a pancreas now. And so -- that's the third leg. You've got the green energy, you've got the core rendering, you got the collagen. And then the fourth leg of the dream is really in the -- as I -- what -- is the SAF molecule. And so I heard Pat talk about SAF up here. Hello, we're the only real SAF producer in the United States here in another year, 1.5 years. And we are so excited about that world because we just see demand just really, really incredible. It's going to be hard to plug an airplane in. And so at the end of the day, the North American airlines have pledged to buy 11 billion gallons, and I'll be the #1 producer at 250 million gallons, nobody else. So I think we're going to get to name our price there, and it's going to be pretty phenomenal where it goes. So those are the 4 pillars of where we're at. I was reflecting with Brad here, and the start of my first day was February 3, 2003. We were paying bills out of a shoe box when the utility would call and $37 million of EBITDA, negative cash flow, and we're a couple of billion dollar EBITDA company now. So it's pretty exciting. And just more of the same, keep doing it.

So -- and part of the beauty of the model is kind of this integrated kind of offsets between the rendering side, the renewable diesel side that you have so far and then as we progress from there. However, on the core rendering side, I think -- and one thing that we get questions on a lot. And to be fair, you've seen vegetable oils have been very heavy and things like that. I mean it just feels like -- so this is a question about supply demand and what's going on right now and why we haven't seen maybe more upward movement? It feels like there was an explanation that made a whole lot of sense through the beginning part of the year. And I think we would have started to see maybe more. It's been a little, but -- how do you frame what's going on from a supply/demand perspective?

Yes. I mean, the fascinating thing while Pat can talk about drinking coffee in the breakfast room with the farmer. I mean we're the true straight from the farm all the way to the consumer on a vertical of our product line, although we would not be branded. Our dream 12 years ago was we needed to create a market for animal fats. And as I always tell people, McDonald's took it out of the formula, I don't know, 42 or 49 and 19 -- 1992, I think, is when it was because I was at Cargill with Pat at that time, and then we -- I bought the Interstate Foods business, which was that business. Animal fats really went to a serious discount to veg oil brothers and sisters, anywhere from $0.10 to $0.15 a pound. There was no market for it. And so when we decided to commercialize plant #1 of this, it was a career bet. It was a balance sheet bet. But I always believed if you can create a product that a customer either needs or wants and doesn't have to tolerate it, but really likes it. It's easy. And so when you created a hydrocarbon, you now become homogenous with the infungible within the whole petroleum distribution system, and this thing has just been a fantastic dream. So serial #1 comes on. We use about 15% of North America's waste fats. October of '21, model #2 comes online. We're now 40% and now Model 3 in November of last year, and it's just up to speed now. We're about 2/3 of all of North America's waste fats and greases. Now that's not answering your question. Number one, we own the carbon -- low carbon intensity feedstock oilfield. We're the ExxonMobil of the world. And there's just no doubt about it. There's no number two. And so as long as climate change continues to have the momentum it has, as long as decarbonization, anyway, that's what we should call it, continues to grow at the rate, waste fats and greases because of their carbon intensity value will continue to command a premium. Today, intrinsically, academically, we could be a $0.05 a pound premium to soybean oil. It can't be more because then you'd arbitrage back to a different oil. So -- at the end of the day, you have to look at the 4 big oils in the world, obviously, palm oil, soybean oil, rapeseed or canola and then sun oil out of the Ukraine. And that basket of goods, if it goes up, we go up if it goes down, we go down. But we've changed the business model, and this is the thing, if I leave everybody in this room with one magical belief on Darling today is that we were -- we're 141 years old. And I still consider as a growth business. The world has changed. We make -- if you say, what does Darling do? You can get really deep in dive and we have 127 different brands and products out there but at the end of the day, we separate fat from protein. That's what we do. Proteins for human use, animal use, some type of BTU generation and then the fats end up in a decarbonization hydrocarbon. And so we've now built this model, Andrew, that even if fats go down, the old Darling, before Diamond Green Diesel, maybe our Feed segment or our core specialty ingredients goes down a little bit but we're 4x bigger over in Diamond Green Diesel, it goes up. So let me give you the math. $0.10 down. That's where fats are. Are we going to have a bad second quarter because fat prices are down? Three years ago, the answer would have been yes. Today, no, we're going to make more money in second quarter than first because fats went down. Why? $0.10 a pound is worth $100 million annually in the feed ingredient sale. It's worth $850 million in Diamond Green Diesel. And even if we capture half of that, it's $425 million. So I don't think there's -- they're really smart people in this room I know they are. They would give me 100 if I give them back 300. I'm pretty sure that's a trade they'll make in here. So that's the world. So we're seeing new capacity come online. I think that's great. We need it. I mean I know one of your thoughts and questions out there is in that crushing world. I mean I think I was the last guy when I was at [indiscernible] back in 1995-something that we were going to build the first crush plant built in the U.S. since like the 1970s or something. There hasn't really been any capacity. There's been some modernizations. I think we've got 20 or 25 new plants coming on that are betting on the renewable diesel/SAF market. Just so let's differentiate. You have to make renewable diesel before you make SAF or at least our technology for proper yield is. So that's where some of this may get converted. But ultimately, there's, I don't know, 2 billion gallons of kind of potential capacity over the next 3 years. But that oil is going to be crushed here and rhetorically or process [indiscernible] produced, rhetorically, the question for everybody in the audience, then to me is, what's China going to do? You're not growing anymore, you might grow a few more. Few -- another 1 million acres of beans or something, but you're not going to convert the whole corn crop to beans. And so at the end of the day, is China going to idle their industry and buy protein and then if they buy protein because the veg oil is being converted here to some type of green fuel or are they going to step into the palm oil market and buy palm oil then to feed their people? And so you get into this incredible global conundrum that is just in the infancy of being understood. Bloomberg today, while is at lunch, carrying an article. BP is going to get into the feedstock sourcing business. I mean I heard Pat say, I'm getting in the used cooking oil business. No, you're not, Pat. But it just -- the world is moving here. SAF is the market. And it's going to -- while there might be a little short-term oversupply down, it will moderate and mitigate and move up. But either way, we're fine.

So that makes a lot of sense. I want to stick on the, I guess, the Feed segment for a minute and that -- in particular, on Valley Protein. It feels like maybe we've turned a bit of a corner of things like -- it seems like some of the improvements that you made internally are coming on a little bit faster than in the first quarter, at least than you had expected. So can you frame kind of how much progress you've made, what is left from a profit perspective to build forward because understanding the balance that you talk about, and in some ways, the weighting towards DGD. At the same time, there are profit growth opportunities within the core business unrelated to that, that could be positive. So how do you think about that piece in particular?

Yes. And when I look back, I violated my own rule for our team, and that was we've been successful. You can go to any PE company and whatever you can look at the statistics out there on acquisitions and 3 out of 4 really don't ever work out or whatever the number is. And we'd always bought good companies with great management teams with good assets, paid a fair value. And then ultimately, we called it a no fail capital structure. If the smart guys in FP&A generated the Excel spreadsheet, everything was wrong, we didn't lose the company and blow it up and break a bank covenant. It's worked for me for 20 years. Valley Proteins, I'd give myself about a D- on and it was a broken company. We kind of knew that. We didn't know how broken it was at the time. And broken is in the form of management. It goes so deep in the company. It was a company that the 2 brothers operated in their final few years, capital deprived and employees were not motivated, working unsafe, and they didn't add enough capacity to meet the growing needs of the poultry industry. They did -- you couldn't have done it any worse. Now you say, why didn't you capture? Understand it when you went into it. Well, when you're at this level of competitor and you're this big, you get access to the financial reports, we valued it. I do my own valuation. The guys can jack out the PowerPoints, but I looked at it and said, it's half the size of our U.S. rendering business, and it made 1/4 of what we made per ton. And I said, my team is good. And even if we can only get half as good there, then it's an accretive acquisition. So it's just that simple. Under the antitrust rules, we went under deep scrutiny, as you can imagine, in the Biden administration. We weren't allowed to talk to him after we put the bid in and it was accepted. And so we really -- we walked through the plants, but you can't see inside the machine. And so ultimately, what we found was really some pretty ominous machines that haven't been replaced in 20 years, et cetera. We fixed all that. Really in the business, it's very simple. What's the most important -- always the challenge people. What's the #1 product we make, water. We evaporate. So you've got to have adequate wastewater systems, they didn't. Then we separate protein from fat. And ultimately, the plants weren't reliable. They were too many employees just really not -- and we fixed all that. The #1 deal in our business today is how you buy the raw material. And it's how you take care of the poultry supplier, the beef processor and that formula has to have 2 things. It's got to make sure that it covers your operating costs, both through fixed and variable. It's got to have adjusters for diesel fuel, natural gas and the yields have to be correct. And what we found in Valley Proteins as they were way over paying for raw material and the yields were off 3% and 4%. We fixed it, first quarter. I don't know that's a long story for everybody, but it's been a real challenge. I will not take credit for it. I will take credit for the passion of helping the operations team realized I was going to kill them if they didn't fix it, but they accuse me over paying for it to it. But it's a great business now.

Okay. That makes sense. When you think longer term about what this business can be, and it's one of the core growth elements of the 4 pillars. You've taken down a lot of competing capacity. Now brought it internal. How much more room is there to grow via that route? How much of it is going to be organic? And I guess, as a feedstock supplier to DGD that could continue to grow, where is your capacity today versus where you ultimately need or want it to be?

We -- like I said, the original comment was the playbook is very transparent. We have 8 new plants under construction, contemplating another 4. So we're back in the organic growth mode. You can't stop growing. You got to be close to your pack hole to customer intimacy. So you got to be close enough to the folks to know what their plans are and then they expect you to grow with them, and that's been our success. So we'll continue to build out around the world. As we look at it, I think there's 4 in the U.S., 1 in Canada, 2 in Brazil, possibly a third one and then a couple more that are out there that I can't talk about yet. But we're just going to keep doing what we do. And then for those in Diamond Green Diesel, part of the Valley acquisition, the Brazilian 18 plants were all supply chain related. Derisking, I didn't want to trade in this world from the short side. I mean, certain most of you understand it, I'd rather have 55% of our needs internally fulfilled if it's the right market and then you own the global arbitrage. And that's what's different of anybody else in the world today in the R&D world.

So I want to switch gears a little bit to the Food segment. And the valuing up of that segment, which you already started to reference has been a tremendous success story. More than doubling segment margins over the last 5 years. Can you put some context around where that value-added mix is today? Where that can get to and how you think about the margin potential over the next 5 years because there's -- my sense is there's still a long runway there to go?

Yes. It's -- and so to give the audience a little background, when I acquired a company back in 2014, it came with the global gelatin business under the brand, Rousselot, a French-based company. I think had 11 plants at the time and it was operated on 4 continents. And -- but it really just made generic gelatin. What's gelatin? Someone know it is jello. You would know it as a gummy bear. You know it as a gel cap. It's an emulsifier, it's a binder with water. And it's thickening agent and those -- it's pretty mature. It dates back to 1907 or something. The largest gelatin producer was, I think, was Kodak. It was a film coating. And so we bought the business and you say, well, why do you need -- where does that fit in the Darling portfolio platform? Very simple. You can either grind up a bone, grind up a skin and put it in animal feed or you can find a higher and better use for it and extract the collagen. So we -- that's our proposition. We go to a slaughterhouse and we say, give us these 9 different products, we'll pay you to separate them so we can make more money on them and ultimately pay you. So that's why we're in the business. The second thing is, and the trivia question again is, out of that skinner bone, how much collagen do you get? Well, about 17%, the other 83% is animal feed and fat. So natural, natural fit for us. Nine years ago, we embarked on basically an enzyme process of hydrolysis with an enzyme to separate out the peptides. And you can go on Google and do your own peptide research, but collagen contains 27, 28 essential amino acids in the world today. And the only thing that's missing, I believe, is tryptophan. And so at the end -- as we looked at this, we started to say, well, can that be used in food uses around the world? Can it be used in beverage? Can it be used in cosmetics? And lo and behold, one of our salespeople in Chicago, who had a friend. And you guys will know he is, he's a billionaire now, but he founded Vital Proteins. And Kurt was an ex NASA scientist, he love to run, but he is bone-on-bone. And he said, Hey, can you give me some of this collagen stuff, I think it will help my needs. Long story short, we help build that brand and that came through 3 factories in Brazil. What changed in the business was that was -- that's considered bovine hide grass-fed hide gelatin. And then -- it's the cheapest gelatin in the world. We converted it to a peptide. So we took a bunch of gelatin off the market, and we watched the rising tide. So now we have 5 peptide factories. And now through additional research, we're now separating an [indiscernible]. So today, as we founded the idea of food, feed and fuel, as I joke with people and a very serious as -- coming back from Europe, looking out over Iceland and how do you develop a platform around animal byproducts that you can continue to bolt on grow? And then I think of the room here in valuation. I said, well, food should get a higher value specialty food ingredient. Feed ingredients should get an ADM bunge value, and then the energy component is really just an annuity. It was before DGD, just a tariff business in Europe predominantly. So that's where we founded it. The growth has been incredible. I think this year, we hit, I think, what, $256 million last year. When I first took it over in '14, it was $120 million or $40 million EBITDA business. So we've grown at that. And this year, we'll be well into the 3s next year into the 4s. And if we hit on these new activated peptides, which are probably still a year or 2 out, kind of tell you the fun stuff there that we're working on and we're not a pharmaceutical company, but this sits in that nutraceutical supplement area, but we have seen hair growth, nail growth, joint health, gut health, slowing of dementia, reduction of insulin intake, so activated glucose. So those are the cool things we're working on today. The fun part is, while collagens have a margin of anywhere $1 to $3 a kilogram of EBITDA margins, these activated peptides, $1 million bucks a ton. So really good stuff that could fuel that segment into something really big, bad and awesome.

You talked about on the earnings call, having the pipeline of new products. Is that what you were talking about?

That's what it is. And it's -- I get a little nervous about it. I mean I've committed EUR 15 million to a clean room to a biomedical test lab. I mean that's how quick this thing is moving. But it's just very, very exciting of what we think it can do.

I guess, can you frame what kind of capacity -- your current capacity, what kind of runway for growth that provides you? When are you going to need more capacity? Are you just going to be shifting the mix where you're replacing and valuing it up? I guess, how do we think about the needs?

Yes. I mean, 3 years ago, we were 95% gelatin and 5% collagen peptides. And now we're 80-20. I think Gelnex was 90-10 or 95-5. So end of the day, we think the global collagen peptide market probably can take us to a 25% or 35% share over the next 3 years. We're very saturated now in the U.S. And I mean you can go to Whole Foods, you'll see Vital Proteins, you'll see other brands, Garden of Eden, Sprouts or whatever, and you'll see Creamers and L'Oreal and their face creams, you'll see Gatorade Bolt now. So what's interesting about a hydrolized peptide is -- it's water soluble. So it's tasteless, odorless, water soluble with benefit. And so the application universe versus gelatin as a thickening agent is just so robust the -- like I said, the challenge is still that it resides in that supplement category, and we all know that supplements come and go. This one seems to have legs to it.