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

[Audio Gap] that links into the production of renewable fuels and really one of the more interesting stories and certainly one of the more interesting valuations in my coverage universe on a go-forward basis. So Randy, why don't we get started with maybe just an intro from you, talk about what Darling is, do a better job than I did of explaining the history of why being green is still cool.

Thanks, Justin. So first off, it was good to be here again. And I'm 22 years in the seat today as we go forward. Darling is still my passion, my love. It's a company that I always like to make people smile because there I see some gray hair at it. So your trivia question when you leave the room today, we were Mike Milligan's last jump on. Now you're going to go do your research. So I see this, so I got your attention. So I was brought in post that in the restructured debt equity swap, what a fun time to do and meet people at Blackstone that really just charge you a lot of fees. And here we are today. We had 21 plants, 600 employees and about $300 million in adjusted EBITDA. Today, as we sit in front of you, we now process one out of every 6 animals in the world on all 5 continents, in 23 countries, 16,000 employees and 270 factories. And so we're -- it's an amazing story. I know I get to be a storyteller up here for just a little bit. We touch your life every day. We're kind of that name out there. If you think back to the BASF when they're running those ads or something more than a chemical company. Well, Darling touches your life, your kid's life, your life every day, whether it's in food, we're one of the larger producers of different health and wellness ingredients, feed, obviously, 1 out of every 6 animals in the world probably eat something we produced. And then fuel, we are between Europe and the U.S., one of the largest green energy producers in the world, whether it would be in green electricity or whether it would be in synthetic or green hydrocarbons and then the next horizon is SAF for jet fuel. So the business model is pretty simple. We collect. We transport, we evaporate and separate. I mean it's just that simple. So we take meat scrap out of whether it's Costco or Albertsons, Public, WimDixies, whatever one you're comfortable and familiar with, slaughterhouses, whether it's JBS, whether it's Cardial, whether it's Tyson, and we transport it to our plants. And we're in the business of making 2 products, fats and proteins. And that's all we do for a living. Really, really simple. We make fats that can be eaten by humans, fats that can be consumed and converted to hydrocarbons, proteins that can be fed to your pet, proteins for health, wellness, nutrition for the human being and proteins to feed animals around the world. The business model was founded 20-plus years ago by my team as a fee-for-service business, meaning that while -- if you think about the Waste Management, Republic, et cetera, the world, they drive circles, pick up the trash, and they're in the real estate management business. We collect material, we charge to collect material and then we put a processing fee for the conversion of it, very similar model in a sense. So it's a managed margin spread business that has huge cash-generating potential. Some years are better than other years. The way that we make our suppliers enjoy our success and their success as we share with them. And so it's driven off of a return standard that's internal. And then after that, we split the upside with them. And the concept there is very simple for us if they grow, we grow. The ultimate thing is if you say, what's the underlying culture underneath the company that we always share with people because I think it's such a powerful message, if we can create more value in the animal supply chain, then ultimately, we make the price of animal protein to feed the world more affordable. And so that's how our team wakes up every morning trying to create. And I think we have 120-something brands around the world that kind of symbolize that value creation.

So Randy, maybe you touched on the broad process of what Darling is, what Darling does day by day. Maybe give us the history of you've been a leader in the renewable diesel space. So you're about to be a leader in sustainable aviation fuel space. Talk to us about starting up the Diamond Green Diesel joint venture with Valero and a dozen years ago now.

Yes, it's -- it makes for a quick fun story, but proteins, if you think back when we say animal-based proteins really early -- as late as 15 years ago, they were basically just animal feed. And then all of the sudden, you decided that your pet should eat better than your children, and that's when we started creating all these high-end value-added pet foods, and that led to a boom within our business. But there was one thing left behind, and this would go back to 2009, we relegated animal fats to basically a caloric enhancer in the animal feed since 1989. And it really goes back to -- and you're going to say, well, how does you know 1989. Well, that's when I bought the animal fat business from a company called Interstate Foods that when I was at Cargill and converted McDonald's French fries from animal fat formula 40-something 49 or whatever to vegetable. And so that day in 1989 was when Animal fats no longer had a place in your diet. Number two, as the world produced more and more palm oil in the oleochemical industry, it replaced animal fats. Animal fats had a place in chemicals and soaps and thing. And so then they were just relegated in our business model to simply nothing more than strained on chicken feed. And so if you think of animal economics, you want to get an animal is static, you can as quickly as you can as cheap as you can in the market and convert it to cash. But my dream, as I looked at it, was animal fat had become somewhere between $200 and $300 a ton discount to palm oil and soybean oil in the world. We were also starting to witness, and this is how far back, we saw oil went up to $137 a barrel, I think somewhere in there that '08, '09. And all of a sudden, here comes the Energy Independence and Security app. And we said, well, how do we participate in that? And ultimately, the concept was in Europe, they've been making ,basically converting and making methylesters which people would know as biodiesel for a lot of years and blending it in their fuel supply. The problem with animal fats into biodiesel was, well, when it gets cold, they get solid. So it doesn't really work very well. It doesn't really work within the distribution system as well as people would like around the world. And that's when we were brought a technology, and we were actually second. So it's kind of funny because the first were the Italians any was going to take this technology from Honeywell and commercialize it, but they fell into some challenges in '09. And so Honeywell asked us to take this new technology, this new black box, if you will, and to take a lipid or triglyceride or let's just say, a bottle of salad oil anything, animal fat, whether type of fat you want to call it, and crack the molecule like it's super hydrogenating, and so many of you will think back hydrogenation, oh, that would have been hard fats, that would have been all purpose shortening that would be Crisco. And so we're just super hydrogenating to the point we bust off the oxygen and the water. And we created diesel fuel by definition of hydrocarbon. First, people never do it. And so end of the day, we started in 2009 down the road, trying to find a partner because hydrogen temperature and pressure do not work with my guys. I mean it's just it really is -- it's a little humorous just saying no way were we going to get into it. I had the honor of courting my old employer Cargill. I had my old the honor of going to a decade, Illinois to ADM, but they just got a new CEO from Chevron that didn't believe in renewals. I called on every other oil company out there, as I always joke with people. I tell everybody that I met with the business development manager that doubled as the night janitor for renewables and couldn't find anybody to take the order. It was a dream. Here we were. We had a product that could go in the pipeline. It was really cool. And then finally, my CFO, who's in here that's been with me for 20-something years, 40 years at the company, said, "Hey, my cousin runs Valero Port Arthur. Let me give him a call", and that's how relationships start. So today, we have a 50-50 joint venture with Valero. We started 137 million gallons, with one plan, expanded it to 160 to 275, built a second plant for another 500 million gallons and build a third plant for 500 million gallons. We have been profitable every quarter for 10 years. And I think it's an incredible story. We've had a first mover advantage, Justin. We're getting ready to transition to a sustainable aviation fuel. I think that's the next unchartered frontier that's out there. We'll see how committed cargo carriers and passenger carriers are in the world to decarbonization. Yes, it's government mandate driven. There's no argument about it. But truly, there is a mandate in Europe. There's not one here yet. There's different incentives around the states in the U.S., but we're seeing incredible interest at this time.

Randy, maybe give us your perspective on kind of the broader renewable diesel industry as it sits today, what's happening in the margin profile? What's the supply and demand balance look like? What's your crystal ball look like for the next couple of years in the R&D space?

Yes. I mean, where we're at and I'm sure there's some really up the curve, educated people in the room here. I mean, clearly, when you make the kind of money that we've made in that business for 10 years, you're going to attract people. And ultimately, in a sense, there was -- there's not much differentiatable about it other than your location economics in the sense of what you're producing. We had 10 years of an absolute incredible profitability returns anywhere from 25% to 37% on a cash return basis. We made $0.81 a gallon last year, a little over 1 billion something, almost 1.1 billion on 1.2 billion, 1.25 billion gallons. That's on a $3 build-out. So I mean you still -- when you think about it, you're still mid-20 returns and you can convert that per barrel, that's how you like to think of things. Ultimately, the oil companies, you have to say, why are you producing the product, you're producing the product for an obligated party in a mandated environment, whether it's in Europe, whether it's in Canada, whether it's in the U.S., Washington or California, Washington, Oregon. And so ultimately, you've seen some people decide they want to try to make it too. The challenges are when we look around the spectrum today, and you can pick up a bunch of Justin's colleagues and competitors out there and read any sell side you want. I dare you to find about 5 of those plants that are really oscillating, which we operated at 98% capacity last year. And that's a pretty incredible thing. So people are trying to -- they're in it for various reasons. They're in it for environmental avoidance of -- they're in it for compliance. I always tell people, when Marathon first entered the business, they were releasing their results. And then all of a sudden, it got put into the segment and just said avoidance of compliance costs. They didn't tell cents per gallon or operating income or anything like that, which for me, I don't mean to pick on them are a great company. It's just simply that's code for -- we're not doing very well. You've got Vertex on the ropes now. At the end of the day, you've got a couple of plants. The challenges in the business are -- it's a location business. And as we looked at it, and my background in 40-plus years and kind of really food, ag and commodities in general, you've got to have the right economics. And you've got to be able to originate the lowest cost crude, if you will, or feedstock, you got to be on the pipeline and you got to be able to send it back out.

Maybe dive in a bit further on the competitive advantage that you guys bring to the table with Valero for Diamond Grain Diesel in and of itself, the purpose-built nature of what you're producing in the first place in terms of actually building these plants from scratch as opposed to converting an old petroleum refinery? And what Darling brings to the table in terms of the feedstock supply advantage maybe 2?

Yes. The marriage was built on 2 things. One, my old background is one of the animal fat refiners in the country. So we call it pretreatment in the business today. What are you trying to do there? You're trying to remove the nitrogen, the impurities, the alkaline metals, why? Because they're catalyst killers, just simple that. It's uptime, it's utilization rate, it's yield within the plant. So that was our expertise. We had no idea of pressure in temperature and cracking a hydrotreater, hydro cracker. So we built a system, plant 1, 2 and 3 now. They're all clones of each other, little tweaks here and there for better uptime. We learned the hard way. And what I mean by that when I share with people is the plant started up in July of 2013. On a Sunday night at 9:30 in September, and I don't remember the day, I got a call and say, hey, turn on KNOL, which is New Orleans TV and went on the Internet and some plant on fire. Why? We learned that this reaction is very challenging. And what I mean by that is you put under temperature and pressure and all of a sudden, if you don't get it right on the downstream or the down pressure side, you will create lots of asset and you will eat every piece of stainless steel in that plant. And so we learned the hard way. And we didn't kill anybody. We were down for months and months trying to put the plant back together and replace different areas with alloys. And that's what we know today. We know catalyst. We know alloys. We know it's just been an incredible marriage of just really subject matter experts on both sides of the fence. We often are asked, well, Randy, what's the most important piece, feedstock knowledge. We have plants in 5 continents, 23 countries. Not all feedstocks created equally. And what do I mean by that? Well, -- we don't run much chicken fat to be honest with your poultry fat. Why? What's a chicken do, eats dirt, right? Picks on the ground. What do you get from that metals, how do you to catalyst metals. And so you learn what you need, what's the best factor process, beef tower, animal or animal or beef fat. Why? It's the most saturated. What are you trying to do? Super hydrogenate best deals, but you got to have the ability to get the impurities in nitrogen out or your catalyst killer. So it's been a long learning curve. We would like to tell people that we're still learning today, which I would tell you, we are. The conversion junkies that are out there that are taking these old hydro crackers or hydro treaters and turn in 100,000 barrel a day gets down to 5,000 barrels. They know how to do it, they'll get it right. But the question is the robustness, the uptime, the yield and all the things that go into building a business. And ultimately, as I said, when a business commoditizes ultimately, you have to look at it and say, am I in the right place? And that's really the Gulf Coast, there's nothing better in the world than where we're at today.

Yes. Randy, you've got sustainable aviation fuel coming up later this year into 2025 as a new source of supply to the story here for Diamond Green Diesel. Maybe give us a sense of what your expectations are for the SAF market, both in the near term and how things look over the next handful of years in that market?

Yes. And you go back, you've got to kind of go back up to 80,000 feet here with me for a minute, and whether it's the Paris climate accord, then you had the different people that signed on to greenhouse gas reductions and the airlines, predominantly the Europeans led the way here. And so now you under read through the renewable energy directive to you have a series of step downs in the amount of greenhouse gas emissions off of an Airbus or a Boeing or Rolls-Royce or Pratt & Whitney engine. It's going to kick in here starting in '25. In the U.S., you had the Inflation Reduction Act, which is kind of a misnomer, but very in that was an incentive to produce SAF. And so you're really kind of on the early stages of developing this market. There really are no tangible gallons that are made today of any scale in the world. It's a fascinating product. I would tell you to stay tuned. The -- you have voluntary markets in the U.S. mandated in Europe, some mandates going into British Columbia. It's a market that I think -- if you just think of just taking just a tiny little piece, 46 billion gallons, give me a 2% or 3% or 5% blend of that, and it's bigger than the renewable diesel business in the world. And so we're excited about it. I think somewhere here in the next 60 days. Hopefully, you'll hear some announcements from us. We have a ton of interested parties. It's a challenge for the customer. There's a commitment to decarbonization, but it's twice the price of Jet A. So they're moving slowly. They don't want to be the first mover. They don't want to be the last mover because there's finite gallons, but I can tell you it's going to span private aviation, cargo carrier and passenger carriers, both here and in Europe. The beauty of our system today is #1 plant is going to be done, hopefully, later this year, really don't have any much impact there. It was as of 2 weeks ago, about 35% done all the steels up and everything the tanks that are constructed. So hopefully here later this year, we'll be starting up. The beauty of that is it's in Port Arthur, Texas, and it has the cheapest freight rate back to Europe that you can have in the business today. Number two, we'll be in St. Charles, Louisiana, not making a financial investment decision today. My colleague at Valero and I are in sync. The commercial team has to bring us the contracts on #1 yet to show us that the proof of concept, there's real demand there at a real price. We're seeing margins $1 to $3 over renewable diesel. So this is a very, very powerful business. The cost to construct. Number #1 is about $315 million, $320 million a gallon, a $1.25 gallon. So we went into it with an FID decision in the mid-40s of seeing what we needed to make in order to cannibalize the R&D business, and we will exceed that. And we'll make the decision on plant #2 probably later this summer, late fall, be a couple of years out then probably haven't seen a real schedule there. But ultimately, we're going to convert a 1.25 billion gallon system to roughly 50-50 SAF road diesel on that arbitrage around the world.

Randy, now that we've covered the high-level aspects of the Darling story. Maybe we get into the weeds a little bit on your 2024 outlook, how you're thinking about the business. And maybe update us in terms of what your crystal ball looks like for the overall earnings profile of Darling over the next few years?

Is that like code asking for guidance?

Yes.

That's what I thought it was. No, it's interesting. I always like to share with people sitting in the seat. We do stop the clock or stop the moment in time program. Some people call it an operating budget. We don't really call it a budget. We say we're going to stop the business for 1 day a year, and we're going to say, here's the tons you're going to run, here's the natural gas costs. Here's the electricity costs in all the countries around the world. And oh, by the way, here's the 6 or 8 or 10 major products we make and here's the selling price. It's a cash generation exercise, because you just kind of want to stop the world, you want to say, okay, if the business operates at this, and the team is asking for why in the form of CapEx, the bankers are asking for G in the form of interest payments and then the G, the government is asking for some taxes. What do you have left? What do you have left to get back to the shareholders? And so ultimately, that exercise is a 1-day event. Why I share that with you is on December 8, I think, this year, we did that, and it said the business was going to generate somewhere around $1.8 billion to $1.85 billion of adjusted EBITDA. 60 days later, that model has taken out between $250 million and $300 million out of it just on that PAT price declines in the world. And it goes back to your earlier guidance or your earlier question what's going on with renewable diesel. Well, if renewable diesel was truly being consistently produced by the plethora of people that are saying they're making it out there at the capacity they see they're making out, then fat prices would not have gone back down. It's impossible. It's a finite bucket. And so that's where we're at today. No, I'm not sitting here going to pick a number today. What I'm trying to telegraph is fat prices have declined, they're going to pick back up on the balance of the year if this capacity runs. And I think we should be in position with the run rate in the back half of the year that will exceed what we did last year. but it's just we're going to come out of the block slower this year. And then as we transition to SAF, first-mover advantage again, even though you take 250 million gallons, let's do simple math at 2, that's $500 million over what we were making before. So there's another $250 million. We've got -- you're going to see us launch in Geneva here in May. One of the most exciting sets of products that I've ever been associated with -- and I always like to share this with people because I am truly passionate about where this product is going. Remember, we take everything from the slaughterhouse, the bones, the skins, the hook, the hair, as it was once said to me, we process everything other than the movie when we can collect. And so we're taking bones and skins. We're extracting native collagen out of them, and we're producing products. I mean the product you're probably most familiar with today would be that blue jar called vital proteins. That's us hydrolyzed collagen peptides. We don't own the brand Nestle does. We're in that jaw. The next phase of that business is separating and concentrating the different peptides. In May, we're going to launch a product in Geneva that show -- that's going to be a glucose moderation drug, insulin moderation drug that we were asked last week. Well, are you competing with Ozempic? I don't like to get involved with big pharma. This is a supplement, a nutraceutical but the clinical studies show that it's glucose moderation and it's very, very effective. We're in the second clinical trials now of our dementia drugs or dementia powders, if you will, that will go into food application. So it's really an exciting time. And you go back to my earlier comments, we're adding value to that animal again and creating some natural proteins, the people love. And I know, by the way, we don't have to have that 45-second blip that says, "Oh, by the way, it isn't a buy or can't breathe and call your doctor or whatever.

Randy, you all have been rather busy on the M&A side of things for the past couple 2, 3 years now. but you've talked about 2024 being a year of paying down debt and delevering the balance sheet. Is that the overarching goal of the business right now is to improve the balance sheet of what you got?

Yes. I mean if you look back, on the 20-plus years, we doubled the size of the company in 2005. We doubled it in 2010. We doubled it in 2015, I had to take a little holiday because I think called COVID in [indiscernible] and double the size again in 2022. The playbook is so obvious. These are family-held businesses around the world. When they come available, you have 2 choices: buy it or don't buy. And we have assembled this platform off of relationships with family-held companies. And ultimately, that's what drove the 3 acquisitions over the 1.5 years was I mean, that's my job. My job is to go out and court these families. Yes, you'd like to buy one business a year and everything, but it never works that way. And so ultimately, you find when you're in a global uptick of a commodity cycle that these families that are based with succession planning issues, that's when they say, well, we just had a couple of good years, maybe it's time, and the phone ring. The last one we did was the Collagen business in Brazil and Paraguay. And that was a family we got the call and been close to them. And dad had dimension, dad passed away 2 weeks ago. And the kids didn't have anything to do with the business, they were living off the trust. And so we had to take it in. But -- and it's great because we needed it to launch our new peptide products. But the answer is yes, I mean, like I said, I gave you the example. It's a moment in time cash generation. It's always been a great cash generation business. I often tell my team, rather than trying to spend too much time in the weeds, the true thing you manage in this business is the balance sheet. And we're levered at the end of the year, 3.26x. I've run the business with 5.5x. I've run it was 0. Our goal right now is we have some debt maturing in Q1 or in about '26 in Q1 of '27, a couple of bonds, very favorably priced. If you think about the world that we've lived in, we've been in a kind of an inverted interest rate environment for 15 years or whatever it's been. And so there's no rush to the market to go refinance and put a cap structure. So at the end of the day, our goal is very simple. We're transitioning the company from this giant growth machine into an income stock, and '24 is that year where we pay down. Brad and I get to sub-investment grade in the year. And then ultimately, we have the alternatives that are out there that it's a 3-way highway then you can find other bolt-ons, expansions, buy back stock or you can put a meaningful dividend underneath this. And it's for me, that's the exciting road that lies for this company.

Randy, last question. What's the key takeaway for the Darling story here? What's the thing you want to leave investors with? Why am I right that the stock is worth $75 and not $43 like it trades today?

Well, I like the number $100 better than $75, just be clear about that. I'm a huge shareholder. I love this thing. I believe in the stock. The question is going to be, how does the market ultimately value the multiple on this? You've got it -- just an incredible position in the world. As I always tell people, if you were sitting in a bar and you're over here in the guy next door or with girl next door telling a story and says, well, we have the #1 position, 1 out of 6 animals goes through our factory. It's a spread management business that generates [indiscernible] cash every year. It's growing up to be and if you think of the world of food and ag, it's the fastest-growing food and ag story ever in the world today, and that's with ADM, Bunge, Cargill, Louis Dreyfus. We are the D in the alphabet now. We have the highest margins in the business today, and we do things that are good for people. I look back and in 2008, I got invited on a show in New York on one of those TV stations. And I didn't know at the time when I said we were green before green was cool. And you think of the world today, whether if you're a European investor and you want ESG, we are the greenest stock that makes the biggest green. If you're BlackRock, we're in their portfolio because we're green and green. So I look at the business as having incredible runway yet for the next generation as I play to the club house here. And I look at it, why? Because population growth, wealth creation, center of the plate dining. 3 years ago, we would have been talking about what's that stuff impossible to be profitable meat, beyond making profit meat, that stuff is not in the narrative anymore. And so you think about China, 1 out of 3 people have access to affordable protein today. Nigeria will be the third largest country in the world in the next 5 years and yet they can't feed their people and it's a little poultry. So we look at the world, Justin, as Darling is a 90-day hedge fund play. We look at the world when we buy businesses, when we manage the business on 5- and 10-year averages. And we say, if you've got that horizon, you're going to love Darling.

Beautiful. Please join me in thanking Randy for being with us today.