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

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. Through acquisitions and capacity additions, expansion into sustainable aviation fuel and mix improvements, Darling continues to enhance its position in the global push towards sustainability and enhance its earnings potential. CEO, Randall Stuewe has been the architect of Darling's transformation, and we are very appreciative Randy, that you're here with us today. Thanks for joining us.

I guess where I would start is that the business has been navigating a transition that you have talked about a bunch from a very favorable supply demand and pricing environment to one that's now has a lot more abundant kind of global supplies. So where are we in that transition now if you could kind of frame that and what the implications have been for or are for the earnings trajectory for the business from here?

Yes. It was -- as I look back, and I'm trying to find the right words here, as Andrew said, 22 years, we started as a small regional 21 plant, 600 employees, operate in 42 states here in the U.S., and now it's 270 factories in 23 countries. And the underpinning there is one of Darling is a growth vehicle that is geared at converting animal byproducts into their highest and best use and ultimately creating value in that supply chain to lower the price of consumer products in the world. And so that all sounds really cool in things, but what -- we're still in a commodity world, and we make products that compete with other things. And so as I look back at our growth, it's always a matter of timing. In 2005, we doubled the size of the company. In 2010, we doubled the size of the company. If you look back in the commodity cycle, you would look and say, we hit it perfectly. In 2014, we doubled the size of the company, and we hit a deflationary cycle. And so for about 4 years, we fought that. We held earnings as we grew around the world. And then in late 2019, we started to shift out of that cycle, and we had these incredible tailwinds, and I always remind our team, we look smarter than we are when there's tailwinds. And so now we've entered a marketplace that now has adequate global supply of grains, oilseeds. And so ultimately, you have to then adjust your business model again. There's only so much you can do, and I always try to remind people of that. I mean, if you think of our business, there's many of our suppliers and customers in the room here, and ultimately, we have to take care of them every day. We have to cover our cost, but we also have to remind ourselves, there's the alternative of going to the landfill if they have to. So there's not unlimited economics in this business. The way the business is structured globally is we try to earn a fair return for our shareholders to attract capital. And I think we do that. And then if the markets cooperate around the world, meaning higher prices for grains, oilseeds, fuels than we share. And that's the way the models worked. We think we're I always hate being the guy that's going to call a bottom here. So I'm not calling a bottom, but I said, we're in the bottom of the trough right now. And we're seeing it turn around the world. The poultry side is resilient here in the U.S. right now, the besides tailing back, a little bit tailing off. The porcine or pork side is pretty darn strong. Europe, everybody had doom and gloom. It's holding in there. But the animal numbers are shifting. They're shifting up the pole and they're shifting down to the Spain and the animal numbers in South America are just we're out of capacity again. And so you just see this global shift that's happening, and then we throw China in the mix. And China is far more robust than the media makes you believe right now, and we've had another solid 3, 4 years. So ultimately, I guess, trying to answer a short way to a long question is we're seeing this thing cycle back up. We completed 6 record years in a row last year. I'm not taking off a seventh record year yet, but I wanted to kind of just kind of temper everybody's expectation at this time until we see how the world kind of shakes out here.

And as you watch that play out, you are taking some internal actions that you talked about to support the margin structure. Can you talk about some of the things that you've been doing? How far along in that process you are? Or maybe how much is left to realize on go for basis?

Yes. And I mean, we look at it, really, the -- out of the 16 million tons that we process 11 or 12 are in the -- really in the animal feed and area. And ultimately, that's the area that has the most commodity exposure. Clearly, as I was reminding a colleague every time an Amazon warehouse popped up around one of our factories, we lost our first shift over the last 5 years. And trying to kind of regain and retrain labor at a fair value has been the biggest challenge. So trying to explain to our suppliers and our customers, the costs that we've had to incur. And I give another example. About 5 years ago, we built 6 years ago, a new -- first new rendering plant in the U.S. in Grapeland, Texas and spent about $45 million on that unit. That plant today is being rebuilt in North Carolina at $100 million. And so the costs are way up, not only people, but tip up a concrete building is now $600 a square foot. And oh, by the way, many -- there's a lot of young people in this room that have never known what inflation was and they thought an interest rate to buy a house should have been 2% or 3%. And I wish your bankers who know that's a better number than their loan to me right now. But...

Very fair. So bottom of the trough, you've talked about kind of a gradual improvement from there. Can you talk about the drivers of that? And maybe within that, the dynamics between international and domestic prices, the arb there. Obviously, a lot of news flow in the last couple of days about what the government may or may not do over time with imports from China. So is there a more bullish opportunity or set of circumstances that could play out? Or I guess, how do you think about the different [ items ]?

Yes, there's probably a half a dozen subjects buried in that question. The -- we're long term and long term is back half of the year, bullish and driven by continued decarbonization in the world. And you think we're on the back end of whether you call it a recession or not, but some global contraction. And ultimately, we -- as I always tell people, we do a couple of things. We make protein and we make fat. And the fats we make in the world predominantly have one use, and that is back into some type of hydrocarbon business. And in a classic sense, we own the lowest carbon intensity oil field in the world today with about 15% to 16% of the world in our control. And so we believe our business model is built around this continued expansion of low-carbon fuels. And we're entering 2.0 now, which is the SAF world. and for those that have followed, we have the first SAF plant under construction in Port Arthur, Texas. It's pretty darn close to being done here. We're on shutdown or turnaround right now for tie-ins. And hopefully, here later this summer, we'll be ready to start the early commissioning. And ultimately, for those that have followed the Darling business model from 2014 to 2018 the earnings were about $400 million to $450 million EBITDA a year, and then they went to, I think, in '19 or '18, $540 million, then $841 and $1.2 billion, then $1.541 billion, then $1.611 billion. And I'm still trying to join the $2 billion club is the goal here. And that's going to be driven off of the world of SAF. And what we're seeing in the SAF world that will drive this for us is we are seeing robust demand. I'm not allowed to say who the customers are, but you would know them by every name and you're probably flying home on them. And ultimately, the margins are coming back into where we thought they would. And then ultimately, we're oversubscribed. We're going to have to build a second plant. I mean that demand is real. And we're excited about it. We'll hold on that decision probably until the first of next year. But we're getting the engineering done. But at the end of the day, what I'm seeing around the world is we've made the adjustments on the, if you will, the procurement side, made the cost adjustments. We've -- ultimately, we have scaled back our spending on CapEx at this time. I'm trying to watch the world and figure it out. But we see the fat prices improving in the world. Your comment about Chinese UCO. We've remained somewhat silent on it. And by a decision. We're the largest importer of it. It's -- I get to wear 2 hats. It's the largest UCO collector in North America and the largest UCO importer in North America that selfish hat over here says get that stuff out of here. The reality is with my partner, Valero, it is all legitimate, ISCC certified that we're processing, and it needs to be converted. It is the lowest carbon intensity feedstock in the world to go back for CORSIA certified SAF and the SAF, because of Port Arthur's location, a lot of it is going to end up back in Europe. Now here's your statistics. So you do -- this is kind of your fun fact for today. There are 2.5 million QSRs in China. There are 200,000 in the U.S. There's 12.6 million restaurants in China. There are 700,000 in the U.S. It is a legitimate source of used cooking oil. It doesn't mean there's not some bad actors out there. But at the end of the day, it's -- there's legitimate supply out there. And ultimately, leading to the discussion here, Andrew, is. I want to say it was 2012 -- or no 2014, we employed LMC out of the U.K. ourselves and Valero to make sure that there was adequate waste fat to do what we thought our dream was. Neste was out there, we're out there. And let's just make sure we're just not going to create a margin crunch off of fighting for feedstock. And LMC bought this like 100-page report. And really the thesis of it was says, if you get the price of waste fat to a reasonable level, it will incent collection and aggregation. I didn't believe it. I was wrong. And so I talked to -- we have a giant presence in China today. And essentially, they changed the rules over there. Chinese UCO used to be referred to as gutter oil. And so after a restaurant was done cooking at a QSR predominantly, they leave it out back, there's a collector and then they would resell it to the street food stands. The government has clamped down on that for food safety and disease purposes. So it needed to find another way to market. And that's what's going on here. So...

That makes sense. We get -- before we move over to DGD, we get the question a lot about the ability to grow the feed business kind of price agnostic, I guess, I would say. You made the acquisition of Miropasz. You have you had made some announcements around offtake agreement, I believe, with One of the beef plants that was supposed to come online with Butterball as well. I guess more generally, how do you think about the growth of that business over time, your desire to continue to grow your own supply there on those opportunities?

Yes. I think we look at the world as having really incredible growth opportunity. And that's the U.S., that's Canada. Clearly, Polish poultry economics are very, very good right now. South American economics. Our -- we've put, I don't know, $2.5 billion in Brazil here in the last 2 years. And ultimately, the view there is that Brazil will become the commissary for China. And between the land, water, grains. I mean you look at the beef production business in South America today and the average weight of the zebu, cow coming in or steer coming into slaughters, 400 kilos or whatever, 800 and whatever, 80 pounds versus a 1,200-pound animal, they can up their production 50%. If they learn to get the genetics right, a little more animal feed or get more grain fed into their different breeds. But you've got a complicated supply chain of currency conversion for the grain farmer to the livestock producer. So it just takes time. But ultimately, we see incredible opportunity still around the world. We've just commissioned 2 more plants in South America, 2 more that are under construction. You mentioned the Butterball. That's partnering with a large supplier to reduce freight. And I mean you can't ever forget people say, what business are we on. We're in the transportation of water, evaporation of water business to a degree that I always call it our trivial pursuit bar question, what's the #1 product Darling makes water. And as I always say, it's the dumbest thing, because we collect it, we transport it, we evaporate it, we pump it, we treat it, and then we pay somebody to take it. What a great business model.

Okay. So with that, we're going to shift to DGD. And we know the margins have gotten better. We've been vocal about that where are our margins today. And I guess kind of a broader level, you put up a first quarter and gave an outlook for the rest of the year that didn't suggest really that much change over the balance of the year. So how are you kind of thinking about the puts and takes for DGD margins over the rest of the year relative to where they've been?

Yes. trying to guide on that is somewhat difficult, but we look at the -- and I always remind people in 2013 in July when we started the plant up the -- after 2 years of construction that the 10-year look back margin was $0.79 a gallon. That was the investment thesis on $3.23 a gallon construction cost. And that's where we're at today. We're at or near that. We thought the market would eventually go there. We've all -- you'll hear me communicate. They say, well, what's the competitive advantage of the DGD system. And I say it's $1 a gallon. And you say, "Well, how do you get that, right? I would just tell you, pull up HollyFrontier, pull up Montana Renewables or whatever they go buy, pull up PBF and they're losing money and we're at $0.70-something. So that's -- it's really ultimately, we knew this business would commoditize. We knew we had a first-mover advantage. Our cost structure is way different than everybody. Our assets are paid for. And now we're moving to 2.0 in the SAF business, which once again will have a first mover advantage there's not enough in the world. And so DGD margins are going to be volatile. We're never going to tell you they're not. But as you said, as we looked and built guidance, I mean, you had to normalize for the inventory adjustment out of Brazil that we had. But that -- it's really when you say what's the base business going to do for this year. It did $1.1 billion last year. Right now, fat prices are down $0.25 a pound from a year ago. And we say each penny is worth about $0.12 a pound. So you kind of -- you're missing [ $300 ]. We think that prices will improve the back half of the year, because of some RD capacity coming online. Some people getting some pretreatment units, figuring out how to run them. And so that's where we got the base business at about 900. And then we see DGD with no SAF earnings predicted in '24 yet being conservative. And that's where you take $0.75 x 1.33 billion gallons, pretty simple. It's always easy because I remind people, it's easy to call this business when you're in a flat or a carrying charge market. When you're in an inverse, you look stupid. And it just -- it's just really, really hard to call a bottom.

You talked about the cost advantages that you guys have. We've seen some of the other players in the space, who report some not so pretty numbers. There were reports of one of the plants that's going to shift back away from RD. I guess -- where do you think we are in this cycle? How do you think this plays out from an industry perspective overall? Because there's part of me that sees those losses and some of those announcements, but also recognizes you've got the SAF opportunity and some of these other things that are exciting. And I don't know how people kind of the pushes and the pulls play out over time. So I guess what's your expectation in terms of the capacity and how some of these players react to where we are?

The -- I think you have to kind of bifurcate the freestanding guy and the brownfield conversion out there. Clearly, Marathon is there. Clearly, P66 is telling people they're there, although I haven't seen the gallons, I've seen the feedstock purchases and the feedstock purchases would suggest a significantly red margin and what they're paying for it. But then the question that you have to ask yourself, are they running for compliance? Are they running for profit? Their crack spreads are so pretty darn good right now that I -- and they're not going to report it in a segment, so I don't know that we'll ever know. The free standards, you're talking about Vertex, HollyFrontier. I mean, when you got a goal of being at 75% capacity, but it's a far more difficult business than people understand. I mean, we're so blessed with our partnership with Valero, because not only do we have access to great people, great engineering, great technology, but great marketing with Valero Marketing Services Corporation. So the vertical here gives us the ability. And then as I said, we looked at this thing and I'm a 40-year commodity guy, commodities come down to one thing, location. Who owns what real estate. And if you had to say where is the best place to build a renewable diesel plant, the Gulf Coast, not Artesia, New Mexico, not Montana, not Dickinson, North Dakota. Probably not San Francisco, but good luck.

That makes sense. Before we go over to the SAF side, I wanted to ask about LCFS and RINs. LCFS values having not reacted yet to some of the policy proposals. And does that surprise you? And what do you think it takes? And maybe you tie that into or layer in how you're thinking about RINs from here, given expectations around the production ramps and maybe on the biodiesel side? How do you think those 2 things play out maybe through the balance of the year and into '25?

Yes. And you buried about 9 things in there this time.

Why don't [indiscernible] let you go.

So clearly, markets anticipate. And clearly, RD capacity is growing. It's replacing Gen 1 biodiesel capacity. That's creating a lot of angst in the farm community right now. And when you can dive in and we'll talk a little bit about RINs LCFS, but it comes down to one thing. Can we get the momentum in D.C. under whichever administration is going to be there to increase the RVO here at the end of next year. Once they do that, this thing fixes itself. And the question for me, and I fundamentally believe they'll do the right thing. And so that's driver number one. If you say what's driving LCFS, what's driving RINs it's not just enough demand. The second thing that's out there is that there's too many imports. That's going to end when I say imports, imports of biodiesel right now. Why? Because this is the last year, the blenders tax credit. So they're bringing 900 million gallons in. So let's do that time 7.5 or 8 pounds a gallon, whatever, that's 6.5, 7 billion pounds of fat. Why are we bullish on the back half of the year because that's going to have to convert. RINs, they seem to be fine in a bottom right now. We're below the marginal cost to produce. Remember that one of the other thesis is we had our hypothesis in a sense was that the RIN became in business school, everybody would say, the marginal cost to produce and you need it. So the RIN was the marginal profitability required to take a feedstock that's above diesel fuel price plus production costs to make it profitable. And while that seems to be true, in most cases, what we're seeing out here right now is that there's just an oversupply of RINs because of the RVO. You're seeing it idle. You've seen Chevron idle a couple of old [ REG ] biodiesel plants. You've seen Vertex reconvert back the other way. I doubt you'll see anything else, [ Bill ]. All the SMDs on the RINs are that the sell side we're doing with the exception of you was having every body run for on day 1 and push the button. That's not happening. That will fix itself. LCFS, there's nothing different than what's been promised out there is there is clearly an ambition, an aspiration to accelerate the decarbonization, the numbers are out there, it's going to happen. It was always supposed to be Jan 1 of 2025. And it looks like sometime in July, we'll get all through the rulemaking public comment period. It's -- you've got a governor out there that I know that he's inserted himself in the process. I'm not sure I can put a finger on why other than -- it's important to him. But I also think that it's not going to make the price of fuel go down in California and he wants to be close to that in CASA Pennsylvania have a new calls him here. So I think there might be an underlying delay there that's part of the driver. But we'll see. I mean, the LCFS piece is very bullish into '25. And the acceleration that it needs. And then I think the other piece that everybody has to start to get their mind around it is very complicated, and I know people hate complicated regulatory environments, but the 45Z, the producer's tax credit. If you're not running waste oils and you're not making renewable diesel, you're not going to make any money in the business. So that will have an icing effect on the industry here. So -- and what I mean by that is if you're making RD out of soybean oil with a producer's tax credit, you're going to -- you're not going to make any money.

Is there -- with respect to LCFS policy, is there a better outcome or a more preferred outcome within the range of options or we're all kind of headed in the right direction?

It's in a right direction. Bigger is better.

Right. Okay. So that makes sense. On SAF, how do you think about the long-term opportunity? We are close to the first one. You've started to talk about SAF, too. How do you think about the evolution, maybe of the DGD portfolio over time, balancing between RD and SAF?