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

Good afternoon, everyone. I'm Jason Gabelman, one of the energy and energy transition analysts here at TD Cowen. Thanks for joining us for day 2 of the second Annual Virtual Sustainability Conference. Pleased to be joined by Suann Guthrie, Senior Vice President of Investor Relations, Sustainability and Global Communications at Darling. She has been there since the beginning of 2022. Prior to that, she worked at Exxon for 8 years, including Head of Public and Government affairs at XTO and she also spent 13 years at BNSF, including Director of Media Relations. Suann, thanks for joining us.

Thanks, Jason. Good to be here.

So a lot to get through here, a couple of topical things that were recently in the news. Let's start on CARB and the LCFS program. They delayed the Board approval until November. It sounds like they're considering a 7% step down in the carbon intensity, is your understanding that the 5% option is now gone. And how do you view the kind of push out of the board approval?

Sure. I think we all would have liked to have seen a Board vote in July or September, because we've all been working very hard at this for the last several years. And clearly, with LCFS price is very low right now, we definitely want to see something, so we can spur our investment and get those LCFS prices up. I think what we saw from CARB yesterday was a clear indication that they are very serious about increasing that step down. They noted in their press release 7% or greater. So we're very encouraged by that. You can see that we submitted our comments to CARB and we're advocating for 9% or higher. So we'll see where we end up. I think November 8 gets us through that election. Clearly, they wanted this to be detached from that. And I still think that a January implementation is still possible.

And is your understanding that 5% is no longer being considered as an option? And then is 7% enough to really have a positive price response in LCFS prices?

We do think 7% is absolutely enough. Regarding the 5%, we won't know really until CARB publishes their new proposal, which we will see before the November date. From there, there'll be either a 15- or a 30-day comment period. So hopefully, we'll see that here in October, September time frame.

And is there any significance to the January 5 implementation, does something happen if they don't get it done by then?

Sure. Well -- what we need to do is -- I think the way the process works is that we need to have them send something over to the office administration before that January 5. Because then -- I mean the process would have to start over again. And I will tell you, in our conversations with CARB, that is not something they want to happen. That's not something the industry wants to happen. So I think the chances of that are relatively low.

Got it. Got it. I failed to mention at the top of the call. If anyone has a question, you could submit it via the web portal and we will try to get to it. The other topical news item out there has been the UCO supply from China, the ramp-up in imports there and the potential that they're spiking that with palm oil and there were some hopes that the U.S. would slap tariffs on those imports, that didn't happen. Can you talk about the quantity that's coming in and the potential for the U.S. administration to force that out of the market?

Sure. Obviously, Diamond Green Diesel is a large importer of fats, not only from Darling, but also they use cooking oil that you're seeing coming in, is Diamond Green Diesel. It's bringing some of that in. And so I can tell you that when we went to start out Diamond Green Diesel III, we've recognized that we need to source fats from all the available options. And our traders did go to Asia. They feel very confident in the testing that we do, both once we -- when we went there, it is ISCC certified. We have all the documentations. We've turned boats away that don't have the proper documentation. We do test for free fatty acids when we receive that. So we feel pretty confident that the UCO that we're using is, in fact, used cooking oil and not laced or spiked, as you mentioned. And there were concerns on that in Europe. I would say that the United States protocol for those imports are very good and they're very strong. I can't speak to Europe, but we feel pretty good that we've taken all of the possible steps we can to ensure that used cooking oil that we're taking in is used cooking oil. Back to the tariffs. You mentioned about the tariffs. We haven't advocated one way or the other. On that. I think that is something that's coming from the soybean lobby that they're very keen to try to limit because they've put a lot of investment into crush capacity in the U.S. And clearly, that could impact their investments there. But from where we sit, we stand agnostic on the issue. But you're right, we didn't see tariffs. Could there be tariffs in the future? There could be. Now a good thing to remember though, is that when we -- if we were to take UCO in that had a tariff and we export that finished good, you get a duty drawback. So again, we're really agnostic in that because we get that back.

So if I'm hearing you, you're kind of indifferent if the UCO gets backed out of the market or not?

So on one side of the fence, we could say from Darling Ingredients, that should move fat prices and being very selfish on that side, we would say, yes, fat prices up would mean very good things. But remember, we also have this vertically integrated business. So we [indiscernible] also better on the fuel side if that prices are lower. So again, we kind of just stay agnostic on the issue, and we can work with that. And like I said, the duty drawbacks allow us to use that if we export that fuel.

Got it. And do you have a sense of census article has been out, if there's been any change in total UCO imports coming into the country?

Well, so the market -- the great thing about markets is, a free market really corrects itself. And so what you saw is fat prices were very high, right, in the $0.70 range a while back when Diamond Green Diesel III started up. And what we saw is now the availability of all this international used cooking oil coming in, and that caused that prices to fall. That as well as China was sending a lot of biodiesel into Europe. And then you had Germans moving their biodiesel into the U.S. So you had all these market dynamics going on and fat prices fell. And we were, in fact, sending some of our European fats to Diamond Green Diesel because we could command a better price. Now what you've seen is sort of a correction in that market and you're starting to see domestic prices now be more favorable. So it's really correcting itself in a free market environment.

Got it. Got it. You discussed DGD margin, I think going into the year at $1.25 a gallon. That came down to $0.75 per gallon EBITDA for the recent guidance for 2024. Is that still fair given the volatility we've seen in the credit prices? And just any broader comments around that EBITDA guidance?

We're saying that for now. We will -- when we report if we have changes in that from what we know, obviously, you've seen LCFS prices come down. [indiscernible] here in the recent months or in the recent weeks even. RIN prices are going up a little bit. We don't have a change right now. The thing that could change that we're not baking into the guidance is sustainable aviation fuel, right? So if we get that up and running and we sell those gallons in Q4, that could be an uplift that we haven't put out in that guidance.

Got it. And something I do want to come back to. But you mentioned LCFS prices falling and they've fallen quite a bit. It seems like they had a floor in the 60s and kind of fell through that here recently. What do you attribute that to?

Well, 66% is online, right? Diamond III is online. There's more volume and not enough in the credit bank. This is why we need an LCFS program revitalized, if you will.

Do you see prices at a level where it's more advantageous for Diamond Green Diesel to export more product now to Europe versus shipping it to California?

So we've always been very active in the export market. For Diamond Green diesel, Canada remains a very important market to us. Interestingly enough, we are selling renewable diesel to non-LCFS states like New York, [indiscernible]. So we are going to maximize our earnings on Diamond Green Diesel with whatever market makes the most sense for us. And right now, it's not California.

Got it. As we look to the RIN market, we're seeing a clear oversupply there. RIN prices have come down quite a bit. It seems like that oversupply could push into 2025. How do you view the RIN market evolving through 2024 and then into 2025?

Well, I would say, 2024, I think we're in an oversupply clearly, right? And then that's demonstrated by the prices. And it's not going to get any better. Could it get worse, maybe? Maybe we'll see some push for imports coming in because the BTC goes away at the end of 2024. But then 2025 changes things, right? We have 800-ish million gallons of imports that came in, in 2023. Most likely not going to be imported because they don't get that dollar anymore, right? They can generate a RIN, but they won't get that dollar. So my guess is some of those imports will find better markets, and that will come off the table. We've started to see other renewable diesel providers go away. I mean you've seen some of those announcements. I'm not going to name the names here, but you've seen some of those. And I guess the question is, how much of that goes forward into 2025. If they're not profitable today, how long will they operate unprofitably before they adopt going back to a performance-based product or perhaps not participating in the market at all. I think we can feel pretty confident that 2 big ones in California will operate. And so maybe the smaller ones go away. So I think that what we would continue to advocate though for would be a larger RVO. I don't think we're going to see anything on that right now, not in this election year. I think that may be visited sometime in 2025.

Got it. What's the time line on the next RVO. They typically have a proposal out in June and finalized it in November. Is that right?

Yes, but I don't think we're going to see anything because of the election. [indiscernible] that anyone wants to deal with right now during an election. So who knows, right? It will be at a different time line than we have seen in the past.

Yes. And you mentioned some renewable diesel supply coming off the market. We haven't really seen biodiesel supply come off in the data yet, but you're hearing anecdotally some capacity being taken offline. What's your sense of maybe how much biodiesel supply has been shut in, if you have a sense off hand? And do you think prices are low enough to push out enough marginal capacity to rebalance the RIN market?

I think we'll see that in 2025. You've mentioned that, yes, we've heard some closings, right? But we haven't seen that in 2024 yet. But our anticipation is some of that biodiesel does come off the market, particularly in 2025 because it becomes very uneconomical when the switch from the blenders tax credit moves into the producer's tax credit, which is a carbon intensity based sliding scale. So we're anticipating that to happen in 2025.

Got it. The other part of maybe balancing in '24 is, a lot of the integrated larger biodiesel producers do hedge their margins a year out? And do you think that is something that's maybe artificially adding to the RIN market and could move offline once those hedges roll off in the summer, do you have a sense of what that supply could be?

I don't have an estimate for you on what that could be. But I do think that, that is definitely a scenario that could happen, that along with maybe these imports don't come in, in 2025. '24, again, like I said, you could see a push to get that blenders tax credit. But 2025, the world changes quite a bit.

Yes. You've alluded to blenders tax credit switching to a producer tax credit a few times. And I want to touch on that. The first question is, do you expect the RIN to compensate for the lost BTC? And if so, how does that impact importers, because they're essentially getting that dollar per gallon via the RIN. So how do those dynamics actually work to back out the imports?

It will be really interesting to see how this plays out. And it theoretically should make the RIN more valuable, because your marginal producer has to be made profitable, right? And they don't have the dollar right now. So if you look at renewable diesel margins today with an RBO provider and you look at spot margins right now, they're in the negative. So they're producing in the negative now. You take that dollar away, that's even more so. So the RIN theoretically has to do more work. But we've not been in this situation before, so it's really hard to model it out and see what is that going to look like in 2025. And then the question is how many of these folks decide not to operate in 2025 either, right? And then remember, if you're exporting, you retire your RIN. So if our production is moving outside of the U.S., we're retiring the RIN as well.

Right, right. So I guess, is there a RIN price level where you compensate for the lost BTC as a vegetable oil producer, but don't incentivize the imports. And that's what -- I don't know if there's a number where those economics are clear or it's just difficult to tell because, as you said, we're in a market environment that we haven't been through in the past.

I think it's really hard to anticipate what the market is going to do there. Yes. And we need a little bit more guidance too from the government on 45Z. But we can kind of figure out where they're going to land on it based on what they did for 40B.

Yes. And do you have a sense of when that guidance will come out?

I would hope we would see something here in the fall, early fall. I don't know. I haven't heard anything, but with 45B done, that sets the way for 45Z.

Yes. And is your expectation that 45Z will be similar to what 40B has out. Yes.

I think it gave us a pretty good indication of where they're thinking.

Got it. Does the 40B guidance impact you guys at all. I mean, you mostly process waste oils and [indiscernible] vegetable oils.

No, it really doesn't. Because like you said, we do use waste fats and oils.