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

Good afternoon, everyone. My name is Justin Jenkins, research analyst here at Raymond James. I'm pleased to be joined by the folks from Darling Ingredients. On my far left is CEO Randy Stuewe. On my immediate left is brand-new CFO Bob Day. So Bob, welcome to the new role, and thanks for coming to our conference.

Thank you.

I think, Randy, I'll pass it over to you maybe and give a 5-minute intro on Darling and how things fit in the state of the union here.

Okay. Well, first off, thanks for having us back. It's always good to be invited back. Darling is a story that is very exciting to me. It's one that, for those that have followed the company for years, I had the honor of taking over at the end of 2002. At the time, we were just a small regional meat byproduct-rendering company with 21 factories, 600 employees, roughly $300 million in revenue and an EBITDA that barely broke $20 million. 22 years later, we are the world's largest slaughtered animal byproduct company with 280 factories in 24, maybe 25 countries and 16,000 people. It's one of the most unique companies you'll get to listen to and learn about today that you'll ever be around. But it's got a unique position in the world. It's #1, meaning 1 out of every 6 animals in the world, after the meat is removed, go through one of our factories. We produce products for human food. We produce products for pet foods and animal feeds. And when we can't feed it to a human or feed it to an animal, then we produce energy or BTUs out of it. We are uniquely positioned as the largest renewable diesel and SAF producer in the world. We started in July of 2013. So we're approaching our 12th year in production, processing about 1.3 billion gallons a year or 4.8 million tons of product globally. So the learnings of the company that we'll give you here is it's a company that creates value out of waste streams. And the waste streams typically come out of the slaughter houses, out of the restaurants, out of the food service establishments and bakeries around the world. And we process about 17 million tons of what people would consider landfill-destined product into higher-value products. The Food segment is comprised of primarily collagen, sausage casings and, believe it or not, edible fats. You saw Steak n Shake come out this week or last week, and they're going to start frying again in animal fat. I guess we found out seed oils and other things that maybe what grandma used to cook in, butter and animal fat, isn't so bad after all. And so the Food segment was anchored by the collagen business. We have, I don't know, 13 or 14 factories in lots -- on all continents, 7 or 8 in Brazil and Paraguay and 4 in Europe, 3 in China and 1 in the U.S. today -- or 2 in the U.S. And so today, as we make -- you guys would be familiar with that product in the sense that probably 100 years ago, Kodak used gelatin for a film coating. It transitioned to what you would know as gummy bears. It's an emulsifier, binds water solution and solids, and then also gel caps. So you would know it as your Advils or your TYLENOL gel caps. But that comes out of bones and skins from animals all over the world. And it's just another chance to take a slaughtered product and convert it into something. The exciting part of that segment that we want you all to start to read and think and follow our excitement is the launch of the collagen peptide library of products. Peptides have been created out of collagen. The collagen molecule carries a significant portion of the amino acids that the body needs to sustain life. We have just recently launched what's called Nextida GC. GC stands for glucose control. As the body secretes insulin or you take in food, you produce sugars, you get glucose spikes. And then ultimately, if you can level that off, you feel better and ultimately weight control. So it's being marketed now as a GLP-1 alternative. You wouldn't look at us as a pharmaceutical company. We're not there. This is sold in the supplement category, but it's one of a library of 5 or 6 products. Next one, I think, that we're trying to launch within a year we'll call it for brain health, women's health, gut health, nails, skin, et cetera. So very, very exciting for us in those products. Why is it exciting? When we acquired that business in 2014, it was about 90,000 tons, making about $90 million a year. Today, it's 145,000 tons, making about $300 million a year. And if we're successful with the peptide launch relative to our other products that we've done over the last 10 years, we see that segment having the opportunity to grow significantly, potentially even double in the next 2 to 4 years. And really the world is looking for health and wellness solutions that aren't pharmaceutical-driven, and that's on all continents around the world. The Feed segment is our largest segment. You would know us there. It's picking up meat scrap that can't go to anything else, but be rendered as they call it, that would describe the process for everybody. That's the removal of the fat, the protein and the moisture. So it's essentially a collection, a transportation, evaporation and separation business where you get -- it's about half water and then we separate the fat from the protein. The protein goes into aquaculture feeds, organic fertilizers, pet foods, the fats and oils end up in the hydrocarbon business now. And then as we said, the slaughterhouse also -- and the livestock producer puts some products both here and around the world that have the mortalities that have to be destructed. And there, we would take them through a rendering or a digestion process. Europe, we're one of the largest biodigesters in the world today, producing biomethane, electricity and then injecting in the grid. Those are the 3 businesses. In about 2010, we opted to try to figure out a new and better use for animal fats and used cooking oil. We're the largest used cooking oil collector in the world. And primarily, that product and products were limited as just a caloric enhancer to animal feed. And as the renewable fuels around the world and decarbonization became the focus, we invested with our partner, Valero, in the hydrocarbon technology of hydrotreating animal fats or waste fats and creating a hydrocarbon. And we've been incredibly successful at it today. We've invested $4.5 billion, $5 billion. The plants returned -- or the 3 plants have returned well in excess of that over the course of history. And we're now embarking on the new frontier of SAF, or Sustainable Aviation Fuel, and we're the largest producer today in the world of that product at Port Arthur, Texas. It's going to be a great product. If you think about it between the U.S. and Europe, I don't know, 40 billion, 45 billion gallons of Jet A is used annually. And we think that up to maybe 20% to 30% of that pool will be converted to SAF over the next probably 10 years. So very excited to create that. It's a business that from an equity investor standpoint, as we talk through, yes, it's got some commodity exposure. It's got a lot of risk management tools and inherent risk management within it, and it's a large cash generator. Like we said, we've doubled the size every 5 years, in 2005, 2010, 2015, took a couple of years off for COVID and doubled again in '22, and that's what we have today. Bob, anything you want to add? I forgot the story. I mean, it's day 4 for you.

Well, I think what you said without exactly saying it is Darling has been so successful over the 20-plus years that you've been leading the charge because it has taken a basic process and then added a significant amount of value up the value chain. And all these examples that you've given has really been true to sticking to that strategy.

I think rightly or wrongly, every conversation that I have with investors these days starts with the regulatory and macro backdrop. Maybe just talk through the first days of the Trump administration, what you're seeing from the policy standpoint, how much uncertainty is still out there. Maybe talk through the dynamics, especially on the renewable fuels business.

I'll let Bob take that, but I want to comment and just say 98% of our investor discussions are on the renewable fuels business. And then I always end up and say, "What about the other $1 billion we make?" And that's really -- as we always want to put it in perspective when we talk to you, this is our refinery at the end of our fat production stream. And it had 10 wonderful years there last year, okay, your investment case. And this year, now it's back to Bob.

Yes. So I think we haven't seen any policy changes as a result of the Trump administration. Perhaps there's a lot of question marks that people have about potential changes. But what we do have in front of us is really what we wanted. We got 45Z guidance. That guidance is clear. We're able to monetize the credit. We can calculate the value of the credit. So all of that is firmly in place. We've got an RVO with an increased mandate in 2025 that with the changes in 45Z make it very difficult for imported biofuels to come in and generate a RIN. It makes it very difficult for imported foreign used cooking oil to come into the country. All of that is -- it's supportive to, one, RIN prices because it restricts RIN production. And then second of all, it's supportive to animal fat prices because animal fat is not restricted from coming in to earn a producer tax credit through the 45Z. So overall, the regulatory framework as it sits here right now, it's very positive. The challenging part of it is we came into the year with a surplus of RINs. And due to a lot of the question marks perhaps surrounding the new administration, what they might do, it appears that the compliance around RINs is delayed. So obligated parties are waiting. That's -- so while the marginal producer of biofuels in the United States is underwater, and we're making fewer RINs, we aren't yet seeing it in the price of the RIN, and that's something that we believe is likely to follow.

Yes. And for the audience, when you think of this, first thing you have to ask is where do renewable fuels fit in the portfolio of solutions in the world? Are they necessary? I think there was a lot of people questioning when Trump 2.0 was going to happen here, was he going to get his pen out and make them disappear? I'd say just the exact opposite now. And the proof is the National Energy Council (sic) [ National Energy Dominance Council ], it listed in their charter biofuels. That's number one. It's headed up by Doug Burgum, North Dakota, right? Ethanol guy, pro-farm, pro-biofuels, coming from South Dakota, pro-biofuels. So we think from our perspective, we're sleeping at night. We've got what we need out here, as Bob said. And really, at the end of the day, as long as you're not just a believer that decarbonization is going away, it's going to be a different catchphrase out here. Under the prior administration, it was climate change. This will be energy security and ag policy as we go forward. 40% of the U.S. corn crop goes into energy. 50% of the U.S. soybean crop goes into energy. If you're going to keep the House and the Senate and win midterms, you are not going to change this thing. You're only going to improve it. Farm economy is at a 7-year low. Interest rates are up. Energy prices are stable but up from years. And ultimately, the stage is set for what we believe is a go-forward, very, very strong renewable volume obligation or mandate, and it just makes sense. And people have to get their mind around this that this isn't a stroke of a pen and it goes away. It a bit feels -- for people that have been investors in the ag energy area, it feels like ethanol 2.0, but I would tell you it's very, very different. And especially for Darling, we always try to tell people, Darling is the only vertical in the world in this. And why are we in this? I don't know anything about energy, and I won't try to tell you I do. What I do know is I know the alternative for animal fats and used cooking oil is half the price that I'm being paid through the hydrocarbon plant. So that's our investment thesis.

Yes. I think everything that we've seen over the past 12, 18 months of this downturn is Darling and DGD's relative position is very clearly at the top of the pecking order. It's the absolute economics that maybe we're uncertain about at this point. But would you expect to see more supply cutbacks from the biodiesel guys if this period of weakness and uncertainty persists for a bit more?

Yes. And Bob and I'll tag team this. Just reflecting back on this, year 1 through 5, we made $1.26 a gallon on a $3.23 a gallon build-out, greenfield properties. Year 6 through 9, we made $2.26 a gallon, unsustainable, and unsustainable because it's too good, right? So what did we do? We attracted competitors. Now what else went on during that time period and why I'm just trying to set the stage for you. We live in Irving, Texas. And if you come into my office and you look out the window, you can see the -- whatever, the death empire over there, ExxonMobil.

They were right up here.

I know that, but there they were. They got somebody in their boardroom on decarbonization. And so the rest of the industry, Mike Wirth at Chevron, he went out and made what I think is probably one of the worst purchases in history in REG. I mean he got nothing. He's shutting plants down now. And then you've got Marathon that went and retrofitted a plant in Dickinson and now Martinez and Rodeo. So the environment has changed. And it went from a very lucrative environment now to an oversupply, which Bob commented about. And now the question is how committed is Big Oil to staying in this because they bring nothing really to it. They don't bring feedstock. They bring a little bit of distribution. And if there's -- if you're losing big money, which is very obvious as they are, is it a make or buy situation? And that will drive then the timing as the margins come back into this. When we sat down and said, "If you could pick one place in the country, where would you want to build this plant?" It was St. Charles, Louisiana. Second one was, "Let's go a little bit out of the way, put it on the water, receive it in, receive it out, put it in the pipeline, sit next to the largest hydrogen plant in the United States." And so at the end of the day, we say, "Well, we're in the right place." Yes, the industry reacted to the margins that were available and now it's got to, I think, react the other way and rightsize.

You talked about SAF at the beginning. You just started SAF production late last year. Maybe talk about that ramp-up process, how things have gone so far and the outlook for SAF margins going forward?

Yes. So when we looked at RD -- and the reason I want to set this up is we were going to get in the biodiesel business. But as everybody knows, what happens when animal fat gets below 55 degrees. It's hard. No different. You don't change the molecule when you make biodiesel. When you remove the oxygen and the water, you've created a hydrocarbon and you've got a fungible product now that can be put in the distribution system in this country and around the world and be transported everywhere. So the first-mover advantage is what brought us into the RD business, and the technology evolved and the learnings that we've had. We would still tell you every day, we're still learning that business. It's a very corrosive business on metal. It's very hard on metal. It can be very hard on catalyst. Our secret sauce is our pretreatment system. Our refining system, that's my background from the vegetable oil side. So we built something that no one else has in the world or been able to duplicate under our processing conditions. As we looked at RD, we said, "This party is not going to last forever." We said, "Let's move over now and make SAF." As we said earlier on, SAF is a product that will help an airline decarbonize a 30% blend, knocks down emissions fairly significantly off of those engines. SAF is mandated in Europe. It's 2% this year, and it keeps stepping up. So 2% of 19 billion gallons is 380 million gallons. There isn't 500 million gallons running in the world today. It might not even be 375 million, and we're 250 million of it. So we've got a margin environment that looks very attractive today and go forward. The U.S. is a voluntary market. Majority of our sales today are in the U.S. And you say, "Well, why are they doing that?" Well, some are doing it for the right consumer reason. I'd say JetBlue is a mover and a shaker in that area. Southwest, American, they're all moving in that direction, but they're moving for a different reason. One is there is some economic impact to them, but there's also a voluntary credit market where they're able to sell that piece of paper back into the market. And you would know the big 5 consumer companies and banks that are either buying farmland or forest land in North Carolina or making tennis shoes or making software. There are those people that are committed to making the planet a better place. And so it's really a young developing market. What's most important is that we were a bit naive, or at least I was, as we entered the market, thinking that all you had to do is make good quality, pricing formulas were pretty straightforward and just when was American, Delta, United going to call. And then we found out, Justin, that there's a supply chain. We make kerosene, basically synthetic kerosene. And then it has to be blended with Jet A, either 1% to 49% and then it's deemed by SAF. And then it has to be transported to an in-wing provider who then has to sell it to the airline. So the supply chain is floor deep on every trade at least domestically. And so it's just taken longer. Our book is solid. Our '26 book is building now. And I think it's something that, number one, we would say, I got to give the hats off to the operations team. The technology, we developed in-house. Our competitors in Europe or Finland have not figured it out yet. They're still struggling. And we're ready to -- I suspect here as the book builds to consider and evaluate building out #2.

Has the conversation around the margin premium versus RD stayed about the same? Has that negotiation with the airlines changed at all? Or has it been pretty steady?

Yes. I think the indications that we gave previously regarding the uplift in margins as it relates to renewable diesel still hold true. And I think building on to what Randy said, there's a real lack of production today. So we're still seeing demand. Even though it's an evolving industry, and we didn't have everyone showing up committing to massive volumes, I think they're waiting to make sure that the product can be made. And there's more demand out there than the industry's ability to produce.

We've got 8, 9 minutes left. I guess maybe shifting to the financial side of things. Randy, you said pretty conservative, what I think is the word I would use for guidance for 2025. Obviously, a bit of uncertainty in the macro backdrop but maybe just high level, walk us through the working parts of '25 guidance.

It was -- '24 was a tough year for me, trying to guide everybody out there, like I always set the table for you here. In December of 2023, we do an annual operating plan meeting, and it's a Board exercise where we take all 280 facilities and we run a cash planning exercise. And we say, here's your volumes, here's your selling prices, here's your energy costs and assume you're 2% or 3% on your labor component. And boom, the Cray supercomputer jacks out a number. That number for the core business on December 9 last year was $1.1 billion, and that number for Diamond Green Diesel was $1.4 billion or $700 million for our share. That was -- we went in. We finished the year right at $1.1 billion. The spread between the core and what it finished at was 100% fat price-driven. Each $0.01 a pound on fat is worth about $12 million, and we were down about $0.20. We came into the year at $0.55. And by January 3, we were $0.40. We already -- I mean the hardest thing when you sit in the seat is to keep your team motivated when they know that the headwinds are really blowing strong. And then we saw the troubles that started in the renewable diesel business with the oversupply, which was a domino effect out of China to Europe and Europe to the U.S. and watch those margins decline pretty rapidly. So that's the environment we went in. So for Justin Jenkins' math, I took Q4 core ingredients times 4, that's $9.25. And I said, Diamond Green Diesel, the environment, I think, is a little cloudy right now, but it's not going to be worse because of the SAF plant than last year. So I took $0.50 times 1.250 billion gallons or whatever it was, and there it is. And it was just that simple. This is a business that I have no problem guiding you when markets are moving -- they're flat or moving up. When they're moving down, we're playing catch-up constantly. And so last year, while it seemed it was a giant miss from what our expectations were, still our fourth best year in the history of the business, and we're very, very proud of it. And our returns relative to our peer groups were still exceptionally well.

Bob, maybe for you on the balance sheet. It's been a focus to reduce leverage, reduce overall debt. Maybe just talk about your priorities on capital allocation front.

Yes. Well, look, I think last year was a great test of our balance sheet. So we were as levered as we have been in a while. We had a lot of -- we had down cycles happening in a couple of areas, down commodity cycles in a couple of areas of the business. But we still managed to pay down $400 million in debt, and we were very disciplined in our CapEx. This year, we want to do more of the same. We'd like to pay down a similar amount of debt. We've set $400 million as a CapEx objective. Most of that's maintenance CapEx, but there is some growth CapEx in there. And I think if we can do that, we'll get down to the ratios that we're looking for.

Yes, we've not wavered from the goals and we're about a year behind where we thought we would be. But ultimately, we've got some debt maturing as we come into the year here or next year and then the following year and then a senior. And so we want to put the company in a position to establish a long-term capital structure that gives us the flexibility. We -- as everybody knows, we bought 3 very large businesses that came to market after the end of the commodity up cycle. And that's when they come. We looked at each other and we said, "Do we have the balance sheet capacity to do it?" We always call it the -- in my world, we call it, is there any risk of joining the wall of shame? And the wall of shame is when you got to go back to Madison Avenue and start renegotiating with the bond guys, right? And so we said, "No, let's do it all with debt. We've got the capacity, skip the equity, let's not dilute and salute." And so we took it on and then boom, there it is. And so we're about a year behind. We'll be $3.5 billion of total debt by the end of the year. And ultimately, at the run rates that we gave you here, we'll be 2.5, 2.75 on a financial leverage ratio. We'll have that opportunity for investment grade. We'll have that opportunity to step in and acquire buybacks and return capital to shareholders, which everybody deserves. And we still have the capital to expand our core and acquire when it makes sense.

I got a couple of minutes left. Any questions from the audience that we can ask?

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So yes, with bird flu, unfortunately, when there's culling of birds and bird flu, they've got to gas the birds and bury the birds on site. So we're not seeing that raw material come. But overall, we're not seeing that as having a major impact on our volumes.

Randy, the question I'll leave you with is, are investors missing anything in the Darling story, the key takeaway for you here?

Absolutely. I mean I've never been more passionate about the business and my team. I'm on the back end of my career here. 2 years ago, I had 7 executives. I have 2 left with me and the whole team is new now with me. And so end of the day, we see the opportunity that still exists in the world today. We are not a 90-day make a number, miss a number company. This is a view of a 3- and 5-year trajectory of where we're going. And I think at the end of the day, if your horizon meets that, this is an incredible company. I mean, as I always tell people, if you were sitting at the bar over at the Ritz and you hear some guy talking, he says, "Well, they got the #1 position in the world. There's really no competitor other than the landfill and they're continuing to grow every year, and they've got all these neat products that are being launched and now they're decarbonizing the planet," how can you not get excited about that? And the multiple that the company is being valued at today is what it is. And you'll never meet a CEO that doesn't think he's underappreciated or undervalued. But this one clearly is in the sense of what it can deliver over the next decade. And we don't see any slowing of our growth, and that isn't to scare people in the M&A and all that. It's just that we fundamentally believe that people are going to continue to eat meat, eat more meat, and we're the provider of services of choice in the world today.

Awesome. Everyone, please join me in thanking the Darling team here.