Darling Ingredients Inc. (NYSE:DAR) Q1 2024 Earnings Call Transcript

Darling Ingredients Inc. (NYSE:DAR) Q1 2024 Earnings Call Transcript April 25, 2024

Darling Ingredients Inc. beats earnings expectations. Reported EPS is $0.5, expectations were $0.4. Darling Ingredients Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the Darling Ingredients Incorporated Conference Call to discuss the company’s First Quarter 2024 Financial Results. After the speaker’s prepared remarks, there will be a question-and-answer period, and instructions to ask a question will be given at that time. Today’s call is being recorded. I would like to turn the call over to Ms. Suann Guthrie. Please go ahead.

Suann Guthrie: Thank you. Thank you for joining the Darling Ingredients First Quarter 2024 Earnings Call. Here with me today are Mr. Randall C. Stuewe, Chairman and Chief Executive Officer; Mr. Brad Phillips, Chief Financial Officer; Mr. Bob Day, Chief Strategy Officer; and Mr. Matt Jansen, Chief Operating Officer of North America. Our first quarter 2024 earnings news release and slide presentation are available on the Investor page under Events and Presentations tab on our corporate website and will be joined by a transcript of this call once it is available. During this call, we will be making forward-looking statements, which are predictions, projections and other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties.

Actual results could materially differ because of factors discussed in yesterday’s press release and the comments made during this conference call and the risk factors section of our Form 10-K, 10-Q and other reported filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. Now, I will hand the call over to Randy.

Randall Stuewe: Thanks Suann. Good morning, everyone. Thanks for joining us for our first quarter 2024 earnings call. As I mentioned to you during our last earnings call in February, the global ingredients markets are facing challenges due to replenish global oilseed and grain stocks, slower global consumer demand for premium ingredients and most importantly delayed or canceled renewable diesel start-ups. For the quarter our combined adjusted EBITDA was $280.1 million but it included a $25 million out-of-period inventory adjustment within the Food segment. As you can see on the slide this is the third quarter in a row we have dealt with a deflationary pricing, but we now feel strongly we are seeing winds begin to change in a positive direction.

Now turning to the Feed Ingredients segment. Global raw material volumes remain strong and we are seeing fats prices slowly improve. Home and soy oil continues to hold a strong premium over waste fats and imported fats are now a premium to North America. This shows me that we are still waiting for renewable diesel capacity and pretreatment to ramp up. Global fat prices illustrate that these announced renewable diesel producers are not yet taking advantage of the economics and lower carbon intensity of waste fats and feedstocks. Also during the quarter, we completed the Miropasz acquisition on January 30, adding three poultry rendering plants to our portfolio. The plants are performing quite well and I expect them to be accretive this year. And after 481 days offline, our Ward South Carolina rendering plant is operational, providing us much needed capacity in the Eastern United States.

Now turning to our Food segment. Our Rousselot sales volumes remain robust. Segment revenue was lower quarter over last year Q1 over last year due to a decline in selling price in collagen, gelatin and our edible fats business. Adjusting for the $25 million out-of-period adjustment related to the Gelnex inventory, gross margins in the Food segment actually widened to around 30%. This is a testament to our laser focus on spread management and a declining price environment. Now we announced earlier this month that we have identified a portfolio of collagen peptide profiles that are believed to provide targeted health and wellness benefits. During scientific trials these active collagen peptide profiles have demonstrated that collagen can be beneficial in reducing the post-meal blood sugar spike in a very natural way.

This is a game changing discovery that opens the door for many new product launches worldwide. Our first active peptide will be available this fall in 2024. Turning to our fuel segment. Feedstock prices tended to trend lower and improved DGD earnings compared to Q4 2023. However, weak RINs and LCFS prices and a lower of cost of market adjustment impacted DGD earnings. The margin outlook remains favorable due to lower fat prices and our competitive advantage plus an optimistic view we have on the LCFS. Our sustainable aviation unit construction is running ahead of schedule and on budget and is planned to start up in the fourth quarter of 2024. We continue to work with a number of interested parties on SAF purchases and remain confident in our outlook for SAF.

Now, I’d like to hand the call over to Brad to go through the financials, and I’ll come back and give you my views on 2024.

Brad Phillips: Okay. Thanks, Randy. Net income for the first quarter of 2024 totaled $81.2 million or $0.50 per diluted share compared to net income of $185.8 million or $1.14 per diluted share for the first quarter of 2023. Net sales were $1.42 billion for the first quarter of 2024 as compared to $1.79 billion for the first quarter of 2023. Operating income decreased $118.7 million to $137.2 million for the first quarter of 2024 compared to $255.8 million for the first quarter of 2023, primarily due to $120.6 million decrease in the gross margin, which as Randy previously referenced, included a $25 million out-of-period adjustment of overstated Gelnex inventories. Also, our share of the equity in Diamond Green Diesel’s earnings, were $15.9 million lower than the first quarter of 2023.

Depreciation and amortization was $11.5 million higher, primarily due to the addition of Gelnex. We did recognize $25.2 million of income from the change in fair value of consideration related to lowering and earn-out liability. Non-operating expenses increased $14.9 million, primarily due to interest expense increasing $12.6 million attributable primarily to additional debt related to acquiring Gelnex April 1, 2023. The company reported income tax expense of $3.9 million for the three months ended March 30, 2024, yielding an effective tax rate of 4.6%, which differs from the federal statutory rate of 21% due primarily to biofuel tax incentives and the relative mix of earnings among jurisdictions with different tax rates. The effective tax rate excluding the impact of the biofuel tax incentives is 25.4% for the three months ended March 30, 2024.

The company also paid $33 million of income taxes in the first quarter. For 2024, we expect the effective tax rate to remain about the same at 5% and cash taxes of approximately $70 million for the remainder of the year. Company’s total debt outstanding as of March 30, 2024 was $4.465 billion compared to $4.427 billion at year-end 2023, primarily due to the acquisition of Miropasz on January 31. Our bank covenant projected leverage ratio at Q1 2024 was 3.71 times and we had $811.1 million available to borrow under our revolving credit facility. Working capital noticeably improved in the first quarter 2024. Capital expenditures totaled $93.8 million in the first quarter as compared to $111.3 million in first quarter 2023. No cash dividends were received from Diamond Green Diesel in the first quarter, and there were no share repurchases in the first quarter.

With that, I’ll turn it back over to you, Randy.

Randall Stuewe: Thanks Brad. For several years, we’ve enjoyed tailwinds from a demand-driven global economy and strong global commodity and specialty ingredient prices. We are now adapting to the new reality of abundant global supplies. In my 21 years plus at this company, I’ve seen this cycle many times and I am confident in the team’s ability to make any necessary adjustments in our procurement processes and lowering our operating costs to regain margin leverage. In April, we saw nice progress in our core ingredients business and DGD has finally worked through its higher priced feedstocks. With SAF starting up in Q4, several contracts are underway and we remain optimistic on LCFS and DGD margin outlook remains favorable. Our goal to reduce debt and working our way toward investment grade has not wavered.

Through aggressive CapEx management and a focus on improving working capital, along with improved performance at DGD, I still believe we can attain by the end of the year-end of 2024. Additionally, as we discussed in February, we’re doing a comprehensive review of our global portfolio and continue to put a strong emphasis on cost and spread management. For the full year, given what we see today around the globe with solid raw material volumes, improving premium protein and collagen demand, along with slowly improving fat prices and DGD performance, we feel optimistic that momentum will be built during the year and we will be able to deliver $1.3 billion to $1.4 billion combined adjusted EBITDA all while setting the table for a much improved 2025.

So with that, let’s go ahead and open it up to Q&A.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Dushyant Ailani from Jefferies. Please go ahead.

Dushyant Ailani: Hi. Thank you for taking my questions. I just had the question on the guide that you have for the 1.3 to 1.4, does that include any reversal of the LCM adjustments? Or could there be additional upside to that?

Randall Stuewe: No, this is Randy. The 1.3 to 1.4 is really what we see today with a small improvement of fat prices but really back half loaded here. It doesn’t include any SAF early start-up. It’s just a snapshot as we’ve always done on what we see right now. As I said in February our hope is to beat last year but we’re going to need some help from fat prices. And ultimately if you do and I’m probably going to answer a few questions here and have Brad help me but you can go straight to the Feed segment and do the kind of the year-over-year quarter-over-quarter type of analysis and you see 100% of that is related to fat prices being down from Q4 to Q1 by 20% and year-over-year by 35% to 40%. And so ultimately fat prices will drive whether that number is 1.3, 1.4, 1.5, 1.6, 1.7, 1.8 as we come back here.

We also remain and as we’ll talk through the Q&A optimistic that we’ll get some LCFS bump towards the end of the year. And clearly, DGD has worked through the higher priced feedstock with the longer supply chain and it continues to perform anybody on the street out there in the business today. So the 1.3, 1.4 as — maybe conservative. And hopefully, we’ll give you some upside here.

Dushyant Ailani: Awesome. Thank you. Randy. And then just a quick question on I guess on your leverage ratio of 3.7. Any kind of updates on targets or what your goal is for the year-end?

Randall Stuewe: Yes. Now, Brad help you. Remember, the leverage ratio is a point in time of total debt divided by the core ingredients plus dividends. And so clearly as we’ve been building out SAF and we had the Q3 and Q4 lower earnings of last year in DGD dividends didn’t arrive here. So that’s just a function of that. As Brad and I and Matt would tell you cash is building rapidly in DGD and we remain optimistic on dividends which will then pull that ratio down. It’s a rolling 12-month calculation. By no means has anything changed other than the delay of the dividend out of DGD. Brad?

Brad Phillips: That’s right. Just the timing and when these dividends get started which we anticipate as Randy just mentioned cash is building has been building at DGD now and the SAF projects winding down.

Matt Jansen: This is Matt, and I would just add that on the dividend out of DGD is a — it’s not a subjective policy here. It’s formulaic. It’s calculated every month. And so there’s not a discretionary push and pull on that.

Operator: The next question comes from Tom Palmer from Citi. Please go ahead.

Tom Palmer: Good morning and thanks for the question. In the past, you’ve given a bit of a breakdown in terms of EBITDA between the base business and DGD. I know at least from your comments to the prior question that maybe there’s a bit more variability on the feed side, but I was hoping maybe you could give us kind of a rough split of how you’re thinking about the year.

Brad Phillips: Tom, you’re referencing really the guidance and splitting that out. Is that — that’s kind of where you’re going.

Tom Palmer: Yes, that’s right kind of base business versus DGD for 2024.

Randy Stuewe: Yes. Tom, if we had to throw that out there today, 900 out of the base business is what we see today and basically a billion out of DGD and that’s $0.75 times, a little over 1.3 billion gallons. Remember, just a point in time.

Q – Tom Palmer: Great. Thanks for that detail. And then — just wanted to follow up on kind of some of the moving pieces within feed. I mean, you noted the expectation for that and potentially protein prices to strengthen a bit here. I guess, could we walk through what the major catalysts are? I mean obviously, there is some disconnect right now between some of the products you sell and what we’re seeing with safe soybean or palm oil. What kind of bridges that gap? And how quickly might that take hold?

Matt Jansen: So, this is Matt. I’ll take the first cut at that. And so first of all, for the last little over a year, we’ve been hindered by the ward plant that we’ve been rebuilding. And we’re actually very proud of the fact that we’ve got that plant now, up and running. We did a total rebuild of that plant in 481 days. And frankly, it could have even done a little bit quicker, if we could have gotten the equipment there even earlier. So, now what that does going forward, that allows us to leverage our footprint in the space especially, in the eastern half of the US where we’ve been over the last year like I mentioned, incurring some cost and it’s frankly been inefficient for the — just because of that plant being down. So, that’s back up and running now. And that’s something that will give us now the ability to leverage our footprint in the space.

Randy Stuewe: Yes. And that’s a good point. And globally, I’d step back Tom and give you three analysis: one, there’s an absolute fact here that anybody that says their pretreating waste fats in North America for R&D, isn’t doing a very good job of it, or we wouldn’t be a discount to where we were 10 years ago to vegetable oil, whether it’s palm or soy or canola, that’s number one. That impact we’re seeing globally. I mean, you had European fats moving here for the first time in my career even with a plus Euro 106-110. Brazil was moving up here. Now Brazil is over US. But at the end of the day the fat pricing drives this thing. And when you look at what’s going on in the segments, you’ve got three pieces. You’ve got animal fats, you’ve got premium proteins.

We saw a massive destocking, the premium pet foods. People were trading down. It seems to have come back, a little bit now. We’ve got great orders in that business, again. So that feels much better. China was — it kind of disappeared for a little while with Chinese New Year, but once again, buying the premium chicken products for the aquaculture business. And then the other piece that obviously, exists in the feed segment because of shared assets is the UCO business and that business has come down sharply and that’s a very profitable business for us. And so at the end of the day, the outlook for the Feed segment is improved protein demand, and then a rebound in fat prices at some point in time here, as we go forward. Bob, anything I’m forgetting here?

Bob Day: I think you highlighted it really well, and it’s the spread between vegetable oil and animal fats. And as time goes on, we should see that spread tighten versus where we are. Otherwise — nothing else. I hope that helps, Tom.

Operator: The next question comes from Ben Bienvenu from Stephens. Please go ahead.

Q – Ben Bienvenu: Hi. Thanks so much. You mentioned the pull forward of the SAF production commissioning making good progress there. Can you talk a little bit about the development of getting that volume contracted, and the potential contribution that you think that could bring to 2025 or even 2024 Randy as you mentioned, maybe there’s some stub contribution?

Matt Jansen: This is Matt. I’ll again take the first cut at this. But — so the — as we mentioned the plant now, we will commission in Q4 of this year, which is a solid quarter ahead of the original plan. That plan is also on budget at $315 million, at the entity level. So we’re tracking there. And so that’s something that we’re very optimistic about. I would say from a contracting standpoint, we continue to see a lot of interest in our product. We are taking what I think is the best approach towards this. And I would — I’m confident that we’ll be able to, let’s say, contract the volume that we are — we’ll be producing out of that plant is going to be oiler plated at 250 million gallons on an annual basis. We don’t have anything in our ’24 numbers related to the project in terms of EBITDA.

But I’m confident given the state of the discussions where we are right now that we’ll be able to; a, meet the volume and certainly; b, meet the return expectations from that project.

Randall Stuewe: Yes, I think, that’s fair enough. And I don’t think there’s been a lot of chatter out there Ben it’s building. The 17,000 barrels a day is not going to be hard to disappear. We have plenty of interest there. It’s down to the final negotiations on spread and pricing here in both the voluntary and the mandated markets. And clearly, that’s going to drive it here. But we have no fear of any challenges there other than hurry up and get it online.

Ben Bienvenu : Okay. That’s great. Thank you. As we think about kind of nearing the end of that CapEx project you’ve built out DGD, you’ve kind of moved through the M&A activity you’ve had over the last couple of years. As you think about cash spend priorities from here, I recognize you want to get leverage down and then distributions will be in the wake of that. How should we think about your appetite for continued opportunistic M&A and/or incremental growth CapEx projects?

Randall Stuewe: Yes. I mean, it’s one that I’ll comment on. Number one, we are on an aggressive CapEx reduction program this year told Brad, we’re going to scale it back. We were $93.7 million in Q1. I think that’s a pretty close run rate. Q1 is always a little lower, because of winter weather and construction, but that also had the final bills of building out rebuilding word as Matt mentioned. And so target there is 400 for the year plus or minus a little bit there. Ultimately, we’ve got some pretty substantial inventories, while we had a pretty big working capital reduction in Q1. There’s still more work to do there. So cash generation is key and then the dividends out of DGD we want to get the debt down below $4 billion. And then it puts us in a different position going forward.

We will not walk away from a well-priced bolt-on, but we’re going to be very, very cautious this year, because our priorities are operating cost management working capital improvement and really just getting DGD lined out and living through the lower-priced inventory. I mean, we’re trying — as you step back macroly what are we trying to do? We’re trying to work towards a share base of owners of this company that both understand that there’s going to be some volatility in commodities. We’ve got a very well managed business model globally. And then ultimately this thing once we’re in position in ’25 here we’ll have chances for all kinds of share repurchases to ultimately considering a dividend. And that’s where we’re headed. And then ultimately as we go into ’25, we’ve got some debt maturing or going current as they say.

And we’ve got to figure out the long-term capital structure. But right now for us it’s really just — as we’ve said it’s just a real focus on margin management, spread management around the world, which I got to give credit to the team. They’ve done a nice job. And that’s what’s evident. If you look between Q4 and Q1 with a massive price decline again of 20%. But yet other than the inventory adjustment, you were three something in Q4 and three middle in their low in Q1 with a 20% fat price decline. And so that’s attributable to people making the changes in the spread management ratios around the world.

Brad Phillips : I would just say that we get asked regularly about what about an SAF 2 on top of our subsequent to the SAF 1. And we’ve got the engineering for that — and that’s something that as the year progresses, I would say, given the fact that we get up and running with Q4 and we are able to contract at the margins and the returns that we are expecting then an SAF 2 is something that we’ve got in the holster for some time in potentially 2025.

Operator: The next question comes from Adam Samuelson from Goldman Sachs. Please go ahead.

Adam Samuelson: Hi. Thank you. Good morning, everyone.

Suann Guthrie: Good morning.

Adam Samuelson: I wanted to come back to the outlook on DGD margins and Randy talked $0.75 a gallon plus or minus. And you were basically there, in the first quarter excluding the LCM adjustments. And I guess I’m trying to just think about the margin capture at DGD with waste fats still at a healthy discount to veg oils relative to obviously whilst the reduction in margin that that implies in the Feed segment. And just how do you think about — is that DGD capture kind of satisfactory given kind of the pressure it has on the Feed business? Or is the disconnect that the LCFS just needs to work up over 60 to get those values up and that has the double benefit of improving the margin realization at DGD and driving kind of broader demand for the waste fats for the Feed business.

Randall Stuew: Yeah. And I’ll tag this with Matt here. Number one, Adam, I’m just going to step forward and just say I’ve learned my lesson here a little bit. We’re coming out conservative. Clearly the LCFS has not reacted to what I think is very positive future look here. I think the RINs SMB is going to tighten up here, because this R&D capacity in real or we wouldn’t be at discount and soybean wouldn’t be a discount to palm oil. So ultimately, this is just a projection in time that we believe as we approach 2025 that that margin structure can — can improve quite a bit, but that’s what we see right now. Matt, Bob?

Matt Jansen: I would just say that the other complexity to this is that there’s a timing discrepancy here in terms of in our Feed business, the fat prices are reflected much more responsibly in the results wherein the price movements in DGD, simply because of the supply chain management that’s required to sustain a 1.2 billion to 1.3 billion gallon business. It’s got a longer tail to it and we’ve seen that over the last few months. If prices have fallen the feedstock prices at DGD haven’t fallen as quickly in the numbers. And so there’s a little bit of a timing discrepancy there. But in terms of — in the bigger broader picture it’s — I would say, it’s doing exactly what we thought it would.

Randall Stuew: Yeah. I think from Adam, from not to get too deep in the sausage grinding, but if we would have rewind the movie 1.5 years ago DGD3 when it came online between the system would use two-thirds of North America’s waste fat supply. So we made a strategic decision to qualify feedstock suppliers from around the world including our own plants in Europe and South America. And that’s the length of the supply chain. That’s the good news. We qualified other people and found other sources. The bad news was that in a deflationary environment that supply chain was much longer and that had to play out in Q4 and Q1. And then you top on that is that there is all these expectations between the some of the Gulf Coast guys we’re going to pre-treat the West Coast guys are going to pre-treat and we’ve never found a consumer yet for Darling’s waste fats in North America.

So we woke up in Q1 here or Q4 and Q1 really with DGD as the only capable technology of pre-treating our fat. Bob, anything you want to add?

Bob Day: Yeah. I’ll just provide some color from a broader SMB perspective on renewable diesel. I think there’s a really different picture between 2024 and 2025. In 2024, we always knew that the RIN SMB was going to be a bit heavy. We’ll produce eight billion or 8.5 billion D4 plus D5 RINs this year versus an RVO of 5.55 and maybe a shortfall in D6 of one. So it’s about two billion RIN oversupply. But when we get to 2025 the RVO increases to 5.95 and if we move to the producer’s tax credit, really imported biofuel and domestically produced biodiesel it loses a lot of support and that represents almost 4 billion of the 8 billion to 8.5 billion RINs. So, it’s a significant change. And if you kind of look at where biodiesel is today at a call it a $0.20 per gallon margin without the blenders tax credit, it goes to minus $0.80.

And so in order for biodiesel to be at breakeven, the RIN has got to do the work. And so we’re bullish RINs as we get into 2025. And then if you just look at the at car’s estimates through the regulatory impact assessment, they estimate we’re going to be seeing $1.30 a gallon type LCFS credit values, at least that’s what they’re aspiring to. And so if you layer that all on top, it really bodes well for renewable diesel margin as we play out. And as we get to the end of 2024, we believe the market is going to see that and we’ll start to react to that type of an S&D reality.