Darling Ingredients Inc. (NYSE:DAR) Q3 2023 Earnings Call Transcript

Darling Ingredients Inc. (NYSE:DAR) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Good morning and welcome to the Darling Ingredients Inc. Conference Call to discuss the company’s Third Quarter 2023 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 now like to turn the call over to Mr. Suann Guthrie. Please go ahead.

Suann Guthrie: Good morning. Thank you for joining the Darling Ingredients third quarter 2023 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 third quarter 2023 earnings news release and slide presentation are available on the Investor Relations 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 or 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 in 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 C. Stuewe: Thanks, Suann and good morning, everyone and thanks for joining us for our third quarter earnings call. Darling’s global ingredients platform delivered as predicted and DGD faced some headwinds and operational challenges during the quarter. Overall, we feel good about the momentum we are carrying into fourth quarter and 2024. Turning to the Feed Ingredients segment. Raw material volumes were flat compared to third quarter 2022. Our gross margins have returned to pre-acquisition levels demonstrating our ability to successfully integrate Valley and FASA. Our work is not done and we expect further improvement. Fat prices were lower year-over-year, but sequentially improved late in Q3. Turning to our Specialty Food Ingredients segment.

Raw material volumes increased 18% year-over-year due to Gelnex acquisition. Our global collagen platform delivered solidly and we continue to shift our product mix into higher-margin products. Hydrolyzed collagen remains an important part of our long-term growth strategy within the Food Ingredients segment. Earlier in the quarter we commissioned a new spray dryer in Epitacio, Brazil adding much needed capacity to continue our growth. I’m also excited to share that our research and development efforts in this segment have resulted in our ability to formulate a product that targets specific health concerns such as glucose moderation. We are currently in scientific trials and expect to bring this ingredient to market during 2024. On October 26, we announced that DGD volumes for the third quarter were lower due to a regularly scheduled turnaround at number 2 in St. Charles Louisiana that took the unit offline for 27 days.

After that turnaround, DGD 2 had a minor operational disruption. So in total DGD 2 was offline for 37 days in the quarter. This resulted in lower gallons produced, higher cost and lower-than-expected operating profits. Year-to-date DGD has sold 910 million gallons of renewable diesel at approximately $1.02 per gallon EBITDA. And Darling has received $163.6 million in cash dividends year-to-date. With that I’d now like to hand the call off to Brad and then I’ll come back and discuss the rest of my thoughts for 2023 and 2024. Brad?

Brad Phillips: Okay. Thanks, Randy. Net income for the third quarter 2023 totaled $125 million, or $0.77 per diluted share, compared to net income of $191.1 million, or $1.17 per diluted share for the third quarter of 2022. Net sales were $1.63 billion for the third quarter 2023, as compared to $1.75 billion for the third quarter 2022, or a 7% decrease in net sales. Although, Darling’s third quarter 2023 gross margin increased $10.1 million and was 23.8% as compared to 21.5% for the third quarter of 2022, operating income decreased $90 million, or 33.5% to $178.4 million for the third quarter of 2023, compared to $268.3 million for the third quarter of 2022 primarily due to Darling’s share of Diamond Green Diesel earnings decreasing $49 million.

Additionally, depreciation and amortization and SG&A increased about $21 million and $32.6 million respectively as compared to the third quarter of fiscal 2022 primarily due to the Gelnex and FASA acquisitions. Now moving to non-operating results. Interest expense increased from $39.8 million in the third quarter of 2022 to about $70.3 million in the third quarter 2023, primarily as a result of increased indebtedness due to the acquisitions. For the three months ended September 30, 2023, the company reported an income tax benefit of $15.4 million and an effective tax rate of negative 13.6%, which differs from the federal statutory rate of 21% due primarily to the relative mix of earnings among jurisdictions with different tax rates and biofuel tax incentives.

The company’s effective tax rate excluding the biofuel tax incentives and discrete items is 25.9% for the three months ended September 30, 2023. The company paid $40 million of income taxes in the third quarter. For the nine months ended September 30, 2023, the company reported income tax expense of $52.3 million and an effective tax rate of 8.4%. The company’s effective tax rate excluding the biofuel tax incentives and discrete items is 28.4% for the nine months ended September 30, 2023. The company also has paid $127.7 million of income taxes year-to-date as of the end of the third quarter. For 2023, we are projecting an effective tax rate of 9% and cash taxes of approximately $30 million for the remainder of the year. The company’s total debt outstanding at third quarter 2023 was $4.4 billion as compared to $3.4 billion at year-end 2022.

Our bank leverage covenant leverage ratio at the end of the third quarter was 3.25 times. We continue to maintain strong liquidity with $1 billion available on our revolving credit facility as of the quarter end. Capital expenditures totaled $146.2 million for the third quarter 2023 and $380.6 million for the first nine months. With that, I’ll turn it back over to you Randy.

Randall C. Stuewe: Hey, thanks Brad. As previously announced a few weeks ago, we revised company guidance to $1.6 billion to $1.7 billion of combined adjusted EBITDA for the full fiscal year 2023. For Q4, we carried good momentum in from the third quarter around the world. Raw material volumes have slightly softened, but our diversified geographic footprint makes the impact negligible. Clearly, the global fats and oils have softened as a direct reflection of an ample supply of global fats and oils and delayed start-ups and inconsistent operations of renewable diesel plants. While we’ve seen a lot of press and noise about significant gallons of new renewable diesel coming to the market, the numbers appear to tell a very different story.

If more capacity outside of Diamond Green Diesel was operating, fat prices undoubtedly would be higher. DGD is performing well and we do not have any planned turnarounds in Q4. Margin structures are adjusting and we are very encouraged with the conversations we were having with a variety of interested parties regarding sustainable aviation fuel and our ability to deliver the margins in line with what we have communicated. Looking forward to 2024, while the heavy lift of our integration work has been completed, there are still a few opportunities that can add some margin improvement in our Feed segment and our Food segment should continue to reflect our product mix shift. From an earnings perspective, we see 2024 shaping up nicely and expect to deliver and delever with an improved performance globally.

The table is set with an improved outlook for the LCFS, growing demand for SAF, strong demand for our low CI feedstocks and favorable tax structures. Given the environment we see for 2024, we — at this time, we anticipate combined adjusted EBITDA to be in the range of $1.7 billion to $1.8 billion. In 2024, we plan to lower capital expenditures, focused on improving our working capital usage and we anticipate regular dividends from Diamond Green Diesel. This will all help us accomplish our leverage targets by year-end. Given the anticipated dividends from DGD and the strength of our Global Ingredients business, we should be well on our way to achieving our target leverage ratio of about 2.5x by year-end 2024. With that, let’s go ahead and open it up to questions and I’ll come back with some closing comments.

Operator: We will now begin a question-and-answer session. [Operator Instructions] And our first question will come from Manav Gupta of UBS. Please go ahead.

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Q&A Session

Manav Gupta: Good morning team. My question first is on a little bit on the macro side. How do you view the recent staff proposal by CARB which increases compliance by 50% by 2030 also has the AAR mechanism which pulls forward the program in case of over generation of LCFS. Do you believe this will be supportive of RD economics once it kicks in 2025?

Matt Jansen: Hi, good morning, Manav. This is Matt. So first of all the answer is, yes. We do believe that this is supportive to the RD business. As you know, the LCFS is an important component to the margin build in the RD space. And given that the SARIA that was put out a couple of months ago and the expected legislation that is forthcoming, there are several components that we think are supportive for the RD and even the SAF business. So obviously, volume is an important part. And then there’s the component for a potential of an SAF in California of up to — in the neighborhood of 150 million gallons, which will line up very nicely with the — our SAF project. And there’s even a component of timing. There’s the possibility of an earlier implementation.

Right now, it’s set for 2025. But there is the chance and we all have to stay tuned on this, but there is the chance for even sometime in Q3 or Q4, an implementation coming on this. So again all-in-all, we are very optimistic and quite satisfied with the LCFS.

Manav Gupta: Okay. I’m assuming you’re basically referring to the fact that the AAR will pull-forward the program into 2024. So the program could actually start in third quarter 2024?

Matt Jansen: That’s the potential, yes.

Manav Gupta: Okay. Thank you. Very quick follow-up is on slide 11. You indicate lower fat sales volume were $32 million year-over-year headwind and lower protein sales volume were a $13 million year-over-year headwind. Given that integration is going well for both valley and FASA, should we assume this was just a temporary blip and the volumes will come back as we go ahead?

Randall C. Stuewe: Yeah. Manav this is Randy. I mean, what we’re seeing in my script I commented on it that’s directly related to lower cattle slaughter numbers predominantly in North America. And clearly the cattle economics have changed in the US, the herd is low but being replenished and that’s just directly related to year-over-year comparisons. If you think of it this way, the red meat has the most fat, the most protein, and then pork and then chicken. And so that’s what that is. The volumes in South America are relatively flat right now. Europe is in good shape but that’s all pretty much North America. Canada is in good shape.

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

Adam Samuelson: Yes, thank you. Good morning, everyone. So I guess first question. Randy I mean if you think about the updated outlook for the balance of this year and you gave a framework for 2024, can you first quantify in the quarter, the resolution in the pre-announcement to a hedge loss at Diamond Green. Can you quantify that? And as we think about Diamond Green for the fourth quarter if there’s no scheduled turnarounds, should we be thinking about production a lot closer to where you were in the second quarter, which if true and even at third quarter margin levels would imply a pretty tough to get to the low end of the way you framed the full year. So can you just help us reconcile that?

Randall C. Stuewe: I don’t know that I would frame it the way you just finish that sentence, no. Clearly there’s always a timing issue of how the fat prices in our core business flow through. And also remember a significant portion of the North American portfolio ends up at Diamond Green Diesel as the purchaser. So you had a little bit of a double wham here. Number one, the prices started to accelerate in third quarter again, but we’d already sold Diamond Green. And so those sales now are coming to be fruition in Q4 for our core ingredient business. On the other side, we saw heating oil spike up. You do get some hedge losses. You can go into the — you can go to straight to the financials and the derivative sections on the Valero release and you can see what that number is.

And it was a significant number. At the same time, you had higher fat prices flowing through then you had heating oil now coming off. And so at the end of the day that’s my comment about margins are adjusting. If you think about the efficiency of the D4 RIN when that thing came down what did it say? It said fat prices had to come down to put some type of margin back in the business. So clearly the margins in DGD are coming back very nicely in Q4 here. And they’ll finish the year strong. And then that’s what gives us then the momentum into next year. I mean like we said, we’re trying to — we’ve always said, we’re not going to guarantee you no volatility in DGD, because there’s a lot of moving parts there, but at the end of the day 910 million gallons at $1.02 for year-to-date.

We said, coming into the year, we’d be somewhere between $1, $1.10. We’re using $1.10 for next year. We’ll finish up somewhere within our guided range for the year. It just depends on how everything flows through. But no from what we see right now we’re right on target.

Adam Samuelson: Okay. That’s helpful. And then just in the Feed segment, can you maybe just — maybe the quarter-on-quarter EBITDA decline help bridge some of that. So EBITDA was down $26 million or so versus the second quarter. Can you help bridge, how much of that is seasonality? How much of that was the commodity prices maybe some of the weakness in pet ingredients. And if we think about the fourth quarter kind of with where commodity prices land, can you help us think about some of the key items in EBITDA in Feed moving forward?

Randall C. Stuewe: Yeah. And I think you’ve kind of answered most of your question there. I mean typically the seasonality hits in this business especially in North America and Europe in third quarter in the Feed segment, because you’re being — the quality of the raw material in the summertime’s is much harder to process. That’s code for, it’s harder to get the fat out of the product and leave it in the protein. So you kind of have lower quality fat less — less fat and that’s how it flows through. It has for 142 years. The Pet Food business is something to put your finger on right now. Pricing remains good in that area. Demand was weak, but it’s ticking back up again. You’ve got a little bit of a trade down going on. It appears around the world right now in the Pet Food side.

But overall when we’re looking at 2024 versus 2023, it looks pretty stable there. Protein prices on most products are in pretty good shape. I mean there’s a little bit of trade disruption in the world right now in different areas that are moving or moving proteins around. Matt, what else you want to add here?

Matt Jansen: Yeah. I mean, I would say the Q3, as you all know was a typical very hot summer and our businesses did as expected feel that. And so — but we are seeing especially now in Q4 a quick return to the pickup and recovery.

Randall C. Stuewe: Yeah. Keep in mind Adam, a year ago today, not sequentially, but a year ago here we still have Ward, South Carolina operating in North America. Ward, South Carolina is going to be, key to 2024 for us as it comes back online here. The plant is completely rebuilt. We are still landfilling a significant amount of product right now that we can’t process in our system. So as we guide higher next year, if you say what you always have to assume fats and oils prices and protein prices in there and energy. But most importantly for us, it’s being able to bring back our system to full strength on the Eastern seaboard.

Operator: The next question comes from Derrick Whitfield of Stifel. Please go ahead.