Darling Ingredients Inc. (NYSE:DAR) Q4 2022 Earnings Call Transcript

Darling Ingredients Inc. (NYSE:DAR) Q4 2022 Earnings Call Transcript February 28, 2023

Operator: Good morning, and welcome to the Darling Ingredients Inc. conference call to discuss the company’s fourth quarter and fiscal year 2022 results. . Today’s call is being recorded. I would now like to turn the call over to Ms. Suann Guthrie. Please go ahead.

Suann Guthrie: Good morning. Thank you for joining the Darling Ingredients Fourth Quarter and Fiscal Year 2022 Earnings Call. Here with me today are Mr. Randall Stuewe, Chairman and Chief Executive Officer; Mr. Brad Phillips, Chief Financial Officer; Mr. John Bullock, Chief Strategy Officer; and Ms. Sandra Dudley, Executive Vice President of Renewables and U.S. Specialty Operations. Our fourth quarter and fiscal year 2022 earnings news release and slide presentation are available on the Investor page under the Events and Presentations tab on our corporate website. And we will be — 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 can 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 Stuewe: Hey, thanks, Suann. Good morning, everyone. Thanks for joining our fourth quarter and fiscal year 2022 earnings call. On February 3, 2023, I celebrated with my team, my 20th anniversary as Chairman and CEO of Darling. Many of you have heard me tell the story of my early days here. At the time, we had 600 employees in 20 locations throughout the United States. Brad and I were paying utility bills out of a shoebox, prioritizing the ones that needed to be paid first to keep our operations running. Our stock was trading about $1 per share. We had to figure out how to move from surviving to thriving. We had a plan. As I sit here today, 20 years later, I can’t help but smile when I tell you we are now 15,000 employees strong in more than 260 locations on 5 continents.

We have 15,000 of the most dedicated and talented employees that come to work every day because they know their work matters, not just to themselves and their families, but to meeting the critical needs of our world. What they do every day is making our world a more sustainable place for our future generations. We provide 2 very needed solutions to the world: food and clean energy. It’s no doubt that Darling Ingredients has transformed over the last 20 years. And in the process, we created our own unique platform with a deep moat surrounding our castle. We have delivered superior earnings growth driven by our global platform, vertical integration and diverse segments. In 2022, we closed on 3 important acquisitions and are in the process of completing 2 more that will continue to strengthen our foundation for growth in 4 key areas: the core rendering business, hydrolyzed collagen, green energy and soon to be sustainable aviation fuel.

2022 also marked the fifth consecutive year of record earnings at Darling Ingredients. Combined adjusted EBITDA for fiscal 2022 was $1.541 billion as compared to $1.235 billion in 2021. Looking at our segments in detail. For fiscal year 2022, our Global Ingredients business came in at approximately $1.1 billion EBITDA. The Feed Ingredients segment ended the year at $810.1 million. Our Specialty Food Ingredients segment earned $256.7 million EBITDA, while our Fuel segment earned $536.6 million EBITDA with approximately $443.5 million coming from Diamond Green Diesel. Now turning to the Feed Ingredients segment in detail. Globally, raw material volumes were up 27% in 2022 as compared to 2021. I’m happy to report that while we are still very early into our 1,000-day integration plan for Valley Proteins as well as the acquisition of the FASA Group in Brazil that closed in mid-third quarter, we realized an increase in gross margins in the fourth quarter of 2022 as compared to third quarter 2022 despite our Tacoma, Washington and Ward, South Carolina plants being down from significant fires late last year.

On February 14, we announced an expansion of our Bellevue, Nebraska plant, which will handle all the raw material from a new 2,000 head per day beef-processing facility being built by Cattlemen’s Heritage Beef Company. Our expansion, which will be completed by the end of 2024 will add about 30% more rendering capacity to our Bellevue plant. We also announced on February 21 that Panda Express has chosen Darling Ingredients as its preferred nationwide provider for used cooking oil recovery services. Darling will collect and recycle used cooking oil from more than 2,400 Panda restaurants in the United States. These projects, coupled with our strategic acquisitions, illustrate how Darling is continuing to build its market presence and strengthen its vertical integration to derisk the supply chain Diamond Green Diesel.

Now turning to our Specialty Food Ingredients segment. Our strategy is to continue to increase our product sales and higher value hydrolyzed collagen, which today represents about 25% of our collagen sales within the Food segment. To accommodate that growth in the market, we are adding more hydrolyzed collagen capacity in our existing processing facility in Epitacio, Brazil, which is due to come online at the end of first quarter or early second quarter this year. And we are super excited that our previously announced acquisition of Gelnex should close sometime in the second quarter. Gelnex operates 6 facilities: 4 in Brazil, 1 in Paraguay, and 1 in Portage, Indiana in the U.S. and has the capacity to produce approximately 46,000 metric tons of gelatin and collagen peptide products.

Gelnex is a very well-run business and will be immediately accretive. Depending on when it will close, I estimate that Gelnex should add anywhere between USD 75 million and USD 100 million of EBITDA to our 2023 earnings. As we modify and bring our technology to these facilities, I anticipate we could see the Food Ingredients segment approaching an EBITDA of $350 million to $400 million over the next 2 to 3 years. Now moving to our Fuel segment. Our record year was driven by the strength of our DGD joint venture, higher sales volumes and prices in Europe and the continued expansion of our European green energy business that is performing extraordinarily well. Diamond Green Diesel set another sales volume record in the fourth quarter with the successful commissioning and start-up of our new Port Arthur, Texas renewable diesel plant.

Photo by Pauline Heidmets on Unsplash

The plant came online mid-November and was completed 9 months ahead of schedule and under budget. For the fourth quarter, DGD sold 208 million gallons of renewable diesel and recorded $1.40 per gallon EBITDA. For fiscal 2022, the joint venture sold 754 million gallons of RD at $1.18 per gallon. Our latest expansion brings DGD’s annual production capacity to approximately 1.2 billion gallons and 50 billion gallons of naphtha. As many of you know, on Jan 31, we announced our entrance into the sustainable aviation fuel market, expected to be completed in early 2025. The project will allow us to upgrade about 50% of our production at Port Arthur to SAF and is estimated to cost around $315 million. With the completion of the project, DGD is expected to be one of the top SAF manufacturers in the world.

Ultimately, if the market develops as we anticipate, additional capacity could be built in Norco, Louisiana. We’re very excited about this project as we believe the conversion gives us tremendous optionality and once again, deepens our moat as we assist the world in decarbonizing. Now with that, I’d like to hand the call over to Brad to take us through some financials, and then we’ll come back and I’ll give you some thoughts on the balance of 2023 here. Brad?

Brad Phillips: Okay. Thanks, Randy. Net income for the fourth quarter 2022 totaled $156.6 million or $0.96 per diluted share compared to net income of $155.8 million or $0.94 per diluted share for the 2021 fourth quarter. Net sales were $1.77 billion for the fourth quarter 2022 as compared to $1.31 billion for the fourth quarter 2021 or a 35% increase in net sales. Net income for fiscal year 2022 was $737.7 million or $4.49 per diluted share compared to $650.9 million or $3.90 per diluted share for fiscal year 2021. Net sales were $6.53 billion for fiscal ’22 as compared to $4.74 billion for fiscal ’21 or a 37.8% increase in net sales. Operating income increased 18.1% to $249.2 million for the fourth quarter of 2022 compared to $211 million for the fourth quarter of 2021 primarily due to a $67.7 million increase in gross margin and Darling’s share of Diamond Green Diesel’s earnings increasing $53.8 million quarter-over-quarter, which more than offset depreciation and amortization increasing $36.6 million and SG&A increasing about $24 million quarter-over-quarter, both primarily due to the FASA and Valley Proteins acquisitions.

Also, a $21.1 million asset impairment charge was recorded as the company made a decision to close the Peabody, Massachusetts collagen location in 2023 in order to optimize our global collagen network. Additionally, in the fourth quarter of 2022, we incurred $2.7 million in acquisition and integration costs. Operating income for fiscal year ’22 was $1.03 billion as compared to $884.5 million for fiscal year 2021. The increase in operating income was primarily due to a $287.6 million increase in gross margin and a $20.7 million increase in Darling’s share of DGD earnings year-over-year, which more than offset depreciation and amortization increasing $78.3 million and SG&A increasing about $45 million for fiscal year ’22 as compared to 2021, both primarily due to the acquisitions of FASA and Valley Proteins.

For the year, there were $29.7 million in asset impairment charges for fiscal ’22 as well as $16.4 million in acquisition and integration costs primarily related to our acquisitions of Op de Beeck, Valley Proteins and FASA as well as the previously announced pending Gelnex and Miropasz acquisitions. Total other expenses increased approximately $34 million quarter-over-quarter and $71.6 million year-over-year primarily due to increases in interest expense of $31.2 million and $63.5 million, respectively, from increased debt. Turning to income taxes. The company recorded income tax expense of $146.6 million for fiscal year ’22. The effective tax rate was 16.4%, and cash tax payments for ’22 were $113 million. For 2023, we are expecting the effective tax rate to remain about the same, around 16%, and cash taxes to increase to approximately $180 million.

As mentioned last quarter, in August 2022, President Biden signed the Inflation Reduction Act, which includes a new 15% alternative minimum tax based upon book income, a 1% excise tax on stock buybacks and tax incentives for energy and climate initiatives, among other provisions. We do not currently expect the new booked minimum tax and/or excise tax on stock buybacks will have a material impact on our financial results. The blender tax credits, which are refundable excise tax credits, have been extended 2 years through December 31, 2024. After 2024, the clean fuels production credit, a nonrefundable income tax credit, becomes effective from 2025 through 2027. The clean fuels production credit will be available to producers of qualifying on-road and aviation transportation fuel.

We are assessing these tax incentives, which can materially change our pretax or after-tax earnings and impact our tax rate in future years. We will continue to evaluate the applicability and effect of the act as more guidance is issued. Now turning to debt. The company’s total debt outstanding in fiscal year 2022 was $3.38 billion as compared to $1.46 billion at fiscal year-end 2021. Our bank covenant leverage ratio at the end of the year was 2.54x as compared to 1.57x at fiscal year-end 2021. We continue to maintain strong liquidity with $1.31 billion available on our revolving credit facility as of December 31, 2022, as well as $800 million of undrawn term loans to be borrowed for the anticipated closing of the Gelnex acquisition. Capital expenditures totaled $134.1 million in the fourth quarter and $391.3 million for fiscal ’22.

The company repurchased approximately 336,000 shares of its common stock for $22.5 million during the fourth quarter, which brought the fiscal year total shares repurchased to 1.9 million for approximately $125.5 million, leaving the company $374.5 million remaining in its share repurchase program as of fiscal year-end 2022. With that, Randy, I’ll turn it over to you.

Randall Stuewe: Hey, thanks, Brad. Well done. No doubt, 2022 was a great year for Darling Ingredients, and we carry tremendous momentum into 2023 as we continue our laser focus on the integration of our new businesses around the globe. While fat prices have eased in Q1 due to turnarounds and unplanned downtime by global renewable diesel producers, we should see improvement as these situations remedy. Global protein demand for animal production and pet food supplies remains robust and modestly stronger than last year. Capital investments in 2023 are estimated to be about $565 million with more than 20% allocated to expansion projects to drive new profitable growth. These projects include expansion of our green energy business in Europe, growing capacity at our existing U.S. rendering plants to accommodate both customer growth and increased waste feedstock supply for renewable diesel production and increased spray-dry capacity for hydrolyzed collagen production.

With respect to Diamond Green Diesel, we expect sales volumes to be about 1.2 billion gallons in ’23, making DGD North America’s largest renewable diesel producer. DGD’s superior logistics, Darling’s vertical integration and access to global waste feedstocks combined with our pretreatment technology positions DGD as the premier renewable diesel provider in the world. Recognizing LCFS prices were lower in 2022 compared to ’21 and the RVO created some noise in the markets sending feedstock prices lower, our performance in 2022 shows that DGD is profitable and will continue to be profitable. For 2023, I expect DGD to sell 1.2 billion gallons of renewable diesel at a minimum of $1.10 per gallon. Our plan for 2023 is to build on our growth strategy and continued success.

We expect to grow earnings between 15% and 20% by the end of the year. And we’re still giving guidance of $1.8 billion to $1.85 billion in combined adjusted EBITDA. And those numbers don’t include the closing of the Gelnex acquisition until we see it happen. We finished the year with a bank covenant leverage ratio of 2.54x. And with the anticipated closing of Gelnex shortly, our debt ratio will peak slightly over 3x. But as we expect DGD to start distributing regular dividends, we anticipate being sub 3.0x by the end of the year. Make no mistake, our financial priorities will be to pay down debt and work toward investment grade. We are committed to continuing our opportunistic share repurchase program, as Brad said, with $374.5 million remaining as approved today.

And finally, with the large acquisition behind us after we close on Gelnex, we will continue our laser focus on integrating all our businesses. Darling Ingredients offers tremendous shareholder value. There are very few companies that can show consistent strong earnings growth while setting high standards for sustainability. Darling Ingredients is the only publicly traded company that eliminates waste from the meat industry and upcycles those products to their highest value. In December 2022, we committed to the Science-Based Targets initiative, undertaking significant Scope 1 and 2 emissions reductions in the midterm aligned with the 1.5-degree Celsius pathway and achieving net zero by 2050. We are currently in the process of quantifying our Scope 1 and 2 reduction targets while account for the recent growth of our business and completing our Scope 3 inventory, which will guide us on where we need to focus our reduction activities.

Additionally, we are in the process of completing a new materiality assessment as we know our footprint and stakeholders have changed over the past 2 years. As I’ve said for many years and before, we were green before green was cool. This year, we will process approximately 16 million metric tons of raw material that could have gone to the landfill or been incinerated. We recognize that our carbon avoidance story is why many of our shareholders believe and invest in our company. We are actively researching how we can calculate our carbon avoidance number, report it and hopefully one day monetize it in the form of carbon credits. I feel very good about our progress, and I’m even more excited about the opportunities ahead. So with that closing, let’s go ahead and open it up to Q&A, and we’ll try to answer your questions.

Thank you.

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Q&A Session

Operator: . And the first question will be from Derrick Whitfield from Stifel.

Derrick Whitfield: For my first question, I wanted to focus on your feed business. With the improvement you experienced in margins sequentially despite seasonal and weather impacts with UCO, could you offer some perspective on how we should think about your trajectory of margin recovery over the next couple of years as you bring additional Valley plants up to Darling spec.

Randall Stuewe: Yes. This is Randy, Derrick. I’ll come at a high level, and Brad and John can assist if I miss over something. But I mean, clearly, as we’ve tried to articulate to people, we’re 200 days into a 1,000-day integration plan at Valley Proteins. Their margins were under half of what ours were. And so when you put together their business with our USA business, you can see the margin pressure and the progress we’re making. I mean, it ranges from renegotiating raw material agreements, optimizing plant labor situations, the systems at full capacity, they were moving material around in ways they shouldn’t have, and then ultimately moving to our customers where they were exporting, they’re now shipping Diamond Green Diesel.

And you can see that coming through. You’re going to see in Q1, in Q2 continued progress there. I mean, I do want to say, as always, we talk about fat prices. Fat prices are down a little bit in Q1. I mean, they’re driven by — obviously, people were trying to position against the Diamond Green Diesel start-up and then also the amount of global fat we’re bringing in along with our downtime and 3 or 4 other people’s downtimes around the world and turnarounds. And so the fat just backed up a little bit. That will remedy itself, as we said, as we go forward. So there may be a little pressure there in Q1. But remember in Q2, DGD then gets the benefit of those lower fat prices, and that translates back through in the Fuel segment. So as always, I want people to think about the total offering, not just down to a segment level because it can move around from time to time.

John, anything you want to add there?

John Bullock: No, I think the — Valley is exactly what we thought we were getting, is a huge block of volume that’s very well geographically positioned. And we can already see tremendous improvements that are happening as we get the Valley folks together with our U.S. rendering folks. Going to take a little time, but they’re moving at an extremely fast pace. We’re very, very excited at what we’re seeing out of that acquisition.

Randall Stuewe: Yes, Derrick, and I would add, I mean, as people were looking at the performance in Q4, the Ward, South Carolina plant lit up on fire on Thanksgiving day or evening, I can’t remember which. It’s a total loss. It is — clearly, we’re insured around the horn at Tacoma and in Ward with business interruption, but there are rules around that as — accounting rules is when we can recognize that. And just for example, in Q4 in December, the Ward, South Carolina plant transferring the volume around to keep the customers happy was around $4.5 million. So it’s a pretty easy bridge to see where we’re headed to. We had a little bit of bad luck there, but it’s going to be built back bigger, better and badder here be online towards the end of the year. But the systems being able to handle it now. And then hopefully sometime later this year, Brad will say we can set up an accrual for the BI payment that’s expected.