Darling International: Rendering Good Results

| About: Darling Ingredients (DAR)

In case you missed the news, corn futures hit a record earlier this month with the July contract touching a high of $7.93 a bushel on the Chicago Board of Trade (figures in U.S. dollars). Over the past 12 months, corn prices have more than doubled with soaring demand for the grain as livestock feed and for the manufacture of ethanol as a gasoline additive.

Even as demand is increasing, supply is tightening. The U.S. Department of Agriculture has reduced its production estimate for 2011 to 13.2 billion bushels, from 13.5 billion, due to extensive flooding in the American Corn Belt.

I found this month's stock recommendation as I was looking for ways to play the tightening corn supply situation. In the course of my research, I came across a report from Goldman Sachs, which pointed out that because of the severe weather the U.S. Midwest is experiencing, there could be a scarcity in August and September as the old corn crop runs out. The new crop, which is just going into the ground now, will likely be slow to mature, thereby creating a supply crunch.

At the bottom of the report, Goldman Sachs highlighted a company I had never heard of called Darling International (NYSE: DAR), which it suggested was going to benefit from higher corn prices. Intrigued, I started researching this interesting business. When I finished, I was amazed that I had not found this hidden gem before now.

Darling International is in one of the oldest businesses in the world and no, I'm not talking about the other oldest profession. Darling is in the rendering business, which for those of you who don't remember their medieval history essentially means recycling animal waste products. In fact, rendering goes back to the very earliest origins of mankind.

But just because a process is thousands of years old does not mean it is obsolete. On the contrary, rendering is becoming more relevant every day as it provides green solutions across a wide variety of industries - solutions that are, for the most part, fairly straightforward with processes that are easy to understand and manage.

It's not very sexy, in fact it's rather repugnant - the sort of thing we really don't want to think about. But it is more high tech than I would have thought and the business has evolved to the point where its products are used in everything from soap to pet food to paint to renewable energy.

The company has a large service operation as well. Working with restaurants, Darling removes used cooking oil, cleans grease traps, and provides storage systems for used oil. Again, it's all somewhat distasteful but a very necessary and very widely used service. The company also works with large bakeries to collect waste material from snack food manufacturers and convert the inedible garbage into animal feed, which is a replacement for corn. This partially explains the relationship between high corn prices and a rising stock price for Darling International.

The company's move into biofuels is particularly interesting. Last year it announced a 50-50 joint venture with Valero Energy Corporation (NYSE:VLO) to build a refinery near Norco, Louisiana. This plant will be able to convert over a billion pounds of fat into nearly 146 million gallons of renewable green diesel fuel. That's equivalent to over 9,000 barrels of oil per day. The company just announced that it has secured funding to proceed with the construction of this important project and did it without the government's help. This won't solve all our energy problems but it is a creative addition to the renewable energy portfolio. It sure beats using hundreds of thousands of acres of corn to produce ethanol. In my view, ethanol is one of the great boondoggles of all time, lining the pockets of Midwestern corn producers, but is not a very smart way to create energy.

Last year, Darling acquired Griffin Industries, which was founded in 1943 and which has been a pioneer in biofuel production. Griffin produces biodiesel fuel, which is completely biodegradable and produces less air pollution than regular diesel. Biodiesel can be used in place of diesel fuel without any costly modifications to the drive trains of the vehicles they are meant to power. The acquisition of Griffin Industries also filled in the company's footprint by adding distribution into areas of the Midwest where Darling did not already have a strong presence.

Darling International has been around for more than 125 years and has been able to steadily grow and thrive over that long period of time. The company has more than 130 locations operating in 42 states with over 3,000 employees. In addition to its domestic business, the company has a strong international business exporting 30% of everything it produces.

Recently, Darling reported excellent first-quarter results with net income of $46.6 million ($0.43 per share, figures in U.S. currency). Net sales were $439.9 million as opposed to $162.8 million for the first quarter of 2010. This large increase was mainly attributable to the company's acquisition of Griffin last year and also reflects Darling's ability to increase prices across many of its product areas. The net income for the quarter was over $35.1 million, better than the comparable quarter 2010 again primarily because of the Griffin acquisition.

The more I looked into this company the better I liked it. It has a great solution for a big problem and it's the only publicly traded company in the rendering business. It has proven that it can acquire a large business and integrate it well and profitably so hopefully there are more acquisitions in the company's future along with more international expansion.

Even though the stock has been building momentum and has had a good run it is still trading at a forward p/e of only 10.3 and I think there are plenty of reasons for it to go higher. The shares do not pay a dividend. The closing price on Friday was $17.31.

Buy with a target of $23.

Disclosure: I am long DAR.