Darling International (NYSE:DAR) is a provider of animal rendering, cooking oil and bakery waste recycling and recovery services. Essentially, Darling collects and recycles animal by-products, bakery waste and used cooking oil from poultry and meat processors, commercial bakeries, grocery stores, butcher shops, and restaurants. Darling also provides grease trap cleaning service. Darling processes the raw materials it collects and produces meat and bone meal protein, poultry meal, tallow, poultry grease, yellow grease, bakery by-products and hides. The products are sold nationally and internationally, primarily to producers of animal feed, pet food, fertilizer, bio-fuels and other consumer and industrial ingredients, including oleo-chemicals, soaps and leather goods for use as ingredients in their products or for further processing.
On November 9th, 2010 Darling announced the acquisition of Griffin Industries for $840mm in cash and stock. The deal closed in December 2010. Post acquisition, Darling now operates over 125 processing and transfer facilities located throughout the United States to process the raw materials into finished products.
Darling released its second quarter 2011 earnings on August 11th and by all accounts it was a very strong quarter. After beating EPS estimates in the first quarter of 2011 by 45%, Darling reported second quarter revenue of $471 million and diluted earnings per share of $0.44 versus Wall Street consensus of $451 million and $0.439 per share. Further, Darling generated $111 million of EBITDA.
Darling’s stock closed on August 12 at $15.18 implying a market capitalization of $1.8 billion and an enterprise value of $2.1 billion. Prior to the market swoon that began in late July, Darling was trading at approximately $18 per share. As the market tumbled Darling traded as low as $13.75 on August 8th. Applying the daily return of the S&P 500 to Darling’s July 22 share price of $18.37 as through August 12 implies that Darling’s stock would be at $16.10 per share, 5.7% above Darling’s current stock price. As a smaller cap company, Darling has fallen more than the market in this current selloff. Combined with Darling’s fantastic earnings report during this period of market volatility it is logical to think that Darling may be undervalued.
Darling’s trailing 12 month EBITDA is $291 million, which implies that Darling is trading at 7.4x enterprise value to LTM EBITDA. This feels like a reasonable multiple. However, recall that the Griffin transaction closed in late December 2010, therefore half of the LTM EBITDA need is not pro forma for Griffin.
While Griffin was a private company, Darling filed an 8-K in November 2010 that provides Griffon’s financials for the 9 months ended September 2010. This reveals that for the first 9 months of 2010 Griffin generated $102 million of EBITDA. Assuming that the fourth quarter of 2010 had the same EBITDA run-rate and adjusting the number to represent only half a year, suggests that $70 million needs to be added to Darling’s LTM EBITDA to pro forma for the Griffin acquisition.
At $361 of LTM EBITDA, Darling is trading at only 6.0x trailing EBITDA. On this metric Darling is inexpensive. But it is also important to consider Darling’s recent performance. In Q1 Darling generated $108 million of EBITDA followed by its $111 million in Q2. Nothing in the earnings release or the earnings conference call suggests that the business is slowing. At this run-rate Darling is trading at only 4.9x trailing EBITDA. Wall Street consensus 2011 EBITDA, which has not yet been updated for the recent strong earnings, is $417 million, implying an LTM EBITDA multiple of 5.2x. Darling represents excellent value. Similar analysis suggests that on an LTM basis pro forma for the Griffin acquisition Darlings generated $175 million of free cash flow for a FCF yield of almost 10%. Further, Darling management suggested on the earnings call that cost savings from the integration of Griffin is proceeding according to plan and is not yet complete, suggesting that there could be margin improvement to come over the next few quarters as integration is completed.
Darling should trade in the 7-9x EBITDA range, and it trading materially below that level. Once the power of the Griffin acquisition is reflected in Darling’s numbers for a full year these dynamics will become strikingly obvious although by then it might be too late to acquire this stock at a bargain rate.
Disclosure: I am long DAR.