- Animal feed business advantaged against high grain prices.
- Food business advantaged against other competing products.
- Renewable diesel is a crown jewel that shines in a high energy environment and is poised for huge volume growth.
- Entire business is an ESG darling.
Darling Ingredients (NYSE:DAR) is one of those companies that has been around for over 100 years that most people, yet with which most people remain completely unfamiliar. They operate very much in the background, collecting the scrap from slaughterhouses and used cooking oil from restaurants and turning it into usable products such as animal feed and basic ingredients for the food and drug industries such as gelatins and stabilizers. More recently, they entered a JV with Valero (VLO) to provide feedstock for a renewable diesel plant. This latest JV is a massively overlooked and undervalued asset in an industry that is set to grow massively over the next few years.
This company is uniquely positioned to be a valuable link in several industries where its unmatched scale and capabilities make it a must-have service provider. It operates over 200 locations in over 15 countries on all five continents.
Source: Darling company presentation
As I said, DAR has been around for over 100 years. The average slaughterhouse like those operated by Tyson Foods (TSN) only uses about half the weight of an animal it processes. The other half, comprised of fat, bone, and offal are largely just waste that has to be removed from the plant. DAR renders the fat, crushes the bone, and processes the other parts for use animal feed as well as the pharmaceutical, cosmetics, and processed food industries. You are likely to come into contact with many of the ingredients they supply every day without knowing it.
The company also collects grease traps and used cooking oil from restaurants. It processes that oil for reuse.
Both activities were and largely still are highly fragmented businesses largely conducted by mom and pop operators. DAR has been buying them up for decades, creating regional clusters with enormous scale. They are a trusted service provider to many large companies who regard DAR as a waste collector. As a result, DAR very frequently gets their raw materials for free or a very small fee.
For years, the only two uses for the tallow, yellow grease, and filtered cooking oil was basic industry. In 2013, DAR formed a JV with VLO to create DGD (Diamond Green Diesel) the owner and operator of a renewable diesel refinery. The 290 million gallon refinery is next to VLO's traditional oil refinery near New Orleans. VLO provided the land and refinery operation expertise and DAR provides feedstocks such as animal fats and recycled cooking oil.
Renewable diesel is chemically identical to petroleum-based diesel. It is, therefore, more valuable than ethanol and biodiesel which are gasoline and diesel additives of around 15% to 20% of volume. The pureplay public biodiesel/renewable diesel company in the industry is Renewable Energy Group (REGI). As you can see below, REGI is still mostly biodiesel (which freezes at 30 degrees F versus renewable diesel -40F freeze point), which makes it less valuable than DGD in my mind.
REGI Biodiesel/Renewable Diesel Production
There are a number of renewable diesel refineries scattered around the US producing about a billion gallons of renewable diesel. Most of them use corn or soybean oil as feedstocks, exposing them to the market prices of those agricultural commodities.
The DGD Advantage
Not only does DGD only produce renewable diesel, DGD's refinery is one of the only renewable diesel facilities that can use multiple feedstocks such as animal fats, recycled cooking oil, OR vegetable products such as soybean and corn oil. In a world where soybeans and corn prices have increased 50% per bushel, this feedstock flexibility is an enormous cost advantage.
DGD has been a huge win for DAR and is set to become bigger. A 400 million gallon expansion is set to start operating in Q4 of this year.
Diamond Green Diesel Refinery in Louisiana
Source: DAR BNP high yield conference presentation
When that happens, fuel will become DAR's biggest operating segment from near equal to that of feed.
Value of Renewables
Renewable Diesel qualifies for all kinds of government subsidies such as LCFS (Low Carbon Fuel Source) credits in places like California and federal RINs (Renewable Identification Numbers). Heavy carbon emitters like refiners such as VLO, Chevron (CVX), Exxon (XOM), Conoco (COP), and Marathon (MPC) need to buy renewable diesel credits to offset the pollution they cause. Therefore, these industrial players are ultimate buyers, not governments.
The price of D4 RINs fluctuates violently depending on a number of factors. Some quarters they are $.50/gallon and others they are $1.50.
RIN Values in cents/gallon
The good news is that I believe DAR's $565 million 2021 EBITDA guidance above for its fuel segment estimates RIN estimates closer to the lower end of that range. Given production at DGD will more than double in 2022, I believe fuel EBITDA can quite easily exceed $900mm in 2022, bring total EBITDA close to $1.6 billion.
Moreover, while the EPA has backdated a lower RIN requirement for 2020, it just increased the requirements RINs in 2022 and 2023. Net/net, I believe there will be more, industry will likely need to be more not fewer RINs in the future. The demand for renewable diesel is also still mostly tied to California. But places like New York have burgeoning efforts to replace traditional diesel with renewable and there are even efforts in Texas for it.
The beauty of the renewable diesel business is that DGD and other refineries have increased the demand of soybean oil. Soybean oil represents about 10% the weight of soybeans. To service the current renewable diesel refineries, about 800,000 tons of soybean oil is used, meaning 8 million tons of soybeans, out of about 120 million tons of annual US soybean production.
World Soybean Producers
A bad harvest in Brazil has hurt soybean supply this year while the renewable diesel industry here and a change in animal feedstock policy in China, which I outlined in an inflation article over the summer, have led to high soybean and soybean oil prices.
These high prices for one feedstock, not only give DGD an advantage on cost, they should improve pricing for the other feedstocks DAR produces as a few other refineries can use yellow grease and animal tallow. Obviously, this better pricing flows through to DAR's entire business.
USDA Tallow and Yellow Grease Pricing
The market still has not placed the correct value DGD or on the pricing improvement DGD causes through DAR's entire value chain appropriately in my opinion. Another report on this site barely mentioned DGD.
Since there are 3 separate businesses here, I think a sum of the parts analysis is appropriate. Historically, the traditional DAR business (before DGD ramp) has traded between 7-11x EBITDA. I use 8x to be conservative. While refiners typically trade at 5x EBITDA given their commodity exposure to inputs or outputs, REGI has traded at a higher multiples of 6-9x EBITDA thanks I believe to the ESG factor even though it has had some violent swings in profitability. I consider DGD a vastly superior asset to REGI given its flexibility of feedstocks and its 100% renewable diesel (which carry higher LCFS credits and higher value RINs) versus REGI being mostly biodiesel.
Following that reasoning, using the EBITDA guidance by segment above, and applying 60mm of corporate overhead equally across the segments, I get the following sum of the parts valuation.
|Feed (8x $550mm '21 EBITDA)||$4.360 Billion|
|Food (8x $180mm '21 EBITDA)||$1.440 Billion|
|DGD (12x $545mm '21 EBITDA)||$6.540 Billion|
|Total Sum of the Parts Value||$12.34 billion|
|less net debt||$1.52 billion|
|Implied Equity Value||$10.82 billion|
Since the stock is currently $73/share, it might look overvalued on current numbers. Since the DGD expansion is set to start shortly and we are approaching '22, I think the forward numbers are more appropriate.
Keeping feed and food flat but growing the company's share in DGD to $900 million, I get.
|Feed (8x $550mm '22 EBITDA)||$4.360 Billion|
|Food (8x $180mm '22 EBITDA)||$1.440 Billion|
|DGD (12x $900mm '22 EBITDA)||$10.80 Billion|
|Total Sum of the Parts Value||$16.6 billion|
|less net debt||$1.52 billion|
|Implied Equity Value||$15.08 billion|
Compare the above valuation to current valuation
|Market Cap (using $73.75 share and 162mm shares)||$11.950 billion|
|Enterprise Value||$13.5 billion|
|EV/EBITDA '21 ($1.275 Billion)||10.58x|
|EV/EBITDA '22 ($1.600 Billion)||8.43x|
Since much of this thesis depends on DGD (Diamond Green Diesel) any operational hiccups there will hurt the stock. Moreover, much of the value of DGD lies in the market price for RINs and the LCFS. Should those go away or decline materially, that would hurt darling's stock price. Lower traditional diesel would hurt the stock as well. I try to compensate for that risk using the company's conservative (I believe) estimates for DGD for 2021 as a downside scenario of $67 and being conservative with 2022 EBITDA (not doubling 2021 EBITDA despite more than doubling production) and keeping the food and feed business flat despite great pricing. That latter estimate gets me nearly 30% higher than the current stock price.
The ESG Benefit
For those looking for ESG investments, I think you'll be hard-pressed to find a better one than DAR. The company's base activity helps reduce landfills filling up. Then it recycles that material for natural ingredients we all use on a daily basis. The benefits of DGD are self-evident. Renewable diesel leads to 80% lower carbon emissions than traditional diesel.
I am hard-pressed to think of another business whose entire value chain benefits not just from the search for clean energy but as an inflation hedge. As I mentioned in my series of articles on inflation, I believe the prices of many commodities are not coming back down to where they were any time soon. DAR literally finds value in scraps. Its base business is very consistent and it has an exciting, feedstock advantaged growth business that ripples through its entire enterprise. I think the downside is well contained with conservative estimated upside of 30%.
This article was written by
Cashfow Hunter has over 25 years of experience in the markets, with nearly 20 of them as a hedge fund portfolio manager. His experience investing in debt and equity markets gives him unique insights into markets. He successfully predicted the implosion of Silicon Valley Bank. He has degrees from Wharton and MIT.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of DAR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.