Earnings Call Transcript
DARLING INGREDIENTS INC. (DAR)
Earnings Call Transcript - DAR Q2 2022
Operator, Operator
Good morning and welcome to the Darling Ingredients Inc. Conference Call to discuss the company's Second Quarter 2022 results. After the speakers' 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 Ms. Suann Guthrie. Please go ahead.
Suann Guthrie, Investor Relations
Thank you for joining the Darling Ingredients' second quarter 2022 earnings call. Here with me today are Mr. Randall C. 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. There is a slide presentation available on the Investor's page under the Events and Presentations on our corporate website. During this call, we will be making forward-looking statements, which are 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 differ materially due to factors discussed in today's press release, the comments made during this conference call, and the risk factors section of our Form 10-K, 10-Q, and other reported filings within 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, CEO
Hey, thanks Suann. Good morning everybody and thanks for joining us for our second quarter 2022 earnings call. Our 2022 second quarter financial results yielded another record quarter illustrating the tremendous growth and diversity of Darling Ingredients. This quarter's combined adjusted EBITDA of $402.6 million is nearly equivalent to our entire fiscal year combined adjusted EBITDA, just five short years ago in 2017. As I reflect on where we've come as a company, I am tremendously proud of the work our teams across the world have done repurposing animal and food byproducts into specialty food and feed ingredients to support the growing population and converting waste fats and oils into low carbon fuel to power a growing world. Going into the quarter in brief here, our Global Ingredients business had a record quarter of $312 million in EBITDA. The Feed Ingredients segment had a record quarter at $242.1 million and our Specialty Food Ingredients segment also had a record quarter posting $65.4 million in EBITDA. Our Fuel segment ended the quarter with $110.8 million, with $90.6 million in EBITDA attributed to our joint venture at Diamond Green Diesel. Starting with our Feed Ingredients segment, globally, raw material volumes were up 23% quarter-over-quarter, or 13% year-to-date. Fat price has continued to climb rapidly illustrating the high demand for low carbon waste feedstocks for renewable diesel. Protein prices were also strong throughout the quarter with some challenges remaining in container tightness for protein exports. Rapidly escalating global energy costs and lower gross margins from the Valley acquisition contributed to a reduction in gross margins for the feed segment. As we have discussed in the past, our procurement formulas will ultimately recover many of the cost increases in the following quarter. Since we closed on the Valley Proteins acquisition on May 2nd, the team has been working hard on the integration efforts with a laser focus on margin improvements. I'm encouraged by our efforts to date and continue to believe Valley Proteins will contribute $150 million of EBITDA in 2023 as we continue to address operational challenges and synergies. Turning to our Specialty Food Ingredients segment, we continue to see uplift from gelatin to higher margin collagen peptides. Hydrolyzed collagen demand continues to rapidly grow as consumers turn to these specialty products for joint, ligament, hair, and skin health. More resistant to commodity fluctuations, we anticipate to grow this business line in the high single digits in the next three to five years. We have pioneered and led the way in this space, and we are excited about its potential for the future. In our Fuel segment, our green energy investments in Europe continue to deliver as predicted with higher sales prices and volumes. Now, let's turn to Diamond Green Diesel. DGD 2 is running at full capacity, which resulted in record volumes at 209 million gallons in the second quarter and 375 million gallons produced year-to-date. In Q3, Diamond Green Diesel recorded $0.91 per gallon EBITDA, lower than Q1 2022 and our full year estimate. However, higher feed stocks, while benefiting our Specialty Feed Ingredient business, impacted the DGD's margins this quarter along with some lower LCFS prices. Second quarter LCFS prices averaged $100 per metric ton compared to about $130 in the first quarter of 2022. On August 5th, Diamond Green Diesel delivered a dividend of approximately $181 million, of which $90.5 million was distributed to Darling. This should once again provide confidence in the strong cash potential for the joint venture as we start at DGD 3. As we head into Q3, DGD margins are improving. Feedstock prices have moderated. Additionally, DGD and Port Arthur, Texas should be operational in the fourth quarter of 2022, bringing our total renewable diesel production going forward to 1.2 billion gallons annually. Our strategy to procure and process waste fats and oils as feedstocks and not food-based oils will continue to position DGD as an advantage over other renewable diesel producers in the market. Our global supply chain augmented by our two recent acquisitions positions our vertical integrations as second to none in the world. Additionally, we continue to see growing public policy that supports low carbon energy solutions beyond California. We're excited about Canada's clean fuel regulations passed last month and encouraged by the rulemaking currently underway in Washington State and Oregon. The Proposed Inflation Reduction Act, if passed, will represent the most robust piece of climate legislation in U.S. history, and bring sustainable aviation fuel closer to reality. These programs give a boost not only to DGD but to Darling's Global Specialty Feed Ingredients business as we are the premier provider of low carbon feedstocks. With access to inbound water, truck, and rail for feedstocks and outbound water and options for either pipeline and rail to both coasts, DGD is well positioned logistically to serve markets well beyond California. Now, before I turn the call over to Brad for details on the financials, I mentioned last week, we closed on the purchase of the FASA Group, the largest independent rendering company in Brazil, for approximately R$2.9 billion or approximately $562 million at the current exchange rates. This acquisition adds 14 rendering plants with an additional two plants under construction to our portfolio, and it processes more than 1.3 million metric tons of beef, pork, and chicken annually. Currently, the EBITDA run rate is around R$500 million per year. With that, I'd like to turn the call over to Brad and then I'll come back to give you a little outlook for the balance of 2022.
Brad Phillips, CFO
Okay. Thanks, Randy. All right, net income for the second quarter 2022 totaled $202 million or $1.23 per diluted share compared to net income of $196.6 million or $1.17 per diluted share for the second quarter of 2021. Net sales were $1.65 billion for the second quarter 2022 as compared to $1.2 billion for the second quarter of 2021, a 37.7% increase in net sales. Operating income increased 3.8% to $278.6 million for the second quarter of 2022 compared to $268.3 million for the second quarter of 2021, primarily due to a $98.1 million increase in the gross margin from our Global Ingredients business, which more than offset a $52.1 million decline in our share of the earnings from Diamond Green Diesel, as well as an increase in SG&A and depreciation and amortization, primarily due to the addition of Valley Proteins. The second quarter of 2022 also included an $8.6 million impairment charge. Additionally, we incurred $5.4 million of acquisition and integration costs, primarily related to our acquisitions of Optivac, Valley Proteins, and FASA. Interest expense increased $8.7 million in the second quarter of 2022 as compared to the second quarter of 2021, due to an increase in debt related to the closing of the Valley Proteins acquisition. Now, turning to income taxes, the company recorded income tax expense of $47.3 million for the three months ended July 2nd, 2022. The effective tax rate is 18.8%, which differs from the federal statutory rate of 21% due primarily to biofuel tax incentives, the relative mix of earnings among jurisdictions with different tax rates, and excess tax benefits from stock-based compensation. For the six months ended July 2nd, 2022, Darling reported income tax expense of $73.4 million and an effective tax rate of 15.7%. The company also paid $72.4 million of income taxes year-to-date as of the end of the second quarter. For 2022, we are projecting an effective tax rate of 19% and cash taxes of approximately $30 million for the remainder of this year. Total debt outstanding at the end of the second quarter 2022 was $2.9 billion as compared to $1.5 billion at year end 2021, and the bank leverage ratio ended the quarter at 2.59 times. The increase in debt was primarily a result of the acquisition of Valley Proteins which included a $750 million issuance of unsecured senior notes due year 2030. We continue to maintain strong liquidity with $1.45 billion available on our revolving credit facility as of the quarter ended July 2nd. Capital expenditures totaled $79.9 million in the second quarter and $151.5 million year-to-date. The company repurchased approximately 700,000 shares of its common stock for $48.7 million during the second quarter, which brought the year-to-date total shares repurchased to 971,000 for $65.9 million. Subsequent to the July 2nd quarter end date, the company also repurchased an additional $29.3 million in shares. With that I'll turn the call back over to you, Randy.
Randall Stuewe, CEO
Hey, thanks, Brad. I am very optimistic about the rest of the year as the market environment remains favorable to Darling. We operate a diverse business platform across multiple sectors that allows us to take advantage of our scale, integration, and technical expertise to deliver shareholder value. We produce what the world needs, food and energy. We maintain our strategy to deliver a positive impact on our planet and society while also providing superior returns. There is no singular solution to the environmental challenges we face, nor is there one priority to focus on. Darling Ingredients is committed to helping the world avoid carbon emissions by turning discarded animal waste into valuable specialty feed ingredients, specialty food ingredients, and low carbon energy. You will hear more about our efforts in this space in our upcoming ESG report, which will be published next month. Our vertically integrated supply chain allows us to fully leverage the strength of Darling's platform. With superior access to waste fats and oils coupled with our technical expertise, pretreatment technology, and superior logistics, DGD will continue to be a leader in the North American renewable diesel market for years to come. While I recognize the DGD's EBITDA this quarter was less than our full year forecast, we expect the back half of 2022 to improve. DGD should be able to deliver $1.10 to $1.25 a gallon EBITDA, and is still a great return, and we remain advantaged over other producers relying on non-waste fats and oils for feedstocks. Looking forward to the back half of the year, our Global Specialty Ingredients business is currently running at a rate well over $1 billion in EBITDA, including the new FASA Group. We believe margins will improve at DGD, therefore, we are reaffirming our forecast to $1.55 billion to $1.6 billion in combined adjusted EBITDA for 2022. So, with that, let's go ahead and open it up to Q&A.
Operator, Operator
We will now begin the question-and-answer session. Our first question will come from Adam Samuelson of Goldman Sachs. Please go ahead.
Adam Samuelson, Analyst
Yes, thanks. Good morning, everyone.
Randall Stuewe, CEO
Morning, Adam.
Adam Samuelson, Analyst
Good morning. Randy, I would like some clarification regarding your comments about DGD and the expected EBITDA of $1.10 to $1.25 per gallon. Is this projection for the second half of the year or for the average margins over the entire year? When we look at current spot margins, even with the lower LCFS prices, it appears they are significantly higher than that. Additionally, regarding the second quarter, it seems that the impact was more related to diesel hedges and the backwardation in diesel curves rather than the declines in LCFS and the increases in feedstocks. Could you clarify how you are assessing DGD's performance?
Randall Stuewe, CEO
Yes, I will respond and then let Sandy add to it. In the second quarter, the volatility associated with how you procure feedstock had a noticeable effect, particularly regarding the hedging process. The fluctuations affected our performance significantly. However, the situation has improved in the third quarter, which will be advantageous for us. Feedstock prices have stabilized, but it's important to note that we typically secure feedstock 60 to 90 days in advance. As this begins to take effect, we should see margins improve. I believe achieving an average of $1.25 for the full year is still very much possible. Sandy, would you like to add anything?
Sandra Dudley, Executive Vice President
No, I think, Randy, you hit it on the head. We had really high feedstock prices that outpaced diesel prices throughout the quarter. LCFS prices did contribute to the decline versus Q1. We saw that RINs continued to work really hard during the quarter, but the LCFS prices were just off.
Adam Samuelson, Analyst
Okay. And then if I take a step back to the whole company, I mean, you talked about the Ingredients business running at a well over $1 billion EBITDA rate. The full year guidance for the whole company level was unchanged. FASA closed four or five months earlier than you thought, wasn't in the prior outlook. And I think equate to $35 million to $40 million or so, based on the run rate you talked about, but incrementally, that wasn't in the prior outlook. So, can you talk about some of the moving pieces and what you're thinking for feed and food and fuel on the parent for the full year and how that has changed relative to May?
Randall Stuewe, CEO
Yes, my name is Randall C., and I approach this situation conservatively. We're currently observing several dynamic factors. Firstly, feedstock prices have decreased slightly, but DGD 3 hasn't begun purchasing yet, which is noteworthy. The market is aware that we will need to secure about 4 billion pounds of waste mass and greases in the last quarter of the year. We're optimistic that feedstock prices will either stabilize or recover as we begin ramping up that facility. Global protein demand remains strong, and the beef segment is expected to perform well in Q3. Valley is meeting our expectations, though we are facing some operational challenges. We're adjusting the movement of tonnage and optimizing synergies from different raw material sources to increase efficiency. We anticipate momentum will build in the second half of the year. The FASA Group is currently generating an EBITDA of $90 million to $100 million, and we will account for two months of that going forward. Overall, if DGD achieves 750 million gallons for the year without counting DGD 3 startup, this reflects my conservative viewpoint. Despite the many moving parts, we feel quite confident. Quality remains a key concern globally, particularly with animal fats in summer, which we have to manage, but our new machine can address these challenges, presenting a different situation than in the past. John Bullock, do you have any additional thoughts?
John Bullock, Chief Strategy Officer
No, I think that's exactly right. If you look at it overall, Diamond Green Diesel has expanded from 300 million to 800 million gallons, and we're set to increase to 1.2 billion gallons. Whether we're making $1 or $1.25, that's a significant amount of money based on those gallons. Moreover, the impact of low carbon fuels in the world has raised fat prices from $0.20 or $0.30 to $0.60 to $0.75. All of this is quite positive, especially considering we have significantly scaled our low carbon vertically integrated supply with the Valley and FASA acquisitions.
Adam Samuelson, Analyst
Okay, that's all very helpful color. I'll pass it on. Thank you.
Operator, Operator
The next question comes from Manav Gupta of Credit Suisse. Please go ahead.
Manav Gupta, Analyst
Hello. Just following up on Adam's question. We could discuss why the EBITDA was $1 a gallon instead of $1.25, but the truth is that you are a leader in the renewable diesel sector. Recently, a new facility started up at 200 million gallons and ended up with a negative EBITDA of $25 million for the quarter, highlighting how you stand out. What I really want to know is what it would take for the best in the business to enter the sustainable aviation fuel market, especially now that sustainable aviation fuel could fetch around $1.75 BTC. I understand that you and your partner have been diligently working on commercializing sustainable aviation fuels. With the help of the Inflation Reduction Act, how close are we to an announcement from Darling-Valero regarding sustainable aviation fuel?
Randall Stuewe, CEO
Yes, Manav, this is Randy. I will have Sandy provide additional comments. We want to address a couple of different aspects that Sandy will cover. Clearly, the Inflation Reduction Act is very beneficial for Darling globally, and the SAF wording in it is also encouraging, bringing us a step closer. Sandy, please elaborate.
Sandra Dudley, Executive Vice President
Yes, thanks, Manav. This is Sandy. I believe the Inflation Reduction Act is one of the most significant pieces of U.S. environmental legislation we’ve seen in a long time. It not only supports our road fuel business but also makes considerable progress toward enabling the production of sustainable aviation fuel (SAF). While reviewing it, we identified several positives. First, we’re excited about the five-year programs that show strong support for biofuels. As a U.S. biofuels producer, we're particularly pleased with the changes to producers and tax credits starting in 2025. Additionally, as a renewable diesel producer that relies on waste feedstocks, we’re thrilled about the new emphasis on emissions reductions. This focus on emissions is very beneficial for Darling, especially since we are a low carbon intensity feedstock producer. Moreover, the FASA and Valley acquisitions were timely and supportive of this effort. Overall, these incentives bring us much closer to justifying SAF production. We hope airlines find that the incentives significantly lessen their burdens, as they are eager to utilize SAF. We are currently reviewing the legislation and its economics and will continue discussions with our partner. I can say that the airlines are committed to closing any potential gaps, and we look forward to supplying them with SAF.
Manav Gupta, Analyst
Perfect. My quick follow-up here is, Randy, we saw the volumes in 2Q, they were extremely high, beating our expectations. So, first, can you talk a little bit about how Valley contributed to the overall volumes? And then what I'm trying to get to is, well, while 2Q had Valley, 3Q will have Valley and FASA, so help us understand how the volumes in the feed segment will trend in the back half of this year?
Randall Stuewe, CEO
Valley’s volume, compared to the U.S. rendering size, is about half. This should lead to growth. Overall, Valley produces around 2.5 million tons and FASA produces 1.3 million tons. If we round that up, it’s close to 4 million tons. With about five months left in the year, we can expect them to contribute roughly five-twelfths of that 4 million tons in the latter half of the year.
Manav Gupta, Analyst
Thank you so much. Thank you all so much for your comments.
Operator, Operator
The next question comes from Ben Bienvenue of Stephens. Please go ahead.
Ben Bienvenue, Analyst
Hey, thanks. Good morning.
Randall Stuewe, CEO
Morning, Ben.
Ben Bienvenue, Analyst
So, I want to ask you, you've got FASA, you've got Valley, I'm sure you're going through an integration process but those are in full swing here. You've started the buyback a little bit of stock, but there's going to be a pretty meaningful cash build on the balance sheet in the absence of either continued M&A, or distributions or share repurchase. And I know we keep asking this each quarter, but the anticipation keeps building around, what are you going to do with all the cash? And is what we saw on the quarter from a buyback perspective indicative of those sort of support that you'd like to allocate to that use of cash?
Randall Stuewe, CEO
Yes, I'll have Brad assist me with this. The dividend we extracted from DGD demonstrates our current position, and the margins of $1.10 and $1.25 highlight our ability to generate cash effectively. It's quite evident now. Additionally, the share repurchases in Q2 reflect the authority Brad and I have to buy back shares as needed. We faced some pressure after Q2, and that's all I'll say on that. Lastly, our priority is to reduce our debt back to two and a half, which we plan to achieve quickly. We're always on the lookout for potential M&A opportunities, and we will evaluate those as they arise. Brad, do you have anything to add?
Brad Phillips, CFO
Yes, just reiterate, Ben, and you know this, I think everyone on the call has heard this, but, we closed FASA, we were at 2.59. So, immediately after FASA here, a little higher than that below 3, but with the dividends and with number 3 coming on, paid for the JV debt-free, going into let's call it going into 2023, the distributions are expected to be material in 2023. So, to Randy's point of delivering, not to mention just the base business and where it's running free cash flow going into 2023.
Ben Bienvenue, Analyst
Yes, okay, great. And then my second question is a follow-up on Randy, your comments on the GDD margins of $1.10 to $1.25, what consideration is there around the startup of DGD 3 and that as a potential kind of margin detriment as you initially ramp it? And I know you guys get better each time you do these ramps; would you expect the impact of that spool up to be less than we've seen over the last couple of iterations?
Randall Stuewe, CEO
Yes, I'll take a front end stab at and then give it to Sandy here. I mean, clearly, we've affirmed 750 million gallons; we ran 200 and plus in Q2, so we're exceeding that already, $1.10, $1.25. So that has no DGD 3 in it. Clearly, that's where we're trying to be conservative. As always, anytime you try to start one of these things up yet, you don't know what you don’t know yet. Although we've got 10 years of experience in history. And Sandy, you want to comment on the ramp up of 3 here?
Sandra Dudley, Executive Vice President
Yes. So, I think we learn a lot every time we do one of these. And it was a big step up for us for DGD 2. DGD 3 will be another big step up and I think we'll see some flows move around. Not sad, I think we've also learned an awful lot since DGD 2, we've expanded who we source from both domestically and internationally and I think that will be advantageous to us.
Ben Bienvenue, Analyst
Okay, great. Thanks so much. Best of luck.
Operator, Operator
The next question will come from Tom Palmer of JPMorgan. Please go ahead.
Tom Palmer, Analyst
Good morning and thank you for the question. Wanting to ask on the expectations on DGD, you paid down debt this quarter, paid distributions to the JV partners. So, I guess it seems like a signal that CapEx winding down, obviously, Port Arthur, just a few months from opening, what are your expectations for distributions for the remainder of this year? Should we start expecting some later this quarter or fourth quarter for the distributions or is it more of a 2023 event?
Brad Phillips, CFO
Yes, Tom, I'll start. This is Brad. So, we do have a distribution policy, obviously, with our partners. So, that's what allowed or created the recent distribution. So, I would say and Sandy add on to this, really, it will depend on the remaining cadence of the spend, as well as really the ramp up in the feedstock here for DGD 3 because that's all taken into account along with the anticipated cash flow. So, at the end of the day, could we receive another distribution? Yes, we could. But really the focus, whether we do or don't, like I said earlier, we're going to want to be significant distributions beginning in 2023.
Sandra Dudley, Executive Vice President
Yes, I agree with that, Brad. We've always said that we expect strong distribution starting in 2023 and we'll see what Q3 and Q4 holds for us.
Tom Palmer, Analyst
Okay. Thank you. And then just in terms of the spread at DGD between what's been produced and shipped, it's been a little wider than we've seen in the past. I think you've actually under-shipped about 20 million gallons in the first half. Should we be factoring in some catch-up here, as we look towards the second half in terms of that shipment timing?
Sandra Dudley, Executive Vice President
Yes, I think we can count on is that we'll get to 750 million by the end of the year; that's what we're projecting. And often between quarters and things like that, we may have shipments that carry from one quarter into the next and that can impact that too. And I think that's kind of what you saw in some of those numbers.
Tom Palmer, Analyst
Okay. Thank you.
Operator, Operator
The next question comes from Ben Kallo of Baird. Please go ahead.
Ben Kallo, Analyst
Good morning, guys.
Randall Stuewe, CEO
Good morning, Ben.
Ben Kallo, Analyst
Hey, thanks for taking my question. Can we discuss the fuel business, excluding DGD, along with the feed or food business? Last time, you mentioned rising energy prices in Europe affecting fuel. How should we view that moving forward? Regarding food, collagen seems to be a leading factor; how do you see that evolving in the mix, and how sustainable is it? Are there any incremental developments in that area? I'll follow up.
Randall Stuewe, CEO
Clearly, Ben. I'm going to pass it over to John Bullock in a moment, as he has been closely involved in shaping the strategy for both the Rousselot business and our European Green Energy business. We like to emphasize that these are primarily de-commoditized businesses, meaning they have much less exposure to the volatility of commodities in the feed segment. We are excited about our growth; during our Board meeting yesterday, we reflected on Rousselot's growth since 2014 and 2015, which has been an impressive journey in the food segment. As we have mentioned, Rousselot is the largest part of that food segment, so that’s expected. On the green energy side, we are not only investing in existing facilities but also acquiring new ones and optimizing different feedstock sources across Europe to enhance profitability. John, would you like to share our current position and future plans?
John Bullock, Chief Strategy Officer
Yes. So, I think just stepping back for a second, what you see with Darling is essentially a company that has been based on value adding the byproducts range on the animal industry around the world. And what's made us so successful over the last 10 years is we have created rockstar products that are on the leading edge of that. That uses low carbon feedstock to create renewable diesel, obviously, in the transportation low carbon fuel segments. And we've also been the world leader in terms of hydrolyzed collagen, on the peptide revolution, which has continued and looks like it's continuing going forward. So, both the European strategy of decarbonizing low CI energy products for fixed power generation, as well as the improvement because of the investments we made in Rousselot in relationship to the collagen peptide, fit into that basic theme. We have rockstar products that we are the leading edge producers in the world, and we are continuing to extend our advantage on those two critical trends that we see as moving positively forward.
Ben Kallo, Analyst
Thank you. My follow-up is regarding whether the pricing changes due to the rendering or the used cooking oil becoming more valuable. Does this impact the protein plants, and how do they perceive it? Are they looking to gain value from you, and how does the negotiation unfold moving forward with this new significant end market? They must recognize the value present. Thank you.
Randall Stuewe, CEO
Yes, Ben, we receive that question frequently, and it's a valid inquiry. The model we established two decades ago was designed for sharing. We aimed to reduce risk and ensure fair credit lines to foster the company's growth. With our major suppliers, we have transparent agreements that allow us to share the benefits while also protecting ourselves with a fixed margin processing fee. We're not facing any resistance regarding this. In a lighthearted manner, if we consider the question about wanting a bit more benefit from Diamond Green Diesel, it reminds me of John Bullock asking for $1 billion to be part of the conversation. Ultimately, our formulas both safeguard us and provide shared benefits. From a philanthropic perspective, I feel it’s my responsibility to ensure that the raw material providers receive as much compensation as possible to support their growth, as their success contributes to ours. This process is very dynamic, and we have no pressure to deliver immediate results. We maintain a proactive and aggressive stance in the used cooking oil market globally. I believe we're in a solid position. John, is there anything you would like to add?
John Bullock, Chief Strategy Officer
No, I think you hit it exactly.
Ben Kallo, Analyst
Thanks guys. Congrats.
Operator, Operator
The next question comes from Ken Zaslow of Bank of Montreal. Please go ahead.
Ken Zaslow, Analyst
Hey, good morning, guys.
Randall Stuewe, CEO
Morning, Ken.
Ken Zaslow, Analyst
Did you mention that you haven't yet made any purchases for the Port Arthur facility, and does this indicate that the Feed business is still not fully benefiting from the increased rendering values? I'm just trying to clarify that.
Randall Stuewe, CEO
Yes, what I mean is that we are close to reaching mechanical completion down there, but we aren’t there yet. Logistics will begin soon; we have a startup in the fourth quarter. So, with this startup, purchasing will start towards the end of the third quarter. While you might have some on paper, the market won't see it until the logistics start flowing. This is something we want to emphasize. Around the start of Q4, we will be sourcing 70% of North America's waste fats and greases, but we're just beginning. I anticipate that there will be movement toward non-traditional markets and others. It's clear that DGD 2 imports from around the world, and part of our FASA acquisition was already a supplier for DGD 2. At the end of the day, although palm oil prices have decreased globally and there’s some correlation with soy, our prices are holding steady. We are currently addressing summertime issues, but I remain optimistic and supportive as we transition back into the feed. John Bullock, would you like to add anything?
John Bullock, Chief Strategy Officer
No, I think that's right. I mean, obviously, and this question was asked earlier, as we bring each of these Diamonds on, these are huge businesses that we're starting up and we go to zero to 100 really quickly as we're operating those businesses. That's going to have an impact in relationship to the feedstock markets. And as the supply chain has to adjust, to be able to feed us the product, but it will happen. We've seen this happen time and time again. We started at a 126 million gallon run rate. And we always wondered, where was the fat going to come from? We wondered that when we went to 160 million, we wondered when we went to 275 million, we wondered when we went to 400 million gallons. We wondered when we went to 800 million gallons and now we're going to go to 1.2 billion or 1.3 billion gallons. The fat is going to come because we have the best machine in the world to buy the fat.
Ken Zaslow, Analyst
Okay. My second question is, is there any reason that you don't generate the industry renewable diesel margin, and that there's not a parallel between what we see in the market and what you generate and saying, ex-hedging? It just seems like I understand that you said there's some hedging issues, but it seems a little bit more dramatic, the differential and I'm not sure maybe we're miscalculating just trying to figure out if there's any other disconnect that we don't know about, and just trying to figure that out. That'd be very helpful.
Sandra Dudley, Executive Vice President
So, Ken, this is Sandy. I think others in the industry often discuss capture rates, which in my view relate mainly to the spot market. That's not our approach at DGD. When considering our supply chain, we purchase our feedstocks several months in advance, giving us the option to let it ride without hedging or to hedge by locking in the feedstock price and selling a heating oil contract to secure our margin. We opt to hedge, which protects us from downward changes in diesel prices. Our margins may not resemble capture rates because we don’t operate in the spot market; we have to buy feedstocks ahead of time. During Q2, diesel prices rose, meaning that unwinding our hedge typically involved buying back at higher prices. However, since we're also selling our renewable diesel at increased prices, these factors often balance out, reflecting in our hedge price. While the hedge might not appear favorable when prices are high, as we transition into Q3 and diesel prices decrease, we expect to see the opposite effect. There seems to be a disconnect between capture rates and our actual business performance.
Ken Zaslow, Analyst
So, right now, in the third and maybe fourth quarter, you would likely be higher than the 170-ish that we're currently seeing, depending on how the hedges are performing.
Sandra Dudley, Executive Vice President
That will all depend on where diesel prices end up.
Randall Stuewe, CEO
Yes, the heating oil curve has flattened from where it was. The inverses we observed in all commodities were among the steepest ever recorded. Consequently, trying to hedge in that environment was extremely challenging. However, from what I currently see on paper, it seems to have leveled off. If this trend continues, spot margins will likely be closer long-term than they have been in the past.
Ken Zaslow, Analyst
Great. I appreciate it, guys. Thank you.
Operator, Operator
The next question comes from Matthew Blair of TPH. Please go ahead.
Matthew Blair, Analyst
Hey, good morning. Could you talk about the expected feedstock mix for DGD 3? And how much of this will be sourced internally from Darling and how much will you have to pick up from external third-party suppliers?
Sandra Dudley, Executive Vice President
So, I think you would tend to see that our feedstock mix would be about the same, we're probably going to be a little bit heavier in terms of your yellow greases, your telos. And just by virtue that there are more of those available. And so I think you expect that in terms of internally sourcing, as DGD, we don't necessarily rely on Darling or Valero to provide corn oil. And so I don't think that there's a set percentage, it's going to be whatever price is the best price in the market and who DGD is going to buy from. So, I don't know what that percentage will be.
Randall Stuewe, CEO
No, I mean, clearly, this is Randy and at the end of the day, as John reflected back, a small portion, or a third of Darling went to basically 1 and 2, it moved up to a little over half now and with Valley and FASA, it's probably going to move up more. Clearly, the numbers indicate that it has to go there. It'll be the best market. Now, keep in mind, it's an arm's length relationship and the procurement teams are obligated to maximize profits, which are defined by both output price and quality. So, at the end of the day, there are always going to be arbitrage opportunities, and that's what we enjoy about the business for some of our products. A lot of the Valley production was being exported, which is now being redirected here. They weren't set up to load railcars. So, when I mentioned operational challenges and efficiencies, that’s what I meant. It's easy to send a truck to a tank terminal in Norfolk, but now you have to load a railcar. That will all happen over time and will increase the amount of Darling's product in this area. We are not at all apprehensive about supplying number 3 here. The team has been traveling globally, and as John always says, the moat around the business is our ability to procure domestically and internationally with ease. By the end of the day, you will likely see much more product arrive by water to us than in the past, and that will help regulate the right product mix for both quality and price that no one else will have. It wouldn’t make sense to originate Chinese products and move them with Artesia, New Mexico. This facility is going to have a significant advantage.
Matthew Blair, Analyst
Sounds good. On the current feedstock mix for DGD, it looks like the paper RD from soybean oil actually looks pretty good here. I know you have advantages with the low CI feeds. I was curious if you have been switching to any soybean oil feedstocks currently at DGD?
Sandra Dudley, Executive Vice President
Yes, I don't think that we're really going to talk about our current feedstock mix. What we do is we focus on waste stocks and if opportunistically, it makes sense to occasionally do soybean oil, we would consider doing soybean oil.
Randall Stuewe, CEO
Yes, I think that's fair, Matt. At the end of the day, the focus is a super high percentage of waste fats and oils. People always have to remember that 40% of the soybean oil production in the U.S. ends up in energy anyway. So, from time to time, we may arbitrage a few trucks or a few railcars in, but at the end of the day, our focus is waste fats and greases, driven because of CI content.
Matthew Blair, Analyst
Great. Thank you very much.
Operator, Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Randy Stuewe for any closing remarks.
Randall Stuewe, CEO
Hey, thanks again, everybody. Appreciate your time and hope everybody stays safe and has a great summer and gets the kids back to school. I look forward to seeing you at some of our upcoming events listed in the earnings presentation and look forward to talking to all of you soon. Thanks again.
Operator, Operator
The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.