Earnings Call Transcript - DAR Q3 2024

Operator, Operator

Good morning, and welcome to the Darling Ingredients Inc. Conference Call to discuss the Company's Third Quarter 2024 Financial Results. After the speakers' prepared remarks, there will be a question-and-answer session 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 Miss. Suann Guthrie. Please go ahead.

Suann Guthrie, Investor Relations

Hi. Thank you for joining the Darling Ingredients third quarter 2024 earnings call. Here with me today are Mr. Randall C. Stuewe, Chairman and Chief Executive Officer; Mr. Brad Phillips, Chief Financial Officer; Mr. Bob Day, Chief Strategy Officer; and Mr. Matt Jansen, Chief Operating Officer of North America. Our third quarter 2024 earnings news release and slide presentation are available on the Investor page under the Events and Presentations tab on our corporate website 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 could materially differ because of factors discussed in today'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, Chairman and CEO

Thanks, Suann. Good morning, everyone, and thanks for joining us. During the third quarter, Darling Ingredients continued to navigate challenging markets with global ingredient demand and pricing remaining sluggish and a difficult renewable diesel market. Despite these headwinds, our core ingredients performance was flat sequentially but generated adequate cash and dividends from Diamond Green Diesel, allowing us to reduce debt by about $192 million. Operationally, our global asset base performed well and we continued our focus on widening margins, managing CapEx and reducing SG&A. For the quarter, our combined adjusted EBITDA was $236.7 million, primarily a reflection of sequentially steady finished product pricing and a challenging renewable diesel market. Turning to the Feed Ingredients segment. Raw material volumes remained strong, primarily driven by growth in Brazil. Fat prices are slowly recovering, but the rebound is much slower than anticipated, clearly reflecting the challenges other RD producers are experiencing ramping their pretreatment units to run on low carbon waste feed, fat feedstocks and the impact of some imported feedstocks. As many of you know, summertime is typically very challenging on our operations, and we naturally see a slight degradation in gross margins. I'm pleased to report that in the third quarter of 2024, we saw a slight increase in feed gross margin percentage sequentially due to the hard work and dedication of our operations team working on spread management and ultimately, cost control programs. Now turning to the Food segment. We saw lower volumes, which were attributed to softer demand in China, new capacity additions in Brazil and continued customer destocking. However, we continue to hold strong margins despite the declining sales price in the global market. On a positive note, next week, we will be at a supply-side West North America trade show in Las Vegas, showcasing Nextida.GC, a natural collagen solution targeting glucose moderation and a clinical trial conducted by Darling Ingredients. Nextida.GC significantly lowers post-meal glucose spikes in the blood by an average of 42%. For Darling, we have unlocked the next wave of collagen-based solutions that are potentially revolutionary. Now turning to our Fuel segment. DGD margins remain challenged given the delay and lack of clarity in the regulatory markets for RINs and LCFS. Despite the softer margins at DGD, we received $111.2 million cash dividend distribution from the joint venture in the third quarter. Our sustainable aviation fuel unit is mechanically complete and in the process of commissioning. We continue to build a strong sales book, and I have now announced our third contract earlier this month. For 2025, we remain very optimistic about the regulatory landscape. We believe we will have clarity on the California low carbon fuel standard program and the federal tax credit known as 45Z very soon, paving the way for greater growth and improved margins at DGD along with stronger demand for our low carbon feedstocks. With that, now I'd like to hand the call over to Brad to take us through some financials, and then I'll come back and discuss my thoughts on the rest of 2024 and the outlook for 2025.

Brad Phillips, Chief Financial Officer

Okay, Randy. Net income for the third quarter of 2024 totaled $16.9 million or $0.11 per diluted share compared to net income of $125 million or $0.77 per diluted share for the third quarter of 2023. Total net sales were $1.4 billion for the third quarter of 2024, as compared to $1.6 billion for the third quarter of 2023. Operating income decreased $118.3 million to $60.1 million for the third quarter of 2024 compared to $178.4 million for the third quarter of 2023, primarily due to a $72.9 million decline in gross margin and a $52 million decline in our share of the equity and net income from Diamond Green Diesel earnings compared to the same period in 2023, which were partially offset by lower selling, general and administrative expenses for the third quarter of 2024 as compared to the same period in 2023. Other expenses decreased $4.9 million in the third quarter of 2024 as compared to the same period in 2023, primarily due to a decline in interest expense as well as an increase from property casualty gains. For the first nine months of 2024, net income was $177 million or $1.10 per diluted share as compared to net income of $563.2 million or $3.47 per diluted share for the first nine months of 2023. Net sales for the first nine months were $4.3 billion compared to net sales of $5.2 billion for the same period in 2023. Operating income decreased $445.1 million to $345.8 million for the first nine months of 2024 compared to $790.9 million for the first nine months of 2023. The decrease was primarily the result of a $264.5 million decline in gross margin and a $236.6 million decline in our share of equity and net income from Diamond Green Diesel earnings as compared to the same period in 2023. Other expenses increased $16.7 million for the first nine months of 2024 as compared to the same period in 2023 primarily due to an increase in interest expense and a decline in foreign currency gains. As far as taxes for the first three months ended September 28, 2024, the company reported an income tax benefit of $17.5 million and a significant negative tax rate, primarily due to the biofuel tax incentives. Given the almost breakeven pretax earnings, the effective tax rate as a percentage of pretax earnings is not meaningful for the three months ended September 2024. The company paid $26.6 million of income taxes in the third quarter. For the nine months ended September 28, 2024, the company reported an income tax benefit of $12.8 million and an effective tax rate of negative 7.6%. The company's effective tax rate, excluding the biofuel tax incentives and discrete items, is 28.1% for the nine months ended September 28, 2024. The company also has paid $82.4 million of income taxes year-to-date as of the end of the third quarter. For 2024, we are projecting an effective tax rate of negative 5% and cash taxes of approximately $15 million for the remainder of the year. In the third quarter, we paid down approximately $192 million in debt. The company's total debt outstanding as of September 28, 2024, was $4.246 billion compared to $4.427 billion at year-end 2023. Our bank covenant projected leverage ratio at Q3 2024 was 4.04 times, and we had approximately $1 billion available to borrow under our revolving credit facility. Capital expenditures totaled $67.4 million in the third quarter and $259.1 million for the first nine months. As Randy mentioned earlier, we received $111.2 million in cash dividends from Diamond Green Diesel during the quarter. With that, back to you, Randy.

Randall Stuewe, Chairman and CEO

Hey, thanks, Brad. We are increasingly optimistic about 2025 and believe tailwinds will commence very soon. Our Specialty Ingredients business is well-positioned, and we've made the necessary improvements to deliver increased margins. In addition, we expect margins to improve at DGD and fat prices to improve globally. The transition to the PTC will definitely favor Darling, and we will once again demonstrate our ability to be the largest, most reliable, most cost-efficient renewable diesel and sustainable aviation fuel producer in the world. With three quarters of the year behind us, our core business is performing nicely, but waste fat prices are still lagging, and R&D margins are modestly improving, but waiting on regulatory clarity. This would suggest 2024 fiscal year combined adjusted EBITDA to be in the range of $1.15 billion up to $1.175 billion, not where we wanted to be, but still our fourth best performance in our 142-year history. As we look forward to 2025, Darling Ingredients has tremendous tailwinds building that have the potential to propel us back into record earnings levels for both our specialty ingredients and renewable businesses. Our global collagen business is positioned nicely for returned growth as we launch new innovations and market conditions become more favorable. From a decarbonization standpoint, both state and federally renewable fuel incentives greatly favor the use of waste fats and oils, of which Darling is the largest producer in the world. In fact, renewable diesel and SAF producers that want to be profitable will need to switch to waste fats and oils, which will ultimately benefit our specialty ingredients business. Diamond Green Diesel is positioned nicely to continue to benefit from both federal and state program improvements as it is the premier producer of renewable diesel and SAF capable of utilizing the most economical waste fats and oils sourced globally. We have over 11 years of successful production under our belt, and now we can say we are the largest and most successful producer in the world. So now let's take a quick look at an early forecast for 2025. Even from a worst-case perspective, assuming fat prices are somewhat steady or unchanged, and Diamond Green Diesel produces approximately 250 million gallons of SAF and 1 billion gallons of renewable diesel, and let's assume RINs and LCFS value stay relatively unchanged or flat, I see the combined earning power of our platform to be in excess of $1.5 billion for next year. However, given what we see in the market, we believe LCFS and RINs will increase and waste fat prices will also move higher. As we have said, a $0.01 move in the waste fat price means about $12 million EBITDA annually for Darling during the year. It's impossible for me to predict precisely how the waste fats and oil and RINs and LCFS markets will shape up over the next year, but clearly the transition from the blender’s tax credit to the Clean Fuels producer credit or 45Z will be positive for Darling in many ways from favoring waste fats to providing additional cash for deleveraging. I'm very bullish on Darling. We have a number of tailwinds pushing us into 2025, and I believe this could all result in the highest EBITDA for our company in its history. With that, let's go to Q&A.

Operator, Operator

Our first question comes from Tom Palmer of Citi. Please proceed.

Tom Palmer, Analyst

Good morning and thanks for the question. Thanks for the color on 2025, just starting out, but maybe we could touch first on kind of the implied outlook as we think about the fourth quarter, it does imply a pretty meaningful improvement versus what we saw in the third quarter. So maybe could we touch on some of the items that you see driving that inflection as we look at the fourth quarter, because it would seem like we're getting close to that $1.5 billion annual run rate in the fourth quarter just based on the implied guidance. Thank you.

Randall Stuewe, Chairman and CEO

Yes, Tom, this is Randy. There are several factors that influence the fourth quarter. Traditionally, we face operational challenges in the third quarter, particularly with wastewater and quality issues globally, so we typically see a natural improvement in the fourth quarter. We did not observe an increase in fat prices during the third quarter, but we are currently selling products and finished fats in South America and North America at higher levels than we did in Q3. The collagen business experienced some difficulties in the third quarter, partly due to the timing of shipments from Brazil, but we're seeing slight improvements there. However, we are still encountering some recessionary impacts globally, affecting demand for fuel and food ingredients in regions like China, Europe, and the U.S. Overall, we have positive expectations for Diamond Green Diesel in the fourth quarter, without any current assumptions regarding SAF shipments. If we succeed in that area, which I believe we will, it could further bolster our numbers and the run rate into 2025.

Tom Palmer, Analyst

Thanks for the color there. I wanted to follow up quickly just on the Food segment. It sounded like some of the issues that we saw in terms of 3Q were more transitory and then some maybe as the competitive environment has changed a little bit. So maybe as we think through the coming year, you do have the new products rolling out. To what extent does that offset the competitive environment? Do you think we've kind of seen the full magnitude of some of the capacity coming online? So from here at least stable to better would be the expectation?

Bob Day, Chief Strategy Officer

Yes. Thanks, Tom. This is Bob. I think you're right. I mean we're seeing today just a bit more capacity that's come on to the market, gelatin margins are kind of a little more pressure than they had been. But like you said, we see that stabilizing as we go into 2025. Our expectation is that the Nextida GC product will gain traction, and that product is sold at significantly higher margins. So I think that's correct that we expect to see stable results in that business in 2025 and a strong trend as we end the year.

Randall Stuewe, Chairman and CEO

Yes, I'll add to that regarding Darling. One of the advantages and disadvantages we face is being a public company. We segment and share information, and the main raw material in our specialty collagen business is grass-fed bovine hide. The transparency in our earnings power, similar to our success with Diamond Green Diesel, has attracted competition. The market size is relatively small globally, ranging from 600,000 to 700,000 tons. When a new plant of 15,000 or 20,000 tons is added, it takes about a year to place that volume. This is currently happening in Brazil with a couple of factories that are searching for customers. Securing a customer often requires purchasing one. This has contributed to a decline in sales value. However, for us, managing spreads in the commodity gelatin business and in collagen is crucial. Collagen is a highly specialized ingredient, and our margins have largely remained stable. We have an exciting outlook for 2025. As we mentioned, we will soon launch Nextida, which is already available to several customers, and we're eager to see how quickly that will grow. We also have a few other products lined up for the next couple of years. We believe we'll continue to set ourselves apart in the market. It's important to note that 80% of this segment relates to feed and fat. Any improvement in fat prices will positively impact this business in addition to the specialty ingredients we produce. Overall, we feel positive about 2025.

Tom Palmer, Analyst

Okay, thank you.

Operator, Operator

Our next question comes from Paul Cheng of Scotiabank. Go ahead please.

Paul Cheng, Analyst

Hey, good morning guys.

Randall Stuewe, Chairman and CEO

Good morning.

Paul Cheng, Analyst

Maybe this is for Brad. Brad, any idea how the 2025 CapEx outlook looks? Also, you guys have had great success on cost reduction. Could you give us some idea how much is left in the fourth quarter and also into 2025? That's the first question.

Brad Phillips, Chief Financial Officer

Okay. If I heard right, the first question was about the 2025 capital expenditure outlook.

Paul Cheng, Analyst

And also a reduction.

Brad Phillips, Chief Financial Officer

Okay. The CapEx outlook would be probably more closer to what we projected this year, probably in the $450 million to $500 million range, I would say. I think for the current year, we're still on track to be in the ballpark of that $400 million or maybe lower.

Randall Stuewe, Chairman and CEO

Yes, Paul, this is Randy. Through Q3, we spent $259 million. That's probably one of our lowest run rates ever. You can see the working capital improvement around $340 million. We're managing the business through improved inventories. Cost reductions are something that we don't break out. It's just part of our culture and how we run our business around the world. We've been successful in closing some offices in North America, taking out some simplifying our organization in many areas. I always tend to be very quiet about that stuff because it impacts people's lives. For next year, kind of use that $450 million number as we go forward here. That will be really the maintenance, environmental, and fleet side here with no growth in that area.

Paul Cheng, Analyst

Randy, regarding the food ingredient business, you mentioned that there is still an increase in supply and that customers globally are destocking. Do you believe this trend is nearing its end? Aside from the upcoming supply that is expected to come online, do you anticipate any additional supply facilities or new supplies being introduced? When you communicate with your customers, what are their insights on the continued destocking, which has been ongoing for nearly a year? How much further do you think it can decline?

Bob Day, Chief Strategy Officer

Yes. Thanks, Paul. This is Bob. I think that we're going to continue to see it over the next quarter or so. I mean broadly, the market has been aggressively pursuing the destocking of inventories. These things typically take longer than expected. The good thing for Rousselot is we've had long-term contracts in place that have allowed us to earn higher margins despite this restocking environment than our competition. We believe that by the time the destocking is over and we do have to renegotiate contracts in the future that will be done with that cycle. Overall, we're not too concerned about that.

Paul Cheng, Analyst

How about on the supply increase?

Bob Day, Chief Strategy Officer

Sorry, say that again?

Paul Cheng, Analyst

How about the supply increase, the new capacity increase?

Bob Day, Chief Strategy Officer

Yes. So new capacity coming on. As Randy said, a 15,000 ton increase in capacity can have a short-term impact on margins. The nice thing about that business is the collagen market continues to grow at a pretty fast pace. So over a relatively short period of time, we can absorb an additional supply increase into the market like that, and that's what we're expecting to see here over the next several months.

Paul Cheng, Analyst

Thank you.

Operator, Operator

The next question comes from Dushyant Ailani of Jefferies. Go ahead, please.

Dushyant Ailani, Analyst

Hi, guys, can you hear me?

Bob Day, Chief Strategy Officer

Sure.

Dushyant Ailani, Analyst

Awesome. Yes, good morning. Thanks for taking my question. One on SAF, just real quick. Could you share some color on your sales book? I know that you guys have announced some orders maybe you could share how much has been contracted thus far besides what you have announced? And do you have a target split between contracted and spot, if any?

Matthew Jansen, Chief Operating Officer, North America

Dushyant, this is Matt. Good morning. I think I understood your question. As Randy mentioned, our SAF plant is mechanically complete. We're in the commissioning phase right now. We're very excited about where we are in that. I would say that, that project has been now actually early and under budget. We've made a few announcements over the last few weeks with some of the contracts that we have made. Not all of the contracts get announced for competitive reasons. We have lots of different discussions going on. We have already completed some contracts, as you know. I'm quite optimistic about our future there and our ability to contract product and make deliveries. A lot of these contracts are one to three years in tenure. It's really not necessarily our intention to go spot right now on material volume, but we'll see as time develops. But again, we're confident in our ability to make the sales on product.

Dushyant Ailani, Analyst

Awesome. Thank you, Matt. And then just a follow-up on your debt targets going forward with the constructive kind of feedback that you guys have or all the constructive picture that you guys have painted for 2025. How do you think about your debt targets, especially as you have some maturities coming in, in 2026? Maybe it's too early to talk about it, but if you have any thoughts there?

Brad Phillips, Chief Financial Officer

Dushyant, this is Brad. Where we are now, just a touch above is for, anticipate year-end here being right around in that ballpark. Obviously, always to a bit degree depends on dividends at DGD next year. We are definitely projecting to be the back half of the year be below 3 times. It will get beyond that in 2026. The momentum will definitely be down. So in 2026, I'll just generally say, all things being equal, we'd be much lower than 3.

Randall Stuewe, Chairman and CEO

Yes. Ultimately, the target is unchanged at 2.5 times. What people need to understand while we're still waiting for a little bit of IRS clarity here, which we believe is coming, the 45Z allows us to market that credit and generate cash rather than waiting for the waterfall or the distribution out of DGD. That in itself creates a very fundamental change in how much cash comes into the mother ship here and how the debt ratio is calculated. A very positive outlook for 2025 puts us in a position to evaluate long-term capital structure and return to shareholders opportunities.

Dushyant Ailani, Analyst

Thank you.

Operator, Operator

Our next question comes from Heather Jones of Heather Jones Research. Go ahead, please.

Heather Jones, Analyst

Good morning, thanks for the question. Brandy, you mentioned that you expect to have visibility on 45Z soon. In some of the conferences I've gone through lately, and people I've talked to, there seems to be a very low expectation of having visibility on that this year. I was just wondering if you could share with us what is underpinning your confidence that we'll get that soon.

Matthew Jansen, Chief Operating Officer, North America

Hi Heather, this is Matt. We understand the concerns you're raising. We are engaged in numerous discussions on our end and remain hopeful that clarity on 45Z will come soon, whether it's provisional guidance or otherwise, and it will likely extend into 2025. We believe this is on the horizon, and we are eagerly anticipating it. We do hear some of the same discussions you're mentioning and take them seriously. However, we expect to gain more insight in the coming weeks.

Heather Jones, Analyst

When you say spillover into 2025, are you expecting the visibility to come in stages?

Matthew Jansen, Chief Operating Officer, North America

Potentially.

Randall Stuewe, Chairman and CEO

Potentially, but we don’t look at it, Heather, as it’s going to happen or not happen. We see the discussions we're having with the proper people are that it’s imminent. A little bit of timing here, but it doesn’t mean that it won’t be retro and be part of it. Looking at our cash generation for next year, we believe we’ll be able to market three quarters of that credit next year. We are taking a conservative approach to it, but we are not taking an approach that it can’t get kicked down the field to mid-25. I just don't see that happening. Bob, do you have any different opinion here?

Bob Day, Chief Strategy Officer

No, I agree with that.

Heather Jones, Analyst

Okay. My second question was on Diamond Green. Looking at margins and live the feedstock, etcetera. There has been a significant improvement in margins. Going from your Q3 to what seems to be implied in your Q4, I'm not seeing that kind of step up. I was just wondering, was Q3 affected by any high-priced feedstocks that you had locked in or something like that? Just given that you're not embedding fast in those numbers, just wondering if you could help us understand why we're going to get such a big step-up in Diamond Green.

Bob Day, Chief Strategy Officer

Yes, what we saw in the third quarter was a lot of fluctuations with all the inputs due to uncertainty in the market. As we move into the fourth quarter, our focus will be on preparing for 2025. Currently, the outlook for renewable diesel companies that can use low CI score feedstocks in 2025 is very positive. We anticipate margin improvements as we progress through the quarter, with companies gearing up for 2025. There are a few important factors to consider. By the end of 2024, we expect to have produced 3.2 billion gallons of renewable diesel, 2 billion gallons of biodiesel, and about 1 billion gallons of imports, totaling approximately 6.2 billion gallons of supply. For 2025, to meet the mandates and regular export demands, we will need 5.7 billion gallons of supply. Renewable diesel could become $0.50 to $1 a gallon more competitive. Biodiesel needs to operate at a positive margin to meet those mandates, and by the end of 2024, this should create significant support. We are also anticipating positive outcomes from LCFS before the year's end.

Operator, Operator

Okay. The next question comes from Manav Gupta of UBS. Please go ahead.

Manav Gupta, Analyst

Good morning, guys. As we are looking at the RIN prices, they are rebounding. LCFS is also rebounding, which could be because of the November 8 meeting. The way the RIN prices are rebounding, it seems that some low-quality biodiesel or renewable diesel production has already started to shut down. So I just wanted to understand if you are seeing that. Do you think this trend accelerates, once we go from BTC to PTC that some of the lower-quality non-profitable BDRD production might continue to shut down in 2025?

Randall Stuewe, Chairman and CEO

We'll kind of tag team this question, Manav. First off, you’re clearly seeing the world reevaluate future investments and sustaining operating of renewable diesel plants or constructing new plants. You saw it with BP, Shell, and now around the world. Neste is having their challenges, that’s been well reported here. When you start to think about what is starting to hit the market here is not only some shuttering of capacity but Neste's offline now. With the transition from the BTC to the PTC, clearly trying to make a cutoff time to be blended and sold is now the clock is ticking. Bob was trying to allude to Heather's question; we're in the midst of watching this change right now. We're seeing California physical gallon demand is very, very tight right now. Ultimately, you can see what’s happening as these imports are starting to slow down. You're seeing that in the RINs. The LCFS with the limited number of obligated parties there and liquidity there, they're waiting for some clarity there. I think you're within a week or so of having that. I see this thing really starting to improve next year. Bob alluded to 1 billion gallons of imports. It was 527 million gallons through June; clearly, it will slow down a little bit in the back half. You need to add on the increase in the RVO next year. Yes, Geismar will probably be online, although they're offline right now. You’ve got a couple of things that are tailwinds for Darling. One is if you're going to be profitable in this business, you've got to learn to run waste fats. So far, the industry hasn't. Imports have slowed of imported feedstocks into the country. That's a result of the European changes and China taking back their feedstocks and processing them themselves. A lot of movement in the world. We were bringing up a lot of feedstock out of our operations in Brazil. The domestic market for biofuels in Brazil now is a premium to the U.S. There are lots of different pieces happening here that are setting the stage for 2025.

Bob Day, Chief Strategy Officer

I would say just to pile on, Manav, one thing to keep in mind is as we go into our SAF production, SAF production, that's one-for-one gallons of RD that will not be available on the market.

Manav Gupta, Analyst

Perfect. My quick follow-up is historically, the Feed segment margins could go in the 23% to 25% range. You're trending around that 21%. So are there any margin enhancement opportunities in 2025 as they relate to the Feed segment?

Randall Stuewe, Chairman and CEO

Yes. Clearly, we're still improving our operations on the Eastern Shore, and we're improving our procurement strategies in South America. We're also focused on improving our procurement strategies on raw material in North America. That should start to translate through into, what I'd say, non-price driven margin improvements for 2025. If you get any uplift in fat prices, that would ultimately return to that 23% to 25% range. Anything you want to add?

Brad Phillips, Chief Financial Officer

It's Brad, Manav. It's spread management, it's fat prices, and it's also reliability and operations of the plant.

Operator, Operator

Our next question comes from John Royall of JPMorgan. Go ahead, please.

John Royall, Analyst

Hi, good morning. Thanks for taking my question. I was hoping you could update us on your expectations around the per gallon profitability uplift from running SAF versus RD at DGD. What's baked into your $1.5 billion soft guide for 2025 in terms of the contraction from SAF?

Brad Phillips, Chief Financial Officer

I would say from a pricing and margin standpoint within our SAF. That's not something that we're openly discussing. I would just say that the margins do meet or exceed our project economics that we had put into the project, and I don’t look for that to change.

John Royall, Analyst

Okay. And I was hoping you could dig in a little bit on the imports you discussed that are dragging a bit on fat pricing relative to your expectations. Just any more color there? Do you expect that to continue, or is that more of a transitory impact?

Brad Phillips, Chief Financial Officer

Imports of fat or fuel or both?

John Royall, Analyst

I believe the comment was on fats in your opener, but correct me if I'm wrong.

Brad Phillips, Chief Financial Officer

Okay. So imports of biofuel have actually had a bigger impact on fat prices in North America than imports of waste oils and fats just due to the fat volume equivalent. We expect imports of biofuel to significantly decrease in 2025 because those imports won't be eligible for a producer tax credit, and so they're going to be less competitive. That should have a positive impact. As for imports of used cooking oil and animal fats, it's really going to be supply and demand and price related, but we believe nothing will prevent those products from continuing to come to the market.

Randall Stuewe, Chairman and CEO

Yes, and ultimately, as you look now, palm oil is now at a high, ever since 2022, with lower production and strong global demand changing biomandates in those APAC countries. We're also seeing in Brazil right now as they move their mandate up. It’s been a long time for several of us in this room to know when U.S. soybean oil has been competitive in the world market for export, but we are today. This is what we’re seeing. The world is moving. About 30% of the globe's renewable fuels demand is supplied by vegetable oils globally. The advantage for waste fats will only be accelerated and exacerbated by the PTC. The full point being that if you have the capability, you will run waste fats. So far, we’re seeing one of the West Coast players trying to operate on waste fats while the other one is not. There are some changes happening right in front of us here.

Operator, Operator

The next question comes from Andrew Strelzik of BMO. Go ahead, please.

Andrew Strelzik, Analyst

Hey, good morning. Thanks for taking the questions. Just first one, I wanted to clarify your comments around the framework for 2025. Does that $1.5 billion that you articulated include a SAF uplift? It doesn't really sound like it since it's the run rate that's implied for the fourth quarter, is there an assumption on tax credits and how that’s going to shake out?

Randall Stuewe, Chairman and CEO

Yes. Andrew, the crystal ball has a little bit of fog in it this early in the season right now. That's the reason we kind of threw the $1.5 billion out there. Clearly, we think we're going to move out of November and December with some pretty good momentum here. How that translates through, whether it's feedstock pricing or whether it's margin and SAF improvement, in 2025, is yet to be seen. We're just telling you that we see a much improved environment next year for cash generation and deleveraging and other opportunities that exist.

Andrew Strelzik, Analyst

Got it. That’s very clear. My other question, you’ve talked about RD margins having improved a little bit. Certainly, you've got the SAF tailwind for next year. But one of the things that we struggle with is kind of the capture rate relative to paper margins, which, by our math, continues to moderate. I guess what I'm asking is, is there something in the recent or current market environment that is limiting the ability to capture those paper margins or maybe on the flip side, as we go into kind of a more favorable environment, is there the ability to increase that capture rate on kind of the base DGD margins going forward? Thanks.

Randall Stuewe, Chairman and CEO

It's an academic question, and I understand it. We track a paper margin every day. When I look back, non-LCM averaged for Q3 around $0.45 a gallon approximately. Without LCM, we got about 80% of that. Looking at the daily margin up and down, there are some big valleys in there. How those contracts work is the bill of lading date of each shipment, whether it’s a vessel, barge, railcar, or a pipeline, some look back 3 days, some look back 7 days. Timing issues make alignment impossible. Bob? Matt, do you want to add?

Bob Day, Chief Strategy Officer

I would just say that it's fair to say that considering the plants and their size and scale, we have a constant book on the purchase side as well as the sales side. Those averages are about one to two months long. As margins don’t change by the tick, we only achieve what we actually do.

Operator, Operator

Okay, our next question comes from Matthew Blair of Tudor, Pickering, Holt. Go ahead please.

Matthew Blair, Analyst

Thank you, and good morning, everyone. Could you talk a little bit about the market for RD exports? European RD margins are moving up in October here, and the British Columbia LCFS pricing has rebounded after some pretty weak numbers in July. Would you expect that RD exports to be a source of improvement in the fourth quarter versus the third quarter?

Matthew Jansen, Chief Operating Officer, North America

Hey good morning. Matt here. Our approach is basically best economics. It determines where we make our sales. You're correct, we’ve seen improvements in some of the export markets. DGD is strategically positioned on the Gulf Coast. We can import and export cost-effectively. So we’re constantly in those markets. If we have a better opportunity to export, we will do that.

Matthew Blair, Analyst

Sounds good. I know your feedstock slate on the RD side typically is 1/3 fats, 1/3 corn oil, 1/3 used cooking oil. Was there any feedstock switching in the third quarter? There were certain points during the quarter where it looked like R&D from soybean oil actually was pretty attractive due to cheap soybean oil prices. So was there any unusual or atypical feedstock movements for DGD in the third quarter?

Matthew Jansen, Chief Operating Officer, North America

Not out of the ordinary. That combination of 1/3, 1/3, 1/3, that's not exactly the true breakout. There are other products. I would say that nothing was unusual in the product mix.

Randall Stuewe, Chairman and CEO

Yes. We are much heavier animal and eco-based than anything else at the locations. It's customer-driven, CI driven, with different CIs and then feedstocks available for different geographies in the world that we ship to. So there's always a mass balance of what we're producing based on availability and, most importantly, quality.

Operator, Operator

Okay, our next question comes from Ryan Todd of Simmons Energy. Go ahead, please.

Ryan Todd, Analyst

Thanks. Maybe a follow-up on the base business side in particular, the feed business. In the third quarter, the base business is running at a run rate of around $850 million in annual EBITDA. I know you’ve typically talked about that as kind of a $1 billion a year business. The 4Q and 2025 guide seem to suggest that improvement. How much improvement do you assume to get to that $1 billion level? Based on your sensitivities, there's probably another $0.12 to $0.13 improvement in fat pricing. So what have you seen quarter-to-date that gives you confidence on getting to those levels? It seems a little more than what we can see on the screen right now.

Randall Stuewe, Chairman and CEO

Yes. Volumes remain strong around the world, and operational improvements are happening in North America and South America for us. Feedstock pricing improvements are happening. I'm seeing - as we said, palm oil is now $1,000 a ton or nearly $0.50 a pound here. We’re moving towards those prices at many of our factories around the world. The main driver is slow but improving waste fat prices as we move forward, Ryan. Improvement in the food business is also expected. Keep in mind, in Q1, there was a $25 million prior year adjustment. So that’s really in our thoughts too. The Q1 reported at $280 million was actually operationally at $305 million. Getting back to those mid-3 level numbers for us doesn't seem out of reach.

Ryan Todd, Analyst

Thanks. A follow-up on the SAF side. Do you have any high-level thoughts on how you expect the European market to figure into things? Do you look at the European market as a potentially higher margin destination for your product as you think about export versus domestic demand looking into 2025 and thoughts on supply/demand into that market?

Randall Stuewe, Chairman and CEO

We’ll team this one. First off, when we wake up in the morning, we're thinking of the best destination for our feedstock. During 2024, it was the first time in my career and probably in the history that we've seen European fats moved to the U.S. That doesn’t happen. What’s that a result of? That's a result of underperformance of the renewables sector in Europe, whether that's R&D or biodiesel. That is changing now, although Neste continues to have their operating problems, but it feels like that's changing now, and those fats will stay within the boundaries of the European continent. When you look at South America, a lot of South America was headed up here to our plants. It’s a great deal because it improves the margins of our rendering business down there. Now with the mandates happening down there, it’s slowly being absorbed at a premium to the U.S. The U.S., we're still waiting on the two big ones on the West Coast to consistently run waste fats, whether that’s biodiesel or animal fats, and that should change things. Geismar should have that ability; they’ve been around nearly as long as we have, and they should have mastered that. The feedstock situation should change here; if you have the capability, you will run waste fats. Regarding the outbound product side, as Matt said, it’s about finding the highest priced market and selling it. Neste is creating spot opportunities right now, whether it’s within the continent or Canada or California for us. That’s given us courage going into Q4.

Bob Day, Chief Strategy Officer

I would just say we’re seeing demand increase globally. The natural supplier of that demand is product that’s been imported into the United States. We expect to see significant increase in demand in the U.S. for renewable diesel on a relative basis because of what’s happening with supply and demand overall. If there are global opportunities, as Matt said, Diamond Green Diesel is well positioned to take advantage of those opportunities, and we’re seeing a really attractive market in the United States in the next year.

Operator, Operator

Our next question comes from Ben Kallo of Baird. Go ahead, please.

Ben Kallo, Analyst

Hey good morning guys. Just on next year, the possibility of shuttering capacity. Could you just talk about any dynamics you think that people would run even at a loss in the marketplace? I have a follow-up question.

Matthew Jansen, Chief Operating Officer, North America

Those dynamics could certainly be present in biodiesel, especially if it’s part of a crush business and the crush margins are favorable. They might operate with a slightly negative margin, but only to a small extent. We don't expect to see a significant portion of capacity operating at large negative margins.

Randall Stuewe, Chairman and CEO

Yes. Ben, this is Randy. Ultimately, Chevron went out and bought those REG assets. They've shuttered two of them. With the 45Z coming, I’m not sure what those economics will look like, even with LCFS increasing here. It’s still capped at 5% biodiesel. You must keep in mind that the RVO grows by 350 million, 400 million gallons next year. Again, that's a big number. It’s hard to see much shuttering. Looking back into 2023, every bet on the table was, sell-side guys focused on P66 and Martinez running wide open and flooding the market with RINs and product; that hasn’t happened. We're watching things shift. While we don't share our sales book, we are now starting to sell some waste fats to others. One player is only buying refined, bleached soybean oil, much of it imported. You’ve got to question the economics on that because it incurs a 19.1% duty and unless you're going to export without the duty drawback, that doesn’t make sense. Rational minds must prevail. We expect enough market growth and good arbitrage opportunities for us, meaning getting out of 250 gallons from R&D to SAF and other factors. Vertex has alternatives that are gearing us up for a solid marketplace next year.

Ben Kallo, Analyst

Thank you. Regarding SAF, we observed the announcement of loan guarantees and various pathways for SAF. How do you see the market developing? Do you think we might experience a period of oversupply?

Matthew Jansen, Chief Operating Officer, North America

Yes, hi Ben. Good morning. I would say on paper, the market for SAF demand is huge, could be up to 4 billion gallons, maybe more. It’s substantially larger than any available production online today.

Randall Stuewe, Chairman and CEO

Yes, Ben, this is Randy again. The SAF market is developing and our book is building out there, as we say. The margins are what we’re focused on. What’s interesting in that business is the supply chain is far more complicated. It’s airport by airport, airline by airline, and then in-wing supplier by in-wing supplier. Those deals are in process; some are announced while others wish to remain confidential. Europe has a mandate for SAF in 2025, but obligated parties have until late 2025 to comply. It’s dragging a bit, but it’s evolving. We also see a SAF mandate from China on the horizon. We believe we have an early mover advantage. We want to sell plants once committed for three years, and we are positioned to move forward with additional production if warranted. The plant is mechanically complete, and we’re optimistic we will be fully operational and meet quality specs before year-end.

Operator, Operator

Okay. Our next question is from Jason Gabelman of TD Cohen. Go ahead, please.

Jason Gabelman, Analyst

Yes, hi good morning and thanks for taking my question. It looks like DGD's distribution outpaced the earnings from the company and the implied cash generation. Can you just talk about that dynamic? Is there a change in distribution policy there? Thanks.

Brad Phillips, Chief Financial Officer

Yes, Jason, this is Brad. Early in the year, we saw coming out of the holidays of 2023 a slowdown in D.C. on payouts back to parties and at least to Diamond Green. They were really two to three months behind. Once revenues came in the middle of May, they started doing a catch-up. We reached a point during Q3 where we got back on track. We received multiple distributions during the third quarter. We’re still looking at the end of the year for possibilities of additional distributions. We’ll see how it turns out.

Jason Gabelman, Analyst

That ETC catch-up is now complete though?

Brad Phillips, Chief Financial Officer

Well, it’s ongoing every month. It’s pretty much caught up. I’ll leave it at that.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Randall Stuewe for any closing remarks.

Randall Stuewe, Chairman and CEO

Once again, thank you for all your questions. As always, if you have additional questions, reach out to Suann. Stay safe. Have a great holiday season, and we look forward to talking to you again in the future.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.