Earnings Call Transcript - DAR Q4 2023

Operator, Operator

Good morning, and welcome to the Darling Ingredients Incorporated Conference Call to discuss the company's Fourth Quarter and Fiscal Year 2023 Results. Today's call is being recorded. I would like to turn the call over to Ms. Suann Guthrie. Please go ahead.

Suann Guthrie, Moderator

Thank you. Thank you for joining the Darling Ingredients' fourth quarter and fiscal year 2023 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 fourth quarter and fiscal year 2023 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 can materially differ because of factors discussed in yesterday'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 statement. Now I will hand the call over to Randy.

Randy Stuewe, CEO

Okay. Thanks, Suann. Good morning, everyone. Thanks for joining our fourth quarter and fiscal year '23 earnings call. In 2023, Darling Ingredients delivered its sixth consecutive record year in terms of combined adjusted EBITDA at $1.61 billion. The vertical platform we have built demonstrated its ability to perform solidly despite significant volatility in the global food, feed and fuel ingredient markets. Turning to the Feed Ingredients segment. Despite lower prices for most finished goods, our global spread management process and increased volumes compared to 2022 helped to offset the impact. Our laser focus on margin management and continued strategic review of our asset mix, both segment and geographic, ensured our margins remained in alignment with our expectations. In addition, during 2023, we made the decision to close two bakery plants, Muscatine, Iowa and Bryan, Texas. Turning to our Specialty Food Ingredients segment. Raw material volumes increased about 11% year-over-year, primarily due to our Gelnex acquisition and continued product mix shift. We continue to see strong performance and continued growth in China and North America consumer markets, and remain very optimistic about our Health Nutrition business line. Hydrolyzed collagen will continue to play a key role in our long-term growth strategy. Leveraging our extensive research and development in this area, we have successfully isolated individual peptides with targeted benefits related to various health concerns such as glucose moderation and memory retention. The potential applications are extensive, and we are excited to introduce some of these innovative products to the market later this year. Turning to our Fuel segment. Our European Renewable Energy segment continues to deliver very strong results. Lower diesel prices, RINs and LCFS values and a lower of cost or market inventory valuation impacted DGD margins for the quarter. However, DGD had an impressive year with 1.25 billion gallons of renewable diesel sold at an EBITDA per gallon of $0.81, which is still above our 12-year-old investment case of $0.79 of EBITDA per gallon. With this, I'd like to turn the call over to Brad to take us through some financial comments, and then I'll come back with my thoughts on the rest of '24. Brad?

Brad Phillips, CFO

Okay. Thanks, Randy. Net income for the fourth quarter of 2023 totaled $84.5 million or $0.52 per diluted share compared to net income of $156.6 million or $0.96 per diluted share for the fourth quarter of 2022. Net sales were $1.61 billion for the fourth quarter 2023 as compared to $1.77 billion for the fourth quarter 2022. Operating income decreased $90.4 million to $158.8 million for the fourth quarter of 2023 compared to $249.2 million for the fourth quarter of 2022, primarily due to Darling's share of Diamond Green Diesel's earnings decreasing $118.8 million attributable to lower RINs and LCFS values and a $60.9 million lower of cost or market adjustment. This decline in DGD's earnings was somewhat offset by Darling's Global Ingredients fourth quarter 2023 gross margin, increasing $47.6 million as compared to the fourth quarter of 2022 due to continued improvement from integration work within our acquired companies, which was supplemented in the fourth quarter by a reimbursement for certain costs related to Valley Proteins. In terms of non-operating items, interest expense increased from $46.1 million in the fourth quarter of 2022 to $68.5 million in the fourth quarter of 2023, reflecting the acquisition of Gelnex earlier in 2023. For the three months ended December 30, 2023, the company recorded income tax expense of $7.2 million, yielding an effective tax rate of 7.7%, 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, state income taxes, certain taxable income inclusion items in the U.S. based on foreign earnings and losses that provided no tax benefit. The company's effective tax rate, excluding the biofuel tax incentives was 33% for the three months ended December 30, 2023. The company paid $24.9 million of income taxes in the fourth quarter. Net income for fiscal year 2023 totaled $647.7 million or $3.99 per diluted share compared to net income of $737.7 million or $4.49 per diluted share for fiscal year 2022. Net sales were $6.79 billion for fiscal year 2023 as compared to $6.53 billion for fiscal year 2022. Operating income decreased $79.3 million to $949.7 million for fiscal 2023 compared to $1.03 billion for fiscal year 2022, primarily due to a $107.3 million increase in depreciation and amortization and a $105.9 million increase in selling, general, and administrative expenses reflective of the acquisitions completed during fiscal years 2022 and 2023. These expenses were primarily offset by a $115.4 million gross margin improvement in the Global Ingredients business as reflected in the gross margin percent increasing in fiscal 2023 to 24.2% as compared to 23.4% for fiscal year 2022. There was a $94.3 million increase in non-operating expenses in fiscal 2023 as compared to fiscal year 2022, which was primarily attributable to a $133.7 million increase in net interest expense for fiscal year 2023 to $259.2 million as compared to $125.6 million for fiscal 2022. The increase in interest expense was somewhat offset by foreign currency gains as well as physical damage insurance recoveries. The company recorded income tax expense of $59.6 million for fiscal year 2023. The effective tax rate was 8.3% and cash tax payments for 2023 were $152.7 million. Now for 2024, we are expecting a 15% effective tax rate and cash taxes to be similar to 2023 of approximately $155 million. The company's total debt outstanding at fiscal year-end 2023 was $4.4 billion as compared to $3.4 billion at fiscal year-end 2022. Our bank covenant leverage ratio at the end of fiscal 2023 was 3.26x. We currently have $832.5 million available on our revolving credit facility as of year-end. Capital expenditures totaled $174.9 million for the fourth quarter 2023 and $555.5 million for fiscal year 2023. The company repurchased approximately 926,000 shares of its common stock during fiscal year 2023 at a cost of approximately $52.9 million. The company enters fiscal year 2024 projecting $500 million in capital expenditures and is committed to applying our expected free cash flows to debt reduction. The company will continue to evaluate opportunistic share repurchases. With that, Randy, I'll turn it back to you.

Randy Stuewe, CEO

Well done. Thank you, Brad. 2023 is in the record books, and we believe we are well positioned to once again deliver strong earnings and cash flow in 2024. We have built a well-balanced global business model between our Specialty Ingredients businesses and Diamond Green Diesel. It's a bit early to guide on 2024 as the global fats and proteins markets are a bit off. This is a result of replenished global oilseed stocks, global consumer demand and phantom or delayed start-ups of renewable diesel plants. However, let me be clear, if these plants get built and become more reliable, and more renewable diesel comes on the market, we should see fat prices move higher. Clearly, the incentive is there to favor low CI waste fats versus refined soybean oil. And this is going to provide opportunity for our core Ingredients business and ultimately benefit Diamond Green Diesel. Prioritizing cost management, working capital improvements and conducting a robust review of our global asset portfolio continues to be our main focus. We are taking a deep dive into every factory's contribution and reviewing opportunities to improve performance. Now DGD is performing well. And despite concerns about RIN markets and LCFS values, our outlook for this business remains very positive as decreasing fat prices are expected to bolster DGD margins. We are excited about entering the sustainable aviation fuel market in the near future and anticipate margins that are well within the expectations we have communicated. We remain committed to working our way toward investment grade through slightly reduced capital expenditures this year, a focus on lowering working capital and anticipated dividends from Diamond Green Diesel. Starting with Q1 2024, we aim to accelerate our earnings schedule, and I anticipate we will release and host our Q1 call at the end of April. At this time, I will be able to provide you more details on guidance and outlook on how I see the year shaping up. With that, let's go ahead and open it up to Q&A.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Tom Palmer from Citi.

Tom Palmer, Analyst

I appreciate your comments about not issuing full year guidance at this point, just given some of the moving pieces, but maybe we could frame at least the first quarter, just given we're a couple of months in. Just any help maybe thinking about kind of the base business and then how margins look at DGD at least up to this point. Thank you.

Randy Stuewe, CEO

No, it's a fair question, Tom. This is Randy. It's been so easy to kind of forecast this business the last couple of years looking forward because we didn't have the fat price volatility that we've seen now. I mean between Q4 and Q1, we've seen fat price come off at least another 20%. They've hit bottom, here is what I would say in February. With your comment about two periods in the books, I've got one on the books in January, and we had a pretty nice January on both sides of the business. So we feel pretty good about where we're positioned. But at the end of the day, we've always communicated that a penny movement in fat was worth about $12 million of EBITDA in the Corn Ingredients business annually. And so clearly, we've moved lower. We moved lower from $0.54 in Q4 into around $0.40 in Q1 here, we're coming back. And so that's, to me, a little bit where my hesitancy is, is to try to do that. Now what I will tell you is the DGD has now worked through its pipeline of expensive fat and we're seeing margins improve there back to where we think they should be for the year. So I mean, at the end of the day, we came into the year seeing or let 2023 having a view that we would have a very similar year and possibly improve with all the integrations of the acquisitions in 2024 and then fat prices move down sharply. Protein prices have contracted a little bit, but at the end of the day, that's related to kind of a slowdown in global consumer demand, some destocking, that should come back. We're starting to see that happen around the world. So ultimately, like I said, I think I'll come back to you in April after I put a couple more months in the books here, and we see that truly the DGD can widen its margins out at the lower fat prices. And clearly, that's how we see the business model tracking. What I told to Matt and Bob and Brad is, our year is focused on execution and simply generating enough cash and managing capital outlays to pay debt down below $4 billion this year and be investment grade. We don't have any bonds or notes coming due here until first quarter 2026. So we're not at any issue where we need to be doing something rapidly, and we have very, very favorably priced debt. We want to create value for the shareholder to get any concern that as the commodity markets in the world cycle here that this company is a very different company when we did the Vion acquisition back in 2014, 2015, very, very different set of dynamics now. I think as I'll continue my rant here for a minute, clearly, the sustainable aviation piece is going to play a key role in widening those margins back at DGD. Clearly, Matt can comment on it later in the call here, we're seeing some really nice demand. And it's always the first movers and everybody doesn't want to be the first mover here, but we're close. The margins are much better than they are in standard, what I call road diesel or renewable diesel, and we're excited. And we'll do our best to get that plant online here sometime later this year and hopefully be up to full rate in '25 there. And then once again, we've changed our business model with the first mover advantage to where we were several years ago. So at that time, I hope I answered everything that you needed to hear.

Tom Palmer, Analyst

Thanks for that detailed reply. Maybe I'll follow up quickly, you mentioned the expected distributions from DGD. Maybe we could just kind of check through some of the items that clear up to free that, right? You've got the debt at DGD. And then I don't know if you guys have commented, but any color on kind of CapEx expectations with DGD? Would it be just something compounded your 2023? Just trying to kind of frame what type of distributions we might see as the earnings do come through.

Randy Stuewe, CEO

Yes. I think you didn't come through totally clear in the room here, but I think you're asking about distributions out of DGD CapEx finish up. We got some debt to pay down that's there related. Do you want to comment Brad?

Brad Phillips, CFO

Okay. Tom, this is Brad. Yes. So you see the debt there at $250 million at year-end. So that does have to be repaid. So we had the holidays, we had a turnaround in January. So typically, with the holidays, with the BTC being at $1 a gallon. Those are significant receipts that come in, but with the holidays, there's a little bit of a delay there usually in December on the BTC. So it backs up some. Our outlook, I would say, which is what I think you're getting at had a difficult time hearing there is a little bit of a deferred timeline on dividends out of DGD, but we're getting closer.

Operator, Operator

The next question comes from Derrick Whitfield from Stifel.

Derrick Whitfield, Analyst

Thanks for your commentary this morning. With my first question, I wanted to focus on the Feed business, where you delivered a remarkable quarter from a margin perspective. First, could you talk to some of the drivers from your prepared comments? And second, maybe speak to your thoughts on the spread between waste fats, oils and greases and SBO and how that will trade throughout 2024 given that we're on the precipice of impactful legislation in 2025?

Randy Stuewe, CEO

Yes, good questions. Clearly, the Feed segment, remember, in the procurement of raw material, when you get into a declining price environment, that's when your margins widen out. You have forward sales on and now you're buying raw material based on the current index markets at a lower price. That widened it out. As Brad also commented, we did recover some expenses from the Valley Proteins acquisition that were part of the stock purchase agreement and that's about all we can comment there on and that widened it out. But nonetheless, it was the volumes up, prices were down against the processing formulas and then a little bit of money came in related to Valley. So that's that. The waste fat RBD soybean oil comments. I mean the first thing, and I'm going to split this with Matt and Bob here. The first thing that I think everyone needs to understand was if the industry was truly operating at the rates that everybody anticipates out there and puts in their spreadsheets, fat prices would not be where they're at today, whether it's soybean oil or waste fats. Second, if the pretreatment capacity was as robust and nirvana in the world, waste fats would not be a discount to soybean oil today, crude soybean oil. So it's really a fascinating environment. All we can tell you is Diamond Green sold 1.25 billion gallons. We had some volatility in margins and an LCM adjustment here in Q4, but the margins are clearly being driven by the spread between soybean oil and waste fats. What do you guys want to add?

Matt Jansen, COO

Yes, this is Matt. I would just note that if you reflect on the situation from about six months ago, we observed that waste fats were priced higher than the soybean markets, but in the past three months, they have been priced lower. Currently, that gap is closing, and we anticipate it will continue to do so. There has been some movement in the pricing of waste fats, which I believe is a reflection of the capacity that has yet to come online.

Randy Stuewe, CEO

Yes. And I would just add, I think this is reflective of the challenge and trying to predict and estimate what's going to happen. I think the thing that I would watch for is, what does the biodiesel industry do? We're seeing biodiesel margins now underwater for the first time in quite some time. So if they don't run and operate, we're going to see weakness in waste fats relative to other waste fats. There's a lot to talk about new renewables diesel capacity coming online and operating and its ability to utilize waste fats, UCO and animal fats, how real is that and how able is it to use those oils. And so those are the things to watch that are going to ultimately determine what those spreads do.

Derrick Whitfield, Analyst

Great. For my follow-up, I wanted to ask about the active peptide you mentioned in your comments that would help with glucose moderation. I’m curious if this is meant to be an alternative to pharmacological agents, and if so, could you provide some insight into the potential market size for this opportunity?

Randy Stuewe, CEO

Well, we're all smiling around here because we don't want to get sued in the morning by big pharmaceuticals. So we're going to be careful how we answer this.

Bob Day, CSO

So this is Bob. I want to clarify that this product will be a nutraceutical, not a pharmaceutical. It targets a slightly different demographic and is likely to provide similar benefits for consumers. However, it is a consumable product with a different profile regarding health and safety. That's probably the best way to explain it.

Randy Stuewe, CEO

Yes, I think that's about all we can say at this time. I will tell you that we will be launching the product, I believe, in Geneva here in May. So we've got a lot of interest in the product worldwide. You think of the applications that it can go into. Remember, a peptide is water soluble, so it can go in solution. It can go into health bars, whatever you want to think. So there's lots of neat applications here that just once again diversify our product mix and ultimately is the underlying rationale for the Gelnex acquisition that we were working on or did.

Operator, Operator

The next question comes from Andrew Strelzik from BMO.

Andrew Strelzik, Analyst

My first question is on some of the kind of internal profit drivers that you guys have that are not related to market dynamics. Is there any way to quantify what that might look like, the efficiencies? Obviously, Miropasz which you closed on and then word coming back up in 2Q, how much could that contribute incrementally in 2024, and then does that also build into '25?

Matt Jansen, COO

This is Matt. Regarding Miropasz, that plant will launch next month, and we anticipate reaching a full run rate from Q2 onward. This will position us effectively in the Eastern region, as we've previously discussed. Darling has made a significant commitment to enhancing the reliability and performance of our operating plants, which sets us apart from many competitors. For example, we benefit from what we refer to as breakdown tonnage. The rendering market is generally balanced between capacity and volume availability, but when there is a breakdown, the entire system can be disrupted quickly. We've invested in improving the performance and reliability of our plants, allowing us to take advantage of such situations when they arise. We receive additional volume that hadn't been planned for, and it often comes at favorable prices, giving us a competitive edge. This is possible because we are willing and able to invest the necessary capital to maintain our plants in optimal condition to avoid breakdowns. This situation exemplifies one of our advantages, and while quantifying it is challenging for this call, we view it as a significant competitive benefit.

Randy Stuewe, CEO

Yes. I mean, Andrew, we look at it and Matt said it very, very well there. I mean, in the month of January, we landfilled 32 million pounds out of the Ward, South Carolina region. That's where not proud of. At the end of the day, it's a huge lost opportunity. So we're excited about getting ward on the MCC shipped at the end of January. We're expecting, hopefully, end of March, 1st of April, start up there. And then that puts a lot of ability to move tonnage to the right locations that we've been unable to do now for over a year. So that's exciting. Miropasz closed here on the 1st of February that's three poultry plants investment case was exceeded at closed here, meaning it's doing better than we thought when we did the original deal, we kind of redid the diligence on that. Gelnex, we have for a full year. We got Peabody down, the old bone gelatin plant, that's out of the system, the noise of that. So there's a lot of good things that we see happen for the year out there. We're carrying large inventories. And if you can read the balance sheet, you can see the working capital out there, you could see that the consumer demand slowed down around the world, and that's built inventories in several of our businesses. And so that's where we come back to, it's mainly the operational efficiency is a very important piece. And as Matt says, focused on it. But at the end of the day, the big cash driver for us next year is really getting the inventories down and managing working capital. And that's why we're so confident in the debt repayment side here.

Andrew Strelzik, Analyst

Okay. Got it. That's helpful. And I appreciate those comments. And then just my follow-up is on DGD profitability kind of at a high level. And I know I've asked before, but I just want to revisit it. Historically, you've talked about kind of a dollar baseline margin over time. And I'm just curious with everything that's going on in those markets, do you still feel like and I know next year as we transition to SAF, that's going to evolve. But I guess from a baseline perspective, do you still feel like that's the appropriate way to think about the business? I don't know if that's feasible for '24 or not in your view, but just any comments around how you think about the underlying margin structure for DGD pre-SAF? Thanks.

Bob Day, CSO

Yes. This is Bob. I think because of some of the things I mentioned earlier, what's going to happen with biodiesel capacity, what's going to happen with nameplate renewable diesel, new capacity as that comes online, it makes it difficult to answer that question. I think what we can say is that Diamond Green has a sustainable advantage over its competitors in the market. And we could talk about what that looks like relative to renewable diesel relative to biodiesel, it's significant. And so it's going to maintain that advantage as we cycle through this margin environment. I think what's a little bit different about the renewable diesel environment than what we might see in a more mature commodity environment is that it's still an evolving industry. There's still new demand coming on and new opportunities. So SAF demand comes on, that will cannibalize renewable diesel capacity in production and provide more support. We're also seeing more evolution in the government programs, whether it's RFS or just the general impact that exports and RIN cancellations will have on RIN SMBs. So I think there's a lot of things that would allow this to reverse course faster than what normally see in a mature commodity market, but really difficult to predict exactly what that margin per gallon is going to look like over the course of the entire year.

Operator, Operator

The next question comes from Adam Samuelson from Goldman Sachs.

Adam Samuelson, Analyst

So I guess my first question, Randy, and I appreciate the comments around there's a lot of volatility and the hesitancy on providing an outlook. I'm just trying to make sure we think about that in the context of you did provide some outlook framing 3 months ago or 3.5 months ago in earnings in November. And so is it just the caution comes from the decline in fat prices that you've seen over the last several months that gives you pause or the lack of response, full response to RG margins. Just you did provide some other commentary with the third quarter earnings and you're refraining to do that today. And I'm just trying to make sure we understand kind of actually what's changed.

Randy Stuewe, CEO

It's a valid question, Adam. Looking back to our November call, we had strong momentum with fat prices at around $0.55 to $0.60 per pound. When we provide guidance in this industry, we assess the situation by asking if those prices hold, along with our tonnage and margins, to see the potential outcome. It's quite straightforward; it takes only a few minutes. The situation has changed from then to now, as fat prices have dropped by $0.20 per pound. I've mentioned earlier that we reached a $12 million milestone, so you could estimate fat prices about $250 lower than that point. Doing the math, our current run rate is between $1.450 and $1.550. The reason for our hesitation in projecting that far into the future is my belief that fat prices will not remain at this level, though I'm uncertain when they will adjust. My comments were focused on the demand for fats, such as soybean oil. A year ago, we were anticipating production from various sources, with expectations of 250 million to 275 million gallons or 2.5 billion pounds being produced from DGD, REG, Chevron Oil, etc. We need to consider new projects in the pipeline, like the Phantom plant, which could produce between 4 billion to 6 billion pounds of fat. There are still two lines inactive at Martinez, and Vertex has been struggling with consistency. As for the situation in Montana, they also seem to be facing challenges and resorting to buying refined soybean oil. There are many variables at play that make it difficult to pin down a clear picture right now. I've learned that in this industry, the only aspect you can control is the balance sheet. Therefore, I believe Brad and I can pay down $400 million of debt this year, reaching an investment-grade status and being prepared for future growth. Regarding SAF margins, as Bob mentioned, we have considerable interest from potential partners and are currently involved in complex margin discussions. Selling SPK while blending it with JEDA is different from our usual processes. I'm optimistic that by the end of the first quarter, we will finalize some agreements, although I can't guarantee how much information we will be able to disclose by then. The margins are currently $1 to $2 higher than renewable diesel, representing another $250 million to $500 million in additional cash flow. Brad has indicated that we'll be reducing our debt to zero shortly. There are many factors to consider, such as the BTC, where the government paused payments for a month during their holiday, leaving us with a significant receivable. Overall, I think we're in a good position and expect a year of increasing earnings starting in Q1. As a reminder, we should not overlook the challenges we faced in January, including several days lost due to snow and gas curtailments that affected our operations. There’s a lot of external noise, but I believe once the business picks up momentum, it will start to thrive again. Bob, do you have anything to add?

Bob Day, CSO

Yes. I think you really hit on it, Randy. When you go back to November of last year, and you looked at the market factors, a lot of what we saw was within our control. As we sit here today, we can't control what the biodiesel industry is going to do with its capacity. We can't control the renewable diesels ability, industry's ability to run and operate in. So it just makes it a lot more difficult to predict right now what's going to happen. But what I would add is that Diamond Green Diesel produced over 1.2 billion gallons last year, that was more than anyone did anywhere in the world and with the capacity utilization rate that is second to none anywhere. And so as this cycle changes, they've proven they have the operational capacity to capitalize on margin improvement in the industry. I think we're optimistic. It's just very difficult to predict exactly what margins are going to look like given all these variables that are out of our control.

Brad Phillips, CFO

One of the things Randy mentioned with DGD and the dividends, as we think about the people on the call here. And I know you know this, Adam, and most of the sell-side analysts, if not all know this, we have a formal policy there for distributions, and that is measured monthly. It is not subjective, so that makes it like clockwork as we look at that and it's obviously a large receivable there from the BTC, not large CapEx to speak of. We're through that one turnaround SAF being paid for. So that's why my comment earlier is we are getting much closer to starting that dividend train, if you will. But I just kind of want to make the point that it is not a subjective calculation, and there's potential there each month as we look at that at the end of each month.

Operator, Operator

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

Randy Stuewe, CEO

Thanks everybody for all the questions today. As always, if you have additional questions, please reach out to Suann. Stay safe. Have a great day. We're off to Scotiabank's Conference, be presenting tomorrow there.

Operator, Operator

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