VLO - Darling Ingredients: Needs To Find The Right Mix

2023-03-06 18:12:13 ET

Summary

• Darling Ingredients Inc. has seen very strong operational momentum since the pandemic.
• The company has achieved higher profitability as the business has transformed greatly.
• Dealmaking efforts felt a bit rushed in 2022, as the company has seen a rapid earnings slowdown as well.
• While Darling Ingredients leverage does not appear to be an issue, a bit more discipline with leverage could unleash potential here.

In October of last year, I wondered if management of Darling Ingredients Inc. ( DAR ) was being too active. The company was doing fine on an organic basis but was quite active in terms of dealmaking, as the company announced a third large deal within the time frame of just a year. This made me feel a bit at unease despite its solid performance and positioning.

Transformation - Recap

For many years, Darling was a somewhat boring and leverage-challenged processor of animal by-products. A transition made it more focused on food recycling, turning the business into a value-added ingredients and solution provider for food, to feed and fuel the world.

By-products from livestock providers, meat processors and food production companies created products and ingredients used by the pharmaceutical sector, healthcare, biofuels, and green energy producers.

A $3.3 billion business in 2019 reported revenues across multiple divisions, one of which was an equity stake in Diamond Green Diesel, a very successful joint venture which the company has with Valero Energy Corporation ( VLO ) . The company posted operating earnings of $486 million that year and net earnings of $313 million, equal to $1.86 per share, as modest debt resulted in a non-demanding multiple with shares at the time trading around the $28 mark.

Revenues rose 6% in 2020 to $3.6 billion as adjusted earnings fell eight cents to $1.78 per share, yet shares rallied to a high of $60 in anticipation of better results. This materialized in 2021, a year in which revenues rose to $4.7 billion, on which $1.23 billion in EBITDA was reported, with earnings rising in a spectacular fashion to $3.90 per share.

The company used the momentum to pursue dealmaking, announcing a $1.1 billion deal to acquire Valley Proteins late in 2021, adding rendering and cooking oil facilities to its business. The company furthermore acquired Brazilian rendering company FASA in a $560 million deal in May 2022. These deals increased net debt to $3.3 billion, yet 2022 started on a strong note from an operational point of view. Based on that performance, I saw EBITDA surpassing $1.5 billion, thereby keeping leverage in check, as earnings should come in around $5 per share. Given all this, I initiated in the sixties over the summer.

Shares rebounded to the $80 mark later in the summer as second quarter results were very strong. Revenues rose 38% to $1.46 billion, although earnings growth was held back by a lower earnings contribution from the Diamond Green Diesel joint venture, as earnings totaled $2.37 per share for the six-month period.

The company announced another deal in mid-October, now paying $1.2 billion to acquire Brazilian gelatin and collagen producer Gelnex. With pro forma net debt rising to $4.5 billion, leverage ratios would likely increase to about 2.6 times, as the deal felt a bit rushed to me. Moreover, a $1.2 billion deal was substantial with Darling´s enterprise valuation standing at $15 billion at the time. Seeing no reason to alter my position, I welcomed some more financial conservative practices.

Coming Down

Since the fall, shares of Darling have generally come under pressure, now trading at $64 per share. In November, the company announced another bolt-on deal, acquiring Polish rendering company Miropasz in an EUR 110 million deal, marking a truly bolt-on deal.

In November, third quarter sales rose 47% to $1.75 billion as earnings were reported at $1.17 per share, up twenty-nine cents on the year before, with net debt posted at $3.1 billion, but this was ahead of the two latest deals. Other than some news on offtake agreements, it has been rather quiet on the corporate front until the end of February, when Darling posted its annual results.

Fourth quarter revenues rose 35% to $1.77 billion, as that was about the good news. Even after adjusting for a $21 million impairment charge, margin pressure was observed, with net earnings being flat at $156 million as modest buybacks allowed for a two penny increase in earnings per share to $0.96 per share. The resulting $4.49 per share number for the year fell a bit short of my estimates.

Net debt was posted at $3.3 billion by the end of the year, with not all deals having closed as the $1.54 billion EBITDA number came in a touch light. While the company guided for EBITDA to rise to $1.80-$1.85 billion in 2023, there were some associated depreciation charges alongside the increase as well. The 163 million shares now value equity at $10.4 billion at $64 per share as the net debt load will likely increase a bit with the Gelnex deal still set to close.

Nonetheless, the increase in the Darling Ingredients Inc. EBITDA guidance makes leverage ratios come in around 2.5 times, albeit that earnings are likely only surpassing $5 per share in a modest fashion this year. The resulting 13 times multiple does, however, still look interesting enough, although some more conservative financial practices would be welcomed from Darling Ingredients Inc.

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