DINO - Darling Ingredients Out Of Flavor For Renewable Diesel

2023-04-16 10:59:39 ET

Summary

• Darling Ingredients’ joint venture with Valero, Diamond Green Diesel, is the leading North American renewable diesel producer.
• California, Canada, and Europe are the primary markets for renewable diesel.
• This $9.4 billion market cap company does not pay a dividend.

Investors should note that this article focuses only on whether Darling Ingredients Inc.'s ( DAR ) renewable diesel joint venture is a reason for buying the company’s stock. It is not.

However, ESG investors and investors in other sectors (food, agriculture) may find the stock of interest.

Darling Ingredients makes products in the areas of pharma, food, pet food, fertilizer, feed, specialties, restaurant & supermarket—and is categorized in the packaged foods industry. The focus here is on its renewable diesel (RD) joint venture with Valero ( VLO ) called Diamond Green Diesel (DGD), a roughly 30% contributor to Darling’s results. DGD is the largest RD producer in North America and the second largest in the world.

Valero supplies the refining and marketing expertise; Darling Ingredients supplies the non-petroleum feedstock.

California, Canada, and Europe are the primary markets for renewable diesel. RD is more expensive than regular diesel but earns offsetting tax credits. However, one of the primary credits, California LCFS (Low Carbon Fuel Standard) Carbon Credit Price has shrunk from $200/metric ton in 2020 to about $60/metric ton in early 2023.

Although this article focuses only on DAR’s renewable diesel joint venture, DAR divides its results into

*feed ingredients,

*food ingredients, and

*fuel (including DGD) ingredients.

Investors interested in refining, including RD, may want to consider companies whose primary business is refining such as the other half of the DGD joint venture - just-reviewed Valero. While OPEC’s cuts and thus higher feedstock crude oil prices may lead to lower margins for gasoline, diesel, and jet, RD margins rely on government tax credits. Moreover, Darling is primarily an agricultural company, a business somewhat far afield from oil and transportation.

I recommend energy investors not buy (sell) Darling Ingredients stock.

Macro

While the so-called Inflation Reduction Act (IRA) provides benefits for renewables, including renewable diesel, actual inflation has increased operating, labor, and other costs, including the cost of the meat byproducts used in making renewable diesel.

Darling Ingredients, through its Diamond Green Diesel venture with Valero, is now producing 78,300 barrels per day (BPD) of renewable diesel. The entire US diesel market is around 4 million BPD, so Diamond Green Diesel, large though it is in the RD sector, represents less than 2% of total diesel demand. This is less an indicator of future markets and more an indicator of the vast regulatory push for what truck drivers experience as a more expensive diesel formulation.

2022 Results

In 2022, Darling Ingredients generated net income of $737.8 million or $4.49/share. This compares to $650.9 million or $3.90/share for 2021.

Combined adjusted EBITDA for 2022 was $1.54 billion. Darling Ingredients’ share of the Diamond Green Diesel joint venture with Valero earned about $443 million in adjusted EBITDA, or 29% of the total.

Cash flows from operations were $814 million for 2022 compared to $704 million for 2021.

Other key highlights for the year include:

*starting up the third renewable diesel plant; Diamond Green Diesel is now North America’s largest RD producer at 1.2 billion gallons/year or 78,300 barrels per day

*grew global footprint with three strategic acquisitions that add to the company's vertical integration for RD

*repurchased $125 million of common stock.

As noted in my report with Valero, Darling Ingredients, through DGD, plans to be producing sustainable aviation fuel by 2025.

Renewable Diesel Process

Although both use the same feedstocks of corn oil, used cooking oil, soybean oil, etc., biodiesel and renewable diesel are not the same. They have different processes and different degrees of applicability: biodiesel can be blended into petroleum diesel at up to 10%; however, renewable diesel can substitute for 100% of petroleum diesel. The US Department of Energy further explains:

“Renewable diesel and biodiesel are not the same fuel. Renewable diesel is a hydrocarbon produced through various processes such as hydrotreating, gasification, pyrolysis, and other biochemical and thermochemical technologies. It meets ASTM D975 specification for petroleum diesel. Biodiesel is a mono-alkyl ester produced via transesterification. Biodiesel meets ASTM D6751 and is approved for blending with petroleum diesel.”

The Diamond Green Diesel website cites additional advantages : as a true hydrocarbon RD has an energy density equivalent to ultra-low sulfur diesel (ULSD) and requires no modifications to either engines or transport pipelines. (Pipeline transport of hydrocarbons is cheaper and safer than rail or truck transport.)

Darling Ingredients supplies Diamond Green Diesel with feedstocks of rendered animal fats, used cooking oil, and inedible corn oil. The feedstocks are pretreated to remove impurities. They then undergo standard oil refining processes of hydrotreating, isomerization, and fractionation.

DGD sells renewable diesel to markets that mandate low-carbon fuels: California, Canada, and Europe. California offers three different subsidies for RD: a) RIN credits, b) LCFS credits, and c) the Blenders Tax Credit.

Renewable Diesel Competitors

Because of special incentives for RD and a market limited to California, Canada, and Europe it is worth focusing on the RD sector.

Diamond Green Diesel’s share of US RD capacity (see graph above) with its total capacity of 1.2 billion gallons/year is 46%. The next-largest RD producer is HF Sinclair ( DINO ) at 334 million gallons/year from three different plants for a market share of 13%.

Overall, in 2022, RD capacity of 2.6 billion gallons/year outstripped biodiesel capacity of 2.3 billion gallons/year.

DAR has a competitive advantage as the largest and a securely-sourced feedstock provider operating a renewable diesel plant since 2013 with a highly-experienced refiner.

The map below shows the locations of all US RD plants. Louisiana has the largest volume at 1.1 billion gallons/year (which includes the large DGD plants); Texas is second at 470 million gallons/year.

The article from AgFax also summarizes the plants and capacities in a table, pointing out that many are complete oil refinery conversions. Indeed, the LCFS (Low Carbon Fuel Standard) does not allow co-processing of RD with petroleum products.

However , as a fuel that meets the Low Carbon Fuel Standard, renewable diesel also competes with other sources for these credits: ethanol, renewable natural gas, and electric vehicles.

Dependence on California Regulatory Changes

Because California forms the major part of the US RD market, any changes in its fuel regulations and requirements, LCFS values, and tax incentives have major repercussions for all renewable diesel suppliers, including Darling Ingredients' DGD joint venture with Valero.

RD is a relatively smaller part of Valero's operations than for Darling Ingredients--Valero's only business is fuels--so Valero has more flexibility. Obviously, California regulatory changes do affect Valero's two traditional California refineries.

Since it is located on the US Gulf Coast rather than in California, DGD also has more, and lower-cost, export options than California-based facilities.

Financial and Stock Highlights

DAR’s market capitalization at its April 14, 2023, stock price of $58.65/share is $9.4 billion. The current stock price is 67% of its 52-week high, where it ranged from $51.77/share-$87.59/share.

The company’s one-year target price is $92.62/share putting its current price at 63% of that level.

Trailing twelve months’ [TTM] earnings per share [EPS] is $4.47 for a current price/earnings ratio of 13.1, while the averages of analysts' estimated 2023 and 2024 EPS are $5.46 and $6.27, respectively, giving forward price/earnings ratio of 10.7 for 2023 and 9.4 for 2024.

TTM return on assets is 5.7% and return on equity is 20.6%.

At December 31, 2022, Darling Ingredients had $5.3 billion in liabilities, including $3.3 billion of long-term debt (net of current portion) and $9.2 billion in assets giving it a liability-to-asset ratio of 58%.

The company does not pay a dividend.

Mean analyst rating is 1.8, or “buy,” from eight analysts.

First quarter 2023 results will be reported the week of May 8-12, 2023.

Notes on Valuation

Book value per share is $23.81, less than half the current market price, indicating positive investor sentiment.

The ratio of enterprise value to EBITDA is 11.9, above the preferred range of 10 or less.

The ratio of net debt to EBITDA is 3.0, which is toward the less desirable high end of the range.

Positive and Negative Risks

Investors should consider not just diesel demand, but the supply-demand balance of RD capacity compared to the markets for RD, bearing in mind that most consumers don’t use higher-priced renewable diesel, or use it only when regulatorily required to do so, as in California.

Moreover, the profitability of the joint venture rides on continuation of the California subsidies, the subsidy marker cost of soybean oil, the cost of meat and other animal waste feedstocks (now much higher), production capacity, the many competitors for LCFS credits, and the price the market will pay for RD.

Recommendations for Darling Ingredients

As a company recycling food waste into fuel for a regulatorily-created and -supported market—especially in California--Darling Ingredients fills a key niche. With partner Valero, Darling Ingredients was a first-mover in RD, offers good governance, and its Diamond Green Diesel joint venture is a market leader.

However, more RD capacity is coming online in the US. Margins are being compressed as feedstock costs are up and the DGD joint venture faces lower prices for RD and lower values for LCFS credits due to proliferation of renewable sources such as ethanol, electric vehicles, and renewable natural gas. Moreover, the technical aspects of turning food waste into fuel add considerable cost friction.

The company does not pay dividends and has a relatively high net debt/EBITDA ratio. After acquisitions, its liability-to-asset ratio has risen to 58%. Inflation has boosted all costs.

As good a California niche as RD production may become, it is just that, a niche. Investing in Darling Ingredients really means investing (71%) in its feed and food ingredients businesses, not mainstream energy businesses.

On the basis of its renewable diesel joint venture (and that sector only, not food or feed) Darling Ingredients is not recommended to dividend, value, or momentum investors in the energy sector. ESG investors may find it of interest.

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