2023-12-14 12:53:50 ET
Summary
- Darling Ingredients Inc. is a global leader in sustainable ingredient production, with a focus on agriculture, food, pharmaceuticals, and bioenergy markets.
- The company experienced challenges in the third quarter of 2023, particularly in the Diamond Green Diesel segment, but anticipates a Q4 recovery.
- Darling Ingredients reported a decrease in net sales and EPS, but achieved an increase in gross margin through effective cost management.
Introduction
In today's article, I focus on Darling Ingredients Inc. ( DAR ), a remarkable player in the ingredient production industry. This company has carved a niche for itself through strategic mergers and acquisitions, transforming from a modest operation into a global leader in sustainable ingredients, with a presence in key markets like agriculture, food, pharmaceuticals, and bioenergy.
What sets Darling Ingredients apart and piques investor interest is its impressive trajectory of double-digit revenue growth, matched with a compelling forward P/E ratio of just 10. This rare blend of aggressive growth in a sector known for its stability, alongside a tempting valuation, marks it as an intriguing investment prospect.
However, the journey hasn't been without its challenges, as evidenced in the third quarter of 2023, especially within the Diamond Green Diesel segment, which affected both revenue and earnings. Despite these hurdles, management maintains a positive outlook, anticipating a Q4 recovery driven by increased production.
Today's article will provide an in-depth look at Darling's financial performance, future outlook, and inherent risks while also placing it in the context of its industry peers, offering a comprehensive view for potential investors such as yourself!
Company Overview and Industry Context
Darling Ingredients operates in the ingredient production industry, specializing in transforming nutrients from animal by-products and other organic materials into various value-added products. This sector serves diverse markets, including agriculture, food, pharmaceuticals, and bioenergy.
Darling's focus on processing and recycling these materials positions it uniquely in the market, catering to an increasing demand for specialized and high-quality ingredients derived from organic sources.
Darling Ingredients has strategically grown through mergers and acquisitions, expanding from a small rendering company to a global leader in sustainable organic ingredients. Key acquisitions like The Van Iderstine Company in 1909, The Standard Tallow Corporation, and TORVAC, Inc. in the 1990s, and more recent significant purchases like Griffin Industries, Valley Proteins, and the FASA Group have been instrumental.
These moves not only increased Darling's geographical reach and operational scale but also diversified its product portfolio, reinforcing its position in the global market.
This consistent M&A strategy has been central to Darling's evolution and success in various sectors, including bioenergy and nutraceuticals.
Third Quarter Update
Revenue
Darling reported net sales of $1.625 billion in Q3 2023, which marked a 7.0% decrease from last year. The revenue shortfall was primarily due to Fuel / Diamond Green Diesel segment setbacks, as revenues dropped 26% from $143M to $106M. The management team recognized these operational challenges in the earnings call yet remained hopeful for a more robust Q4. They foresee a revival in DGD's performance, driven by a ramp-up in production and potential advantages from hedge gains.
Earnings Per Share
The company's EPS was reported at $0.77, a significant drop from $1.17 in the corresponding quarter of the previous year. This 34.2% reduction reflects the impact of various market and operational challenges during the quarter, including issues in the aforementioned DGD segment.
Gross Margin
Interestingly, despite the decrease in net sales and EPS, Darling Ingredients achieved a 2.7% increase in gross margin, reaching $386.5 million. This improvement suggests effective cost management and operational efficiencies in the face of revenue challenges.
Balance Sheet and Leverage
Likely due to its acquisitions, the balance sheet revealed an increase in total debt, rising to $4.4 billion from $3.4 billion at the end of the previous year. An increase in debt levels by one billion dollars in less than a year is a big deal for a company of this size. As a result of its debt levels rising, its leverage ratio increased from 2.54X all the way up to 3.25X.
Looking Ahead
For 2024, Darling projected adjusted EBITDA expected to be in the range of $1.7 billion to $1.8 billion. This forecast suggests confidence in the company's strategy and operational capabilities in the 4th quarter.
Q&A Insights
In the Q&A section of their recent earnings call, Darling Ingredients' management shed light on the Diamond Green Diesel (DGD) segment's challenges and future prospects. Despite a rough patch affecting production and financials this quarter, they are upbeat about a turnaround in Q4 2023, buoyed by the expectation of increased production and favorable hedge outcomes.
The conversation also touched on the promising effects of the California Air Resources Board's new renewable diesel regulations, aligning neatly with Darling's strategic initiatives in renewable diesel and sustainable aviation fuel. This savvy move showcases their adeptness in navigating regulatory shifts.
Beyond this, the company's financial strategy was further articulated by management, as they indicated they are focusing on reducing debt to strengthen its leverage position, which could open the door to share buybacks in the future.
Q3 Summary
All told this quarter was a challenging one for the company as it faced declining revenue and EPS. Furthermore, the debt and leverage ratio increase will be critical areas for investors to pay close attention to, especially in light of the higher interest rate environment we now find ourselves in. Management has indicated that debt reduction will be a focus for them, but the results are yet to be seen.
Risks
One of the most significant risks currently facing Darling Ingredients is the impact of rising interest rates. This economic shift directly impacts the company through increased interest payment expenses. As rates climb, the cost of servicing existing debt becomes more burdensome, effectively tightening the company's financial flexibility.
This increase in financial obligations is particularly pertinent given the company's recent strategic acquisitions, which have driven growth. Consequently, the heightened interest expenses could constrain Darling Ingredients' ability to pursue acquisitions in the near term.
This limitation on expansion opportunities through M&A, a key growth strategy for the company, could pose challenges to its strategic development and market expansion plans in the foreseeable future.
Darling Ingredients vs Peers
Stock Ticker | Market Cap | P/E GAAP ((FWD)) | EV/Sales ((FWD)) | Revenue Growth ((FWD)) | Revenue 3 Year ((CAGR)) |
---|---|---|---|---|---|
DAR | 7.55B | 10.69 | 1.77 | 14.18% | 26.72% |
Ingredion ( INGR ) | 6.96B | 11.42 | 1.09 | 7.13% | 11.45% |
Fresh Del Monte Produce ( FDP ) | 1.16B | 9.56 | 0.38 | 2.30% | 0.99% |
Limoneira ( LMNR ) | 330.81M | 37.07 | 2.21 | 5.66% | 1.32% |
Source: Seeking Alpha
Compared to peers and in terms of absolute value, Darling appears to be a decent value, at least according to its price-to-forward earnings ratio of 10.7X, which is lower than its closest US-listed peer, Ingredion, which is at 11.4X. Furthermore, looking at historical and forward revenue growth, Darling is at the front of the pack with a three-year CAGR of ~27% and analyst expectations for growth of 14%.
Double-digit growth in the consumer staples sector is a rarity in the post-covid world. Most large-cap consumer staples companies generate revenue growth in the low single digits, making Darling a serious outlier. But then again, most consumer staples companies are not nearly/at all exposed to the energy sector in the way that Darling is; this exposure drives much of the volatility in their growth rates.
At 10.7X future earnings, a dollar invested today effectively generates an earnings yield of 9.3%. That appears to be a steep value in today's stretched market.
Conclusion
In conclusion, while Darling Ingredients Inc. demonstrates notable strengths in the ingredient production sector, I currently rate the stock as a Hold. Although its valuation appears sound and revenue growth prospects are optimistic, my neutral stance stems from concerns about the company's long-term growth potential in the face of rising interest rates.
These economic conditions, impacting debt and leverage, could pose significant challenges to the company's future expansion and growth strategy. Therefore, while Darling Ingredients presents certain attractive elements, caution is advised due to the potential impact of the broader economic environment on its long-term prospects.
For further details see:
Darling Ingredients: A Deep Dive Into Q3 Performance And Q4 Expectations