2023-10-03 06:37:53 ET
Summary
- Diamond Green Diesel is a key growth driver for Darling Ingredients, contributing over 50% of EBITDA in Q2 2023.
- DAR exceeded production expectations in Q2 2023 and is projected to produce 58% more biodiesel in 2023.
- Revenue from animal fats declined, but revenue from protein feed and collagen in the food ingredient segment saw significant growth.
Investment thesis
We see Diamond Green Diesel, a joint venture with Valero Energy, as a key growth driver for Darling Ingredients. Importantly, over 50% of Darling Ingredients ( DAR ) EBITDA in the second quarter of 2023 was contributed by the Fuel Ingredients segment.
Diamond Green Diesel production in Q2 2023 was 350 million gallons of biodiesel versus our estimate of 263 million gallons. DGD posted record results in Q2 2023 due to exceeding design capacity at its Port Arthur plant and lower soybean oil prices. We expect the company to produce 1,236 million gallons in 2023, up 58% from 2022.
Segment of Feed Ingredients
In the segment of feed ingredients, revenue from the sale of animal fats continued to decline, falling from $490.3 mln (+33% y/y) in 1Q to $405.3 (-19% y/y) in 2Q 2023, as prices for tallow and yellow grease dropped to $56.6 per 100 pounds (-29% y/y) and $46.1 per 100 pounds (-23% y/y), respectively.
Because yellow grease is used, among other things, as a nutrient-rich additive for pet food, its price is to a certain degree subject to influence from prices of other feed ingredients. For example, prices of corn, soybeans, proteins and fats can affect the price of yellow grease. However, the largest consumer of yellow grease is the biodiesel/renewable diesel-fuel industry. Since 2021, yellow grease has ranked as the second most prevalent feedstock to make biodiesel in the US. In 2022, its proportion was 20%, behind soybean oil, for which yellow grease is a substitute. USDA forecasts average prices of soybean oil to drop in 2023 and 2024, so we do not expect yellow grease prices to rise.
Lower revenue in the animal fats segment was offset by continued increases in meat-and-bone meal prices over the past seven quarters. It was reflected in steadily expanding revenue from protein feed sales, which brought the company $436 mln (+24 y/y) in 2Q 2023.
Meat-and-bone meal is made by rendering by-products from slaughterhouse operations, such as the inedible parts of slaughtered livestock, including carcass trimmings, condemned carcasses, condemned liver, inedible by-products (lungs) and bones. Cattle slaughter pace is expected to slow in 2023, as feedlots have fewer cattle available, which will cause prices for meat-and-bone meal to continue to hold high.
Segment of Food Ingredients
In the food ingredient segment, on average 80% of growth comes on the back of rising revenue from collagen, which brought the company $412.3 mln in 2Q 2023, posting a growth of 47% y/y and 29% q/q. On March 31, 2023, Darling Ingredients completed the acquisition of the Brazilian gelatin and collagen producer Gelnex. As part of the deal, DAR bought five plants in South America and one in the US, which have the capacity to produce 46 thousand metric tons of gelatin and collagen per year. Gelnex exclusively sources from grass-fed and pasture-raised cattle, producing Peptinex collagen peptides from bovine and porcine feedstock.
Initially we based our assumptions on publicly available collagen prices, but now we have changed our approach to revenue forecasting to reflect synergies between DAR and Gelnex. DAR estimates that Gelnex's EBITDA will reach about $75 mln in 2023, which corresponds to an additional production by DAR of 46 thousand metric tons of gelatin and collagen per year. Given the revised revenue model, we are lowering the forecast for the segment's revenue from $2567 mln (+76% y/y) to $1920 mln (+32% y/y) for 2023, and from $2981 mln (+16% y/y) to $2132 mln (+11% y/y) for 2024.
We are also cutting the forecast for the segment's EBITDA from $449 mln (+75% y/y) to $330 mln (+29% y/y) for 2023, and from $531 mln (+18% y/y) to $371 mln (+12% y/y) for 2024.
Segment of Fuel Ingredients
Diamond Green Diesel posted a record quarter, generating a revenue of $2246 mln (up 54% y/y and 34% q/q), compared with our forecast of $1860 mln (+28% y/y). In 2Q 2023, the company produced 349.5 mln gallons of renewable diesel fuel, up from our forecast of 262.5 mln gallons. This rapid growth was driven by production in excess of nameplate capacity at the 470 mln gallons/year renewable diesel plant that was put into operation at the end of 2022. DGD is in the middle of a phase of ramping up its output: Production was 372 mln gallons in 2021 (+28%), 780 mln gallons in 2022 (+110%), and we expect the company to produce 1236 mln gallons in 2023 (+58%). For 2024, we project production based on the assumption of 100% capacity utilization and production of 1.2 bln gallons per year.
Because we forecast diesel prices based on Brent oil quarterly price movements, the lower-than-expected actual diesel price in 2Q 2023 created the effect of a low base for all subsequent periods. The negative impact was partially offset by the higher quarterly oil price, but it ultimately resulted in a downward revision of the forecast for diesel prices from an average of $4.26 to $4.17 per gallon for 2023 and from $4.48 to $4.45 per gallon for 2024.
Initially, in order to estimate DGD's production costs, we used the number of gallons produced and the average production costs per gallon of renewable diesel. We have now revised our cost model. It is known that it takes an average of 8.125 pounds of feedstock to produce one gallon of renewable diesel fuel, and the most common feedstock is soybean oil. Based on how much soybean oil it takes to produce the expected amount of renewable diesel and the forecast for the soybean oil price, we have built a new model for DGD production costs, also adding some other cash costs incurred in the process. We have also revised the model for how the selling price is formed for a gallon of renewable diesel, which, when in combination with the changes in the production costs model, resulted in the increase of expectations for the joint venture's average margins from 18% to 20% for 2023, and their reduction from 24% to 22% for 2024.
Said changes in the valuation approach have led us to raise the forecast for DAR's income from Diamond Green Diesel from $545 mln (+46% y/y) to $661 mln (+77% y/y) for 2023 cut it from $902 mln (+66% y/y) to $761 mln (+15% y/y) for 2024.
As such, our expectations for DGD's EBITDA have also undergone a revision, from $708 mln (+60% y/y) to $812 mln (+83% y/y) for 2023 and from $1075 mln (+52% y/y) to $930 mln (+15% y/y) for 2024.
Financial results
We are lowering the forecast for the revenue of Darling Ingredients from $7866 mln (+20% y/y) to $7246 mln (+11% y/y) for 2023, and from $8628 mln (+10% y/y) to $7882 mln (+9% y/y) for 2024 due to reduced forecast for collagen production revenue.
Given the cut to the Darling Ingredients' revenue forecast, the decrease of the forecast for average margin from 24.3% to 23.7% for 2023 and from 24.7% to 24.2% for 2024, and reduced expectations for revenue from DGD in 2024, we are lowering the EBITDA forecast from $2010 mln (+30% y/y) to $1975 mln (+28% y/y) for 2023, and from $2530 mln (+26% y/y) to $2229 mln (+13% y/y) for 2024.
Valuation
The fair value price of the shares is $93. The status for the shares is BUY.
Conclusion
Thus, given the expected high growth rate of Fuel Ingredients segment coupled with the strong performance of the rest of the business, we see a bright outlook for DAR and expect strong upside, maintaining BUY status.
For further details see:
Darling Ingredients: Biodiesel Production As A Major Growth Driver