Exec Summary

Darling Ingredients [DAR - ~$6.5bn market cap; $11bn EV) is a well-run, durable business that is trading at a trough multiple on trough earnings.  Further, the company is completing a large capex project imminently (ahead of schedule) that will begin generating meaningful earnings.  The combo of fading capex, earnings from the project coming online, and their core business inflecting positively, should drive a sizeable increase in FCF, which will translate into de-leveraging below 3x and the company initiating sizable capital returns in the coming months.  Several insiders have been buying stock recently. 

I believe FCF could double over the coming 2 years (vs ~350 LTM or 5% of market cap) driving 50-100% upside with significant downside protection given the cash flow generation and prospect for capital returns.  DAR will likely generate 25-40% of its market cap in cash in the next 3 years. 

Business Summary

Darling ingredients is a multi-decade consolidator of the global rendering industry, now with ~15% market share, making them the largest player, rendering 1 in every 6 animals in the US.  They collect animal waste at 270 sites in 23 countries from 200k suppliers (such as grocery stores and butcheries) to produce fats and proteins.  Scale is a significant competitive advantage, allowing for high utilization and specialized, more local facilities that can extract more value from the same carcass, driving a virtuous cycle in acquiring supply.  The 3 largest players today are Darling, Tyson, and Baker Commodities. 

~1/3 of the output is for human consumption (food and medicine ingredients such as gelatins, collagens, and fertilizers) and ~2/3 of the output goes into livestock and pet feed.  The profits are much higher (nearly 10x) for human as for pet output. 

In 2013, DAR launched a JV with Valero (VLO) called Diamond Green Diesel, which converts waste fats (or vegetable oils) into "renewable" diesel, which is different from biodiesel (the predecessor) in that it can be dropped directly into a traditional engine.  While RD is good for the environment, it is not profitable without government subsidies which come in the form of RINs, the Blenders Tax Credit, and LCFS (California).  While your intuition would suggest that this is very much a Democratic pet project, it actually is most beneficial to farmers who are a powerful political group on both sides.  Recently, Democrats have been opposed to any liquid fuels in favor of electric/hydrogen, so this ecosystem is not as election-sensitive as you would think at first glance. 

Both RD and legacy food/feed are both around cyclical troughs

Darling originally got into the RD (renewable diesel) business as a hedge to the cyclicality of its waste fat business.  As RD consumes waste fat as an input, when waste fat prices are low, the RD business would make a lot of money, smoothing out the profits.  This proved to be true for many years, but eventually the RD business got so large that it drove waste fat prices and the businesses now move together rather than in inverse.  Since this change (from counter-cyclical to co-cyclical), the company is going through its first cyclical downturn, which I believe the market hasn't fully understood yet - both businesses are currently under-earning, not just one. 

From 2013 to 2019, DGD was consistently profitable , with best in class margins, making ~$1.25-2.50/gal on their 1.2bn gallons of capacity.  They generally outperformed peers (many who are not making ANY money right now in RD and shutting down) due to their scale, facility locations, flexibility around feedstocks, and 10 years of experience in the business. 

However, in 2021, the RD market exploded in supply (nearly 4x'ing - see EIA data in appendix).  In classic commodity boom-bust fashion, margins tanked (see VLO data in appendix).  Additionally, the demand for waste fats driven by the booming RD demand incentivized foreign imports (from China and Brazil) into the waste fat market (see data from Render magazine in appendix), pressuring that business as well.  The boom in supply was also exacerbated by the EPA setting a low renewable fuel credit mandate, increasing the over-supply of RIN's, driving prices down.  There are rumors that the EPA will revise this mandate after the election, before inauguration, regardless of the outcome. 

Today, both businesses sit around trough earnings power as margins have been pressured and now competitors are going offline in RD (as RIN and LCFS credits have fallen).  Further, in 2025, there are shifts in the way govt credits work in the RD market.  First, the mandate is likely to be improved (this has already started in CA).  Second, there is a large incentive to produce RD from cleaner (this is called "low-CI") feedstocks such as waste fats (this is what DAR makes) as opposed to vegetable oils (what many of the competitors run).  This will push facilities running vegetable oil further off the cost curve and out of the market, improving the margins for facilities running waste fats.  While this should help DGD (which of course runs waste fats), it will especially help "legacy" DAR which produces the waste fats, not just for DGD but for the whole market.  Overall, I expect RD margins to improve ~20-30c/gal but do not underwrite the >$1 normalization that many other RD management teams are praying for. 

I will discuss SAF ("Sustainable Aviation Fuel") a bit more later on, but a large amount of RD capacity is also converting to SAF.  This should tighten the RD and waste fat markets as well.  Some experts we have spoken to believe there is nowhere near enough waste fat to supply the amount of SAF capacity that is coming, leading to potential for extreme price levels in waste fats.  You don't really have to believe that to be bull-ish DAR from here though. 

We can see that waste fat prices seem to have bottomed.  The RD market as a whole is still messy (see VLO tracker in appendix), but it feels closer to a trough than a peak.  I would note that CLMT has been well discussed on VIC for many years and while I have no position there, one should seriously consider the assumptions used on RD margins by CLMT bulls (+~$1/gal relative to today's spot margins) and consider what DAR would look like under those assumptions.  Conversely, if RD margins stay where they are today or only improve by 20-30c/gal (what I am underwriting for), one should consider what CLMT/Montana are worth…..

For every ~1 move in waste fat prices, "legacy" DAR gets a $12mm EBITDA bump:

SAF Project inflecting from cash consumer to cash generator

Beginning in 2025, many European countries are mandating the usage of "Sustainable Aviation Fuel" (SAF).  This is similar to RD, except with a few more steps in the process (a fractionation unit and a heater), to create an alternate to Jet-A (aviation fuel) instead of diesel.  Just as DGD was one of the pioneers of the RD market, they are about to finish a project to convert ~250mm gallons per year of RD production into SAF.  They have begun selling fixed quantities to airlines at an ~$1-2/gallon premium relative to RD.  Accounting for DAR's 50% share of DGD, this should drive a $150mm+ FCF tailwind. 

Further, while the capex for the SAF program is occurring at DGD, dividends of cash flow back to DAR have been dramatically reduced, with only ~$77mm YTD vs $168mm in 2023.  In 2025, that should grow to $300mm+. 

While we don't underwrite to this, excitement over the SAF market could also drive a re-rating / multiple expansion in the stock.  During the peak of the RD boom, many of those assets traded at 10-12x EBITDA or higher given the ESG sheen and I suspect SAF is a "sexier" story (far larger market).  Our work indicates that just like the RD market, SAF will experience booms and busts in supply vs demand, but SAF seems much closer to RD in 2013 than RD in 2021 today.  The "announced" demand by airlines relative to stated capacity builds seems favorably skewed so far.  However, we do acknowledge it's possible that many airlines are over-stating their actual intent to use/pay up for SAF.  Once again, I would note that the political environment around SAF mandates in the US is complex/unlikely - the end market to focus on here is Europe. 

Cheap and Levered + FCF Inflection Drives Favorable Risk-Reward

DAR has historically been quite acquisitive.  They levered up to buy the largest remaining independent American renderer (Valley Proteins) as well as a Brazilian business (Gelnex) in 2022-2023 just before both of their markets took a simultaneous downturn.  While I believe both acquisitions will appear thoughtful when the markets recover, they have left the company levered >4x today. 

As the aforementioned FCF ramp plays out, the combined effects of 2025's $400mm+ of FCF and EBITDA recovering from ~$1.3bn this year to >$1.5bn next year should drive leverage <3x.  At that point, I believe the company will begin returning 5-10% of the market cap or more to shareholders annually through a combination of share repurchase and dividends.  I believe my forecast is fairly conservative in light of the $800mm-1bn of FCF management previously talked about back in 2023 before markets softened. 

Summing it all up, compared to ~$1.3bn of EBITDA and ~$350mm of run-rate FCF, the combination of improving waste fat prices, RD margins recovering by ~30c/gal, SAF coming online and capex fading, and ~1-yr of FCF driving de-leveraging could drive FCF to nearly triple. 

Keep in mind, at the end of the day, this is a fairly commodity business, so the precise nature and timing of these estimates should be taken with a grain of salt, but I think directionally, FCF should go up a lot….

A 6-8% FCF yield on $900mm of FCF implies a $70-90 stock.  This doesn't given any benefit for accretive share repurchases between now and then, which hopefully they do.

GLP-1 Bonus Kicker

I'm not under-writing this in any way, but some of you may take Vital Proteins, a collagen supplement invented by an ex NASA engineer, that was sold to Nestle a few years ago.  The "hydrolyzed collagen peptides" in these supplements (as well as some forms of Gatorade and Estee Lauder cosmetics) comes from rendered animal fat that Darling produces.   It's supposed to help with joint health, recovery, all sorts of Huberman-lab-ey things.  These products are ~3x-10x the margin of using it as gelatin (IE a gummy bear), so any mix shift towards these higher value uses can be a meaningful profit driver.  Their peptide business has grown from ~$90mm of profits in 2014 when they first bought it to ~$300mm today due to this mix shift.  

Interestingly, the company is launching Nextida GC (under the co Rousselot - https://www.rousselot.com/health/media/news/introducing-nextida-a-groundbreaking-innovation-shaping-the-future-of-collagen-peptides), a natural collagen peptide supplement that is supposed to mimic the effects of the popular GLP1 drugs.  As with Vital Proteins, DAR will just supply the ingredients, not spend money on marketing the product.  It's a long shot, but it's possible an OTC GLP1-type supplement could capture a lot of imaginations.  If the stock triples on this, I won't be mad at someone for writing it up as a short. 

Appendix - Resources on RD and SAF

VLO Industry RD Margin Tracker:  https://s23.q4cdn.com/587626645/files/doc_downloads/2024/08/key-commodity-prices-8-26-24.xlsx

VLO Basics of RD Deck: https://s23.q4cdn.com/587626645/files/doc_presentations/2023/Feb/15/basics-of-refining-and-renewable-diesel-2024.pdf

CLMT Analyst Day - good info on RD industry spreads/cost curve/drivers.  Note I disagree with their view that they are the low cost producer of RD (I believe it is DGD): https://calumet.investorroom.com/download/MRLAnalystDayFinal18April2024.pdf

Neste LCFS Credit Tracker: https://www.neste.com/investors/market-data/lcfs-fuel-standard-credit-price

Neste 2024 Analyst Day: https://www.neste.com/files/pdf/23KAHSfsgjeX9zHLnJPV6j-Neste_Investor_story_-_Rotterdam_site_visit_-_2024.pdf

Render Magazine - Esp Table 2, US Production, Consumption, and Export of Rendered Products: https://pubs.rendermagazine.com/archives/2024/2024-04.pdf

EPA Data on RD Production: https://www.eia.gov/totalenergy/data/browser/index.php?tbl=T10.04B#/?f=M&start=201101&end=202403&charted=20-16