Darling Ingredients Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Darling Ingredients is a global company that develops and produces sustainable ingredients from edible and inedible bio-nutrients, spanning industries such as feed, food, and fuel.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Darling Ingredients (DAR) is a unique company that operates at the intersection of the food, feed, and fuel industries. It’s a global leader in repurposing animal protein and fats, and other by-products, into a variety of products. Here’s a breakdown:

  • Revenues Distribution:
    • Feed Ingredients: A significant portion of their revenue comes from transforming animal fats and proteins into ingredients for animal feed. This segment is sensitive to fluctuations in agriculture and livestock markets.
    • Food Ingredients: They produce specialized ingredients for the food industry, such as edible fats, oils, and gelatins. This segment is generally more stable than the feed ingredient segment, driven by underlying consumer demand.
    • Fuel Ingredients: Darling is a producer of renewable energy sources like biofuels and renewable diesel. The demand for fuel ingredients is heavily influenced by global energy markets and government policies.
    • Other: A small portion of revenue comes from sales of hides, leathers, and other items.
  • Industry Trends:
    • Sustainability: The global push for sustainability is a major tailwind for Darling. They are a major player in the circular economy, turning by-products into useful materials, reducing waste and pollution. The increased focus on environmental concerns is driving demand for their bio-based products.
    • Regulation: Government policies and regulations regarding renewable energy and waste management are major drivers for the industry and impact Darling’s operations significantly.
    • Food and Feed Demand: The growing global population and increasing consumption patterns in developing economies are boosting the demand for both food and animal feed.
    • Biofuel Mandates: Governments worldwide are increasingly looking to renewable fuels, pushing up demand for bio-based fuel alternatives.
    • Consolidation: Larger players like Darling are driving consolidation in the industry, as scale is increasingly important.
  • Margins:
    • Margins vary across segments based on the value-add of their products. Higher value-added products such as those used in pharmaceuticals or human food have higher margins, while commoditized feed and fuel products have lower margins.
    • The company is working to achieve EBITDA margins of greater than 20%.
    • Operating margins for the Fuel segment has steadily improved over the past few years and could improve even more in the coming years.
  • Competitive Landscape:
    • The industry includes smaller local operators as well as larger, global players.
    • Competition is largely based on price and quality.
    • Large companies with wide-moat strategies generally operate at higher volumes and therefore lower costs of production. This is the primary focus of competition.
    • Barriers to entry are pretty high due to regulation, access to specialized byproducts and feedstocks, and large capital needs.
    • Some competitors also focus on specialized and higher value niches within the industries.
  • What Makes the Company Different
    • Scale: Darling’s global scale and wide sourcing network give them a competitive edge in procurement.
    • Diversification: They operate across the food, feed, and fuel industries which adds stability to their revenues and dampens the effect of shocks in certain industries.
    • Proprietary technology: They continue to improve the way in which they process the raw materials, making production more efficient and yields better.
    • Long-standing relationships with suppliers: Their decades long ties with suppliers is key, especially in obtaining quality raw materials and feedstocks.

Financial Analysis

Darling’s financial performance is tied to a very diversified global industrial environment. Let’s examine it closely:

Income Statement Analysis

  • Revenue Growth: Darling has seen steady revenue growth in the last few years, but they have been inconsistent. For the full year 2022, revenues stood at 5.7 billion, an increase of about 30% from 2021 and a growth of ~7% in 2023. Much of these increases came from increased selling prices rather than an increase in volume, due to inflation and supply constraints.
  • Operating Income: Darling continues to improve its margins. They were able to grow their 2023 revenues with very similar gross profit as 2022. However, they cut costs on raw materials, selling, admin, and R&D by around $1 billion in 2023 which resulted in large operating profit gains.
  • Net Income: Net income has had a turbulent ride. In 2022, they posted a net income of $517 million, but they lost $378 million in 2023. A major driver of this volatility has been the significant decline in the price of biodiesel and fuel credits. This was offset by an increased demand for food and feed products, but there was still a considerable net loss.

Balance Sheet Analysis

  • Assets:
  • Property, plant, and equipment totaled around $4 billion in 2023. * Inventory and raw materials were valued at over $1.3 billion in 2023. * Goodwill and intangible assets were valued at more than $4.5 billion in 2023.
  • Liabilities:
    • Total liabilities of ~$11 billion in 2023, driven by higher short-term debt.
    • Darling has $6.5 billion in short term debt and obligations.
    • Also has more than $2 billion in other long-term liabilities.
  • Equity:
    • Equity sits at around $7 billion in 2023.
  • Debt levels: They have a fair amount of debt to maintain operations. However, there are some concerns with the level of debt they have been taking in the form of credit facilities.
    • The company’s leverage ratio has increased to roughly 3.5 times. A deleveraging plan was put in place to take advantage of high interest rates and free cash flow, but management has yet to act on the deleveraging plan. They intend to target a leverage ratio of about 3 times going forward.
    • They do note that they have sufficient liquidity and flexibility in their operations and current operations will still maintain profitability.

Cash Flow Analysis

  • Cash From Operations: Darling had $690 million of cash from operations in 2023, and $460 million in 2022. Much of the recent increase has been due to a drop in accounts receivable and inventory, and changes in certain other working capital.
  • Free Cash Flow: They had free cash flows of around $400 million in 2023, and had negative numbers for 2022. Free cash flows are highly variable based on the volatility of energy and agricultural markets.

Recent Concerns & Controversies

  • Declining Biofuel Prices: A major concern for DAR in 2023 was the decline in prices for renewable diesel and fuel credits. This resulted in significant write downs and negative returns for the firm in this segment. This shows their sensitivity to the energy markets. However, this decline also has a positive affect as well due to lower raw material costs.

  • Debt Levels and leverage: The company has increased its debt level quite a bit in the last few years. There have been concerns over the leverage ratio the company has been using and if they can deleverage if needed.

  • Commodity Market Volatility: Darling is exposed to fluctuations in commodity prices for both raw materials (such as animal byproducts) and finished products (like fuel and food additives), potentially impacting margins.
  • Operational improvements: Company management intends on making structural improvements in operational efficiencies. That is going to be critical to ensure consistent results.

Moat Assessment

Based on the above factors, Darling Ingredients has a narrow moat (3 / 5). Here’s why:

  • Intangible Assets (Positive): Darling benefits from regulatory approval at various levels of the value chain, which is somewhat of a moat, but due to some competitors having similar licenses and approvals it is a narrow one. Furthermore, its strong client relationships also offer some protection from competitors, but this is only narrow.
  • Switching Costs (Positive): Some of DAR’s segments, such as customized feed or specialized food ingredients, have switching costs due to the specialized nature of their ingredients and the need for consistent supply chains. Also companies that use DAR for byproducts or waste collection have less incentive to switch because the process becomes an important and integrated part of their value chain. However, this is not very difficult to replicate and doesn’t constitute a wide moat.
  • Scale (Positive): Darling’s huge size and scale give them a unique ability to procure a wide variety of raw materials, which is helpful for profitability. They are also one of the largest processors in the space, which provides a cost advantage. Also their large distribution network helps with the logistics of distributing products. It must be noted that for the most part their supply chain and processing isn’t difficult to replicate, and thus many new players are able to compete in the industry.
  • Network Effects (Negative): There are no significant network effects in this business model.
  • Cost Advantages (Neutral): Although some segments can generate cost advantages through unique feedstocks or processing technologies, there is less scope for sustained cost advantage.
  • Durability: While their business is sustainable, and has a high degree of demand, they operate in a competitive industry. The returns on their business are susceptible to fluctuations in the market that are not within their control. This leads me to believe that though sustainable, they aren’t as durable as some other moat type businesses.

Moat Risks and Business Resilience

  • Technological Disruption: The company is vulnerable to disruption from newer technologies that can better process byproducts more cheaply. The company could potentially have to adjust significantly to the emergence of alternative fuel sources that might disrupt the demand for biofuels.
  • Regulatory Changes: Changes in government policies, especially with respect to renewable fuel mandates, taxation, and waste disposal, could greatly impact its operations and profitability. The government could at any point decide to change policies that directly benefit their business.
  • Economic Slowdowns: The company is also sensitive to economic cycles, which greatly affect demand in multiple of their end markets and industries.
  • Commodity Price Swings: Their profitability is tied to the price of commodities such as beef, tallow, and used cooking oil. Fluctuations in these prices could affect margins.
  • Competition: While barriers to entry are reasonable, the low moat of the company makes them susceptible to competition. New and existing competitors could copy their processes or value-added propositions, and steal market share.
  • Operational risks : In spite of good leadership and management, a few operational risks remain, including managing a complex supply chain and production, managing the safety of employees and maintaining production in remote areas and diverse environments, and meeting requirements that come with being a global multinational company.

Despite the risks above, Darling has demonstrated the ability to generate profits and adapt to changing markets. The push for sustainability and global awareness of recycling should help support growth for years to come.

Understandability

The business model of Darling Ingredients is moderately complex, rated a 3 / 5 for understandability. Here’s why:

  • On one hand, the basic concept of collecting and transforming animal by-products into different materials is understandable. On the other, their value-chain is vast, spanning across many different segments and industries, and each requires deep expertise and knowledge. The way that their revenue generation process impacts each segments profitability isn’t straight forward.
  • There are numerous regulations that change depending on country and segment, and can create complexity.
  • Their financial statements can also get pretty complex due to numerous operating segments, goodwill and intangible asset amortization, and tax implications for foreign subsidiaries.

Balance Sheet Health

Darling Ingredients has a moderately healthy balance sheet, earning a rating of 4 / 5.

  • They are a very profitable company, but they do take on substantial amounts of debt to fuel their growth. They are at a point where the deleveraging process is very important.
  • They have substantial assets, especially property, plant, equipment and intangible assets, but they need to be managed well going forward to ensure their growth can translate into profits.
  • Given their strong cash generating potential, their debt is manageable for the time being. However, there are concerns over the size of debt the company has.
  • Their financial position is not at the level where they have no leverage, but it is not at the point where the company is at risk of bankruptcy.