Betting On Renewable Diesel: Valero or Darling?

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Valero Energy (VLO:  NYSE) recently disclosed ongoing discussions to expand its renewable diesel production to a second plant that would be built and managed by its Diamond Green Diesel joint venture with Darling Ingredients (DAR:  NYSE)
Diamond Green Diesel
The proposed plant that would be located in Port Arthur, Texas and turn out 400 million gallons of renewable diesel and 40 million gallons of naptha per year.  As a food by-products processor Darling has easy access to low-cost used cooking oils and animals fats that serves as the feed stock for Diamond Green’s renewable diesel production. 

Valero management has cited increasing global demand for low- to no-carbon fuel sources as a solid reason to expand production.  The interest in expansion also makes considerable sense in light of the success the two partners have achieved with Diamond Green’s first plant.  Located in Norco, Louisiana near one of Valero’s oil refineries, the plant is currently undergoing an expansion to 674 million gallons of renewable diesel per year from the original 275 million gallon capacity.  The expansion is expected to be completed by the end of 2021.   The Norco plant has managed to service its own debt and kick up dividends t the two partners over the last several years.  Those dividends have served to offset Valero’s costs and works as an effective hedge against adverse selling prices for recycled oils and fats.

In addition to cash flow from the joint venture, Valero gets to burnish its image as an environmentally friendly oil and gas producer.  Investors might find it difficult to wrap their heads around the concept of an oil and gas producer as a friend to the environment, given that nearly every weather report is now stitched together with an analysis of how this impending violent storm or that unusual weather pattern is directly attributable to the effects of a warming planet.  Yet this is what Valero wants us to believe.  

It is a seductive concept that a well established company like Valero, with excellent cash flow generation and a strong balance sheet, is an appropriate investment for investors who are also careful with how their capital is deployed.  That fact of the matter is that even with the planned addition of a second plant, the investment Valero has made in Diamond Green Diesel is but a drop in the bucket of the company’s overall capital spending.  Valero puts down much greater capital to pull more and more barrels of oil up from underground –  an action that simply accelerates the death knell that has begun to toll for Earth’s environment.

The view looks different from the Darling Ingredient’s front porch.  The company specializes in recycling by-products from food production and processing, turning scraps into protein, fat and gelatin products for animal feeds and sometimes even human food.  The company also diverts hides and used oils and fats from the waste heaps and into usable materials.  Darling’s nation-wide oils and fats collections have helped keep Diamond Green’s renewable diesel production humming along.  While the company does have a carbon footprint of some size due to energy use in its production facilities, it is not producing carbon-laced products.  Unlike its partner, Darling Ingredients can lay claim to a business model 100% devoted to sustainability.

Investors have to come up with 22 times forward earnings to get a share of Darling Ingredient’s.  The number seems high given the company’s product line of largely commodity-likes products.  A strong track record to delivering profits even during cycle downturns is at least one reason to pay-up for a stake in Darling.  In the twelve months ending June 2019, the company converted 12.8% of sales to operating cash flow.

Despite the appearance of being a cash generator, Darling leadership has yet to approve a regular dividend.  Instead, management has invested heavily in expanding operations as well in acquiring competitors and complementary businesses.  Not shy of using debt to pay for its projects, management has also been mindful of keeping leverage at a manageable level.  Long-term debt is currently at $1.8 billion, giving the company a debt-to-equity ratio is 74%.

By comparison Valero shares are a ‘cheap date,’ trading at just 10 times earnings expected in the next year.  What is more, the current stock price the shares offer a tempting dividend yield of 4.25%.  The significantly larger company has a strong balance sheet with plenty of girth to withstand any economic eventuality.  What investor can pass up a solid rock like VLO for a small pebble like DAR.

The answer is clear:  an investor who is thinking about the long-term and realizes that Valero’s business model is undermining the very market it looks to for revenue.  Hidden carefully in Valero’s profit and loss statement are increasing costs for maintenance of facilities due to the impact of rising seas and more erratic weather.  It is only a matter of time before even a large company like Valero can no longer hide the impact of a toxic business model.

Thus the dilemma is easily solved by choosing the company that, while more expensive, offers a sustainable business model.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

This article was first published on the Small Cap Strategist weblog on 9/10/19 as “Investor Dilemma: VLO or DAR”.

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