Darling Ingredients’ Bean Stalk

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by Debra Fiakas CFA

Once upon a time there was a boy named Jack,
Who lived with his widowed mother
On their small farm in the country.
Benjamin Tabart, The History of Jack and the Bean Stalk

Jack made a mistake or two on the road to fixing his family’s income problems, but in the end Jack’s bean deal prove lucrative.  We are wondering if Darling Ingredients’ (DAR:  NYSE) acquisition of VION Group in early 2014, will prove as beneficial to the food by-products processor.  The VION operation was a division of VION Holdings N.V. based in the Netherlands that just like Darling collects and re-purposes by-products of grain and animal food production in Europe.

The VION deal expanded Darling’s food by-products business with six new brands that at first appeared to simply add processing capacity and visibility in the European and Asian markets.  Indeed, like its new parent VION operates rendering plants that produce both edible and non-edible fats, cures hides, biofuel, and proteins, blood and other edible products used as food ingredients.  However, over the last year and a half, the addition of those six brands appears to have confused rather than enhanced valuation of DAR.

Darling’s long history as a recycler of food by-products was altered with the Company’s entrance into a renewable diesel joint venture with Valero Energy (VLO) in 2009.  This week the Company staged an investor-analyst forum in New York City to highlight its building position in the food ingredients market.  Darling is recasting itself as a producer of ‘sustainable food, feed and fuel solutions’ and has put VION in the middle of the table as the center piece.

VION produces two products that standout among others as more than Darling’s usual commodities. Gelatin is produced from chicken, beef and pork bones and is sold under the brand name Rousselot.  In the increasingly health conscious society gelatin food producers are finding more and more applications for gelatin.  Likewise gelatin is gaining use in the pharmaceutical industry for capsules, sponges, vaccines and fillers.  Made from bioactive proteins collagen is sold under the name Peptan, which is becoming increasingly visible in final products that advertise the use of organic and healthy ingredients.  These two products require closer collaboration by VION with end users and lift the veil of anonymity that typically hide commodity producers.

We believe Darling paid for VION’s high value-added product line, but its shareholder base has not fully appreciated the merits of the deal.  The purchase price of $2.2 billion, represented a multiple of 8.0 times EBITDA and 0.9 times sales at the VION division in the twelve months ending June 2013.   Darling shares have struggled since closing the VION deal, in part because profit margins have been under pressure and in part because of the added leverage required to complete the deal.  However, we also believe the highly visible brands of VION have been more a cause for concern than a reason to bid the stock price higher.

The senior executives of VION were in attendance at the Darling analyst forum, providing details on the product line and explaining VION’s position in end markets.  The event was designed to make clear Darling’s expanded share of its markets.  Although it was not immediately apparent in trading in DAR, in the days following the event, the presentations may eventually accomplish the desired effect on valuation.

The forum event may have also provided unintended peak under Darling’s corporate kimono.  There appears to be a cultural divide between the U.S.-based senior management and the European-based leadership at VION.  One side was typified by the gregariousness, age and mostly wide-girth of U.S. executive leadership and the other by the more svelt and youthful Europeans.  The former knows well the requirements of managing the spread between the cost of raw materials and selling prices for finish goods  –  knowledge which have driven the consistent profits that are at the core of our bullish investment thesis for Darling.  On the other hand the VION team appears to understand the competitive positioning and marketing requirements for a line of leading edge food and feed ingredients, but lacks the full awareness for conservative management of profit margins.

Indeed, the two groups were physically positioned apart from each other, providing a somewhat unsettling optic for the forum event.  Retirement age and health questions were clearly visible as executive officers stood before the audience of analysts and investors.  The image at the event begged the question of succession.  The company already had to call back its chief financial officer from retirement after his replacement failed to ‘find a home’ in Darling’s corporate culture.  We foresee more turbulence related to cultural and succession issues in the coming years.  Of course, VION is not the only source of talent to tap for the C-suite.  There are any number of possible candidates among experienced and capable individuals in the U.S. and Canadian operations.

We continue to rate Darling a Buy at this time.  A stable, consistent management style and a conservative operating structure have always been at the foundation of our investment thesis for Darling.  The issue of succession is causing some concern that as the Company has grown, the old decision making frame work and operating infrastructure cannot sustain the company in the future.  The ‘VION bean’ that Darling has sown may depend upon real change in Darling’s corporate culture.

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

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. Crystal Equity Research has a Buy rating on DAR and Darling Ingredients is included in the Biofuel Group of the Beach Boys Index of alternative energy developers and producers.


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