In July 2013, Darling Ingredients (DAR: NYSE) and its joint venture partner Valero Energy (VLO: NYSE) commissioned the largest facility in North America to convert waste animal fats into renewable diesel. The facility was strategic located adjacent to Valero’s petroleum refining installation in Norco, Louisiana.
At the time the facility was capable of pumping out 12,000 barrels of renewable diesel per day that could be dropped directly into Valero’s distribution network and blended with fossil fuel. Even at that production level the facility showed promise to deliver strong dividends back to its owners. The partners named their venture Diamond Green Diesel and celebrated the unparalleled achievement.
The two partners in Diamond Green Diesel have not stood still. The Renewable Fuel Standard (RFS) in the United States and growing policy support around the world for low carbon fuels has boosted demand for renewable diesel. Darling and Valero expanded production capacity to 160 million gallons per year in 2015 and now undertaking another expansion to 275 million gallons per year in 2018. An engineering study and construction cost review completed in late 2017, considered an expansion to as many as 550 million gallons per year. Darling and Valero have promised a final decision on the extra 275 million gallons sometime yet in 2018.
Potential dividends that could be delivered by a plant with a 550 million capacity might be all Darling and Valero need to give the nod to the added expansion project. In the quarter ending June 2018, Diamond Green Diesel delivered a $25 million dividend to each of the two partners – a dividend that drops directly to each company’s bottom line. The dividend is made possible by strong profit generation. Cash earnings (EBITDA) were $1.05 per gallon in the quarter even without the benefit of the Blenders Tax Credit.
The Blenders Tax Credit has been the target of intense lobbying over the years. The U.S. Congress has let the tax credit expire at times despite widespread support from a trade groups and industry associations around the country. In February 2018, the tax credit was approved retroactivity for the year 2017, at $1.00 per gallon of biodiesel or renewable diesel used to blend with fossil fuel. Then the fight was renewed for getting the tax credit approved for 2018 and 2019. A decision is still pending as Congress continues its Hide and Seek game lobbyists!
Diamond Green Diesel proves that, with good management and astute capital investment, there are profits to be made even without government support. As a consequence, Diamond Green Diesel has not been a victim of the on-an-off support from Congress for renewable fuels. For other smaller renewable fuel companies, the uncertainty has disrupted access to capital and made difficult long-term operating plans. Retroactive approvals of the credit have made it possible for investors to assume business models will eventually benefit from the credit, but the inconsistency still disrupts cash flows.
Deep pockets of its two joint venture sponsors are a boon for Diamond Green Diesel. At the close of the most recent quarter Darling Ingredients reported $104.1 million in cash on its balance sheet, including the $25 million dividend from Diamond Green Diesel. Darling does have $1.7 billion in debt to service and the debt-to-equity ratio is 72.5%. However, the company has generated strong operating cash flows – $341.1 billion in the twelve months ending June 2018 – providing ample capital for new investment.
Investors have recognized Darling’s financial strength, driving the price of its shares higher by 9.2% over the past year. Analysts following Darling appear certain that Darling has even greater success ahead with its portfolio of sustainable food and feed ingredients and renewable diesel. While it appears sales will be as much as 5% lower year-over-year in 2018, top-line growth is expected to resume in 2019. Even so earnings are expected to more than double in the year 2018 and then growth again by more than 10% in 2019. At a forward price earnings ratio of 19.5 times, Darling with its promise of earnings growth might be considered a good value.
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.
This article was first published on the Small Cap Strategist weblog on 9/21/18 as “Darling’s Diamond.”