Darling Ingredients Stock: Turning Waste into Wealth (NYSE:DAR)

Darling Ingredients Inc. (NYSE:DAR) is considered to be the largest public company that turns edible by-products and food waste into sustainable products, such as food ingredients, animal feed, biofuels, and green energy. This aligns well with the globe’s growing environmental focus. It has been recognised as a top-rated ESG industry company by Morningstar Sustainalytics. Despite recent stock fluctuations and concerns over negative levered free cash flow, the company has shown top and bottom-line growth over the last five financial years, although EPS and revenue expectations were missed in the most recent Q3 2023 earnings report.

As global interest in eco-friendly practices grow, the company appears well-positioned to capitalise on this expanding market, although aware of the risks associated with its performance sensitivity to commodity price fluctuations. Considering these factors, Darling Ingredients presents a promising long-term investment opportunity within the sustainability sector. Therefore, investors may want to take a bullish stance on this stock.

Company overview

Darling Ingredients, established in 1882, specialises in repurposing food waste and animal byproducts into valuable resources like animal feed and biofuels. It has a strong competitive advantage in the rendering industry due to the sheer size of the company, with more than 260 facilities and 14,000 employees worldwide. It has a diversified portfolio of products and customers, serving various industries and markets, such as pharmaceutical, food, pet food, fuel, and fertiliser.

It operates within three industry segments, namely feed, food and fuel ingredients. The company saw a decline in YoY sales in its Q3 2023, mainly due to lower prices and volumes in the feed segment, which was partially offset by higher sales in the food and fuel segments. However, if we look across the last nine months, we can see that there has been an increase across every one of the segments, driven by higher demand and margins for the company’s products.

It has a key growth driver in Diamond Green Diesel, its joint venture with Valero, which produces renewable diesel from low carbon intensity feedstocks, such as animal fats and used cooking oil. Diamond Green Diesel is projected to produce 58% more biodiesel in 2023. The expected enhancements in DGD margins based on current market conditions indicate a positive upward trend for the company in 2024. It also has a potential upside from its acquisitions over the last few years.

One example is Valley Proteins, a privately owned rendering company primarily serving the poultry industry in the southern, southeast and mid-Atlantic U.S. The acquisition expands Darling’s capacity and supply of low carbon intensity feedstocks, as well as create synergies and cost savings.

Darling is anticipating a combined adjusted EBITDA of $1.6 to $1.7 billion for FY 2023. Furthermore, the increasing concern towards sustainable solutions provides long-term tailwinds, as the company is well-aligned with the global efforts to reduce greenhouse gas emissions and promote circular economy.

Financials

Reviewing the past five years, it’s evident that the company has demonstrated consistent growth in both top-line and bottom-line figures. Despite this positive trajectory, there’s a noteworthy uptick in debt accumulation alongside a concerning trend in the TTM cash flow, indicating a potential risk of cash burn. Amidst these cautions, the company’s revenue and gross profit have shown a consistent upward trend over the same period, with the current TTM revenue standing at a robust $6.94 billion.

Assessing the TTM, the net income stands at $732.4 million, marginally dipping below the fiscal year 2022 figures. However, an encouraging pattern emerges when we observe a promising upward trajectory in net income over the past five years.

The TTM Levered Free Cash Flow registers a negative $81.5 million, signalling a potential cash burn. However, a closer examination of the annual trend reveals a generally positive trajectory over the last eight years, barring the exception to FY 2019. This consistent positive trend has empowered the company to allocate resources toward rewarding investors, debt settlements, and reinvestment in business endeavors.

Potential investors should be aware of the rising debt from $3.4 billion to $4.4 billion YoY. While the bank leverage covenant ratio at 3.25 times indicates a reasonably balanced debt-to-earnings ratio, the notable increase in debt prompts considerations about financial flexibility and effective debt management. The knowledge that Darling maintains $1 billion in its revolving credit facility offers some assurance of liquidity, but the substantial capital expenditures signal the company’s commitment to strategic growth.

Valuation

Darling Ingredients has seen its stock decline by 18.53% over the past year. However, this downturn contrasts with the company’s historical performance, which peaked at $81.66 in May 2022, signalling prior market optimism. The stock also trades below its average price target of $71.00, implying a significant upside potential. Its price-to-earnings ratio of 10.70 is also lower than its industry average of 16.65, suggesting that it is relatively cheap compared to its peers.

Analysts anticipate 10% average growth rate over the upcoming five years, supported by the company’s robust global expansion strategy, notably leveraging successful integrations like Valley and FASA, and a focused initiative on innovative product development, particularly within Specialty Food Ingredients which we saw updates on in the Q3 2023 Earnings call.

Utilising a discounted cash flow (DCF) analysis, considering the analysts’ predictions and the demonstrated confidence of the management team in the forthcoming Q4 2023 results and momentum into 2024, the intrinsic stock value is estimated at $66.46. The DCF analysis is based on the following assumptions:

• A free cash flow of $1.02 billion for FY 2023, based on the company’s guidance of $1.6 to $1.7 billion in adjusted EBITDA and an estimated capital expenditure of $600 million.
• A terminal growth rate of 2.5%, reflecting the long-term growth prospects of the company and the industry.
• A discount rate of 8.46%, based on the company’s weighted average cost of capital (WACC), which reflects the required return on the company’s equity and debt.

At the current price, there is a lot of upside potential. In my opinion, the clear growth strategies and untapped opportunities, such as benefitting from emerging market trends, like the demand surge for renewable diesel and sustainable aviation fuel (SAF), make Darling Ingredients an attractive investment opportunity. However, the market may be missing some of the company’s competitive advantages and growth drivers, such as its innovation capabilities, its diversified revenue streams, and its strategic partnerships. Additionally, the market may be overlooking the company’s resilience and adaptability to the challenges and opportunities of the energy transition, as well as its alignment with the global sustainability goals. Therefore, I believe that Darling Ingredients is undervalued and deserves a higher valuation.

Risks

Investing in Darling Ingredients carries risks tied to its financial performance, especially its susceptibility to commodity price fluctuations, notably in feedstocks and energy sources. This volatility exposes Darling to potential swings in margins and overall profitability, impacting its financial stability. The company’s dependence on subsidies to balance the cost gap between renewable diesel and traditional fuels poses another risk. Alterations in subsidy structures or reductions in governmental support could directly affect Darling’s financial health and market competitiveness. Moreover, Darling’s involvement in the feedstock and renewable energy supply chain leaves it vulnerable to disruptions, whether due to transportation issues, unforeseen events, or natural disasters, potentially impacting production and distribution and impacting operational and financial performance. Without substantial investment in innovation and flexibility, Darling may struggle to maintain competitiveness in an industry constantly evolving due to these shifts.

Final thoughts

Darling Ingredients is a major player in the sustainability sector. Despite some recent fluctuations in its stock and concerns about cash flow, the company has improved its financial position and is well-positioned to take advantage of the growing global demand for eco-friendly practices. As an expert in waste-to-resource conversion, growing through acquisitions, it is perfectly aligned with the increasing environmental consciousness. Based on a discounted cash flow model, the stock is projected to have an intrinsic value of $66.46, which is significantly higher than the current trading price. As a result, investors may want to take a long-term bullish stance on this stock.