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spk10: Good morning and welcome to the Darling Ingredients, Inc. conference call to discuss the company's third quarter 2023 results. After the speaker's prepared remarks, there will be a question and answer period and instructions to ask a question will be given at that time. Today's call is being recorded. I would now like to turn the call over to Ms. Sue Ann Guthrie. Please go ahead.
spk00: Good morning. Thank you for joining the Darling Ingredients third quarter 2023 earnings call. Here with me today are Mr. Randall C. Stewie, Chairman and Chief Executive Officer, Mr. Brad Phillips, Chief Financial Officer, Mr. Bob Day, Chief Strategy Officer, and Mr. Matt Jansen, Chief Operating Officer of North America. Our third quarter 2023 earnings news release and slide presentation are available on the Investor Relations page under Events and Presentations tab on our corporate website, and will be joined by a transcript of this call once it is available. During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results can materially differ because of factors discussed in yesterday's press release and the comments made during this conference call and in the risk factors section of our Form 10-K, 10-Q, and other recorded filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. Now, I will hand the call over to Randy.
spk18: Thanks, Sue Ann, and good morning, everyone, and thanks for joining us for our third quarter earnings call. Darling's Global Ingredients Platform delivered, as predicted, and DGD faced some headwinds and operational challenges during the quarter. Overall, we feel good about the momentum we are carrying into fourth quarter and 2024. Turning to the feed ingredients segment, raw material volumes were flat compared to third quarter 2022. Our gross margins have returned to pre-acquisition levels, demonstrating our ability to successfully integrate Valley and FASA. Our work is not done, and we expect further improvements. Fat prices were lower year over year, but sequentially improved late in Q3. Turning to our specialty food ingredients segments, raw material volumes increased 18% year over year due to Gelnex acquisition. Our global collagen platform delivered solidly, and we continue to shift our product mix into higher margin products. Hydrolyzed collagen remains an important part of our long-term growth strategy within the food ingredients segment. Earlier in the quarter, we commissioned a new spray dryer in Epitácio, Brazil, adding much-needed capacity to continue our growth. I'm also excited to share that our research and development efforts in this segment have resulted in our ability to formulate a product that targets specific health concerns, such as glucose moderation. We are currently in scientific trials and expect to bring this ingredient to market during 2024. On October 26, we announced that DGD volumes for the third quarter were lowered due to a regularly scheduled turnaround at number two in St. Charles, Louisiana, that took the unit offline for 27 days. After that turnaround, DGD2 had a minor operational disruption. So in total, DGD2 was offline for 37 days in the quarter. This resulted in lower gallons produced, higher costs, and lower than expected operating profits. Year-to-date, DGD has sold 910 million gallons of renewable diesel at approximately $1.02 per gallon EBITDA. And Darling has received $163.6 million in cash dividends year-to-date. With that, I'd now like to hand the call off to Brad, and then I'll come back and discuss the rest of my thoughts for 2023 and 2024, Brad. Okay, thanks, Randy.
spk15: Net income for the third quarter of 2023 totaled $125 million, or $0.77 per diluted share. compared to net income of $191.1 million, or $1.17 per diluted share, for the third quarter of 2022. Net sales were $1.63 billion for the third quarter of 2023, as compared to $1.75 billion for the third quarter of 2022, or a 7% decrease in net sales. Although Darling's third quarter 2023 gross margin increased $10.1 million and was $23.8 as compared to 21.5% for the third quarter of 2022. Operating income decreased $90 million or 33.5% to $178.4 million for the third quarter of 2023 compared to $268.3 million for the third quarter of 2022, primarily due to Darling's share of Diamond Green Diesel earnings decreasing $49 million. Additionally, depreciation and amortization and SG&A increased about $21 million and $32.6 million, respectively, as compared to the third quarter of fiscal 2022, primarily due to the GELNEX and FASA acquisitions. Now moving to non-operating results, interest expense increased from $39.8 million in the third quarter 2022 to about $70.3 million in the third quarter 2023, primarily as a result of increased indebtedness due to the acquisitions. For the three months ended September 30, 2023, the company reported an income tax benefit of $15.4 million and an effective tax rate of negative 13.6%, which differs from the federal statutory rate of 21% due primarily to the relative mix of earnings among jurisdictions with different tax rates and biofuel tax incentives. The company's effective tax rate excluding the biofuel tax incentives and discrete items is 25.9% for the three months ended September 30, 2023. The company paid $40 million of income taxes in the third quarter. For the nine months ended September 30, 2023, the company reported income tax expense of $52.3 million and an effective tax rate of 8.4%. The company's effective tax rate, excluding the biofuel tax incentives and discrete items, is 28.4% for the nine months ended September 30, 2023. The company also has paid $127.7 million of income taxes year to date as of the end of the third quarter. For 2023, we are projecting an effective tax rate of 9% and cash taxes of approximately $30 million for the remainder of the year. The company's total debt outstanding at third quarter 2023 was $4.4 billion as compared to $3.4 billion at year-end 2022. Our bank leverage, covenant leverage ratio at the end of the third quarter was 3.25 times. We continue to maintain strong liquidity with $1 billion available on our revolving credit facility as of the quarter end. Capital expenditures total $146.2 million for the third quarter 2023 and $380.6 million for the first nine months. With that, I'll turn it back over to you, Randy.
spk18: Hey, thanks, Brad. As previously announced a few weeks ago, we revised company guidance to $1.6 to $1.7 billion of combined adjusted EBITDA for the full fiscal year 2023. For Q4, we carried good momentum in from the third quarter around the world. Raw material volumes have slightly softened, but our diversified geographic footprint makes the impact negligible. Clearly, the global fats and oils have softened as a direct reflection of an ample supply of global fats and oils, and delayed startups and inconsistent operations of renewable diesel plants. While we've seen a lot of press and noise about significant gallons of new renewable diesel coming to the market, the numbers appear to tell a very different story. If more capacity outside of Diamond Green Diesel was operating, fat prices undoubtedly would be higher. DGD is performing well, and we do not have any planned turnarounds in Q4. Margin structures are adjusting, and we are very encouraged with the conversations we are having with a variety of interested parties regarding sustainable aviation fuel and our ability to deliver the margins in line with what we have communicated. Looking forward to 2024, while the heavy lift of our integration work has been completed, there are still a few opportunities that can add some margin improvement in our feed segment, and our food segment should continue to reflect our product mix shift. From an earnings perspective, we see 2024 shaping up nicely and expect to deliver and deliver with an improved performance globally. The table is set with an improved outlook for the LCFS, growing demand for SAF, strong demand for our low CI feedstocks, and favorable tax structures. Given the environment we see for 2024, at this time we anticipate combined adjusted EBITDA to be in the range of $1.7 to $1.8 billion. In 2024, we plan to lower capital expenditures, focus on improving our working capital usage, and we anticipate regular dividends from Diamond Green Diesel. This will all help us accomplish our leverage targets by year-end. Given the anticipated dividends from DGD and the strength of our global ingredients business, we should be well on our way to achieving our target leverage ratio of about 2.5 by year-end 2024.
spk08: With that, let's go ahead and open it up to questions and I'll come back with some closing comments.
spk09: We will now begin the question and answer session.
spk10: To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. In the interest of time, please limit yourself to one question and one follow-up.
spk09: At this time, we will pause momentarily to assemble the roster. And our first question will come from Manav Gupta of UBS.
spk10: Please go ahead.
spk01: Good morning, team. My question first is a little bit on the macro side. How do you view the recent staff proposal by Cobb, which increases compliance by 50% by 2030, also has the AR mechanism which pulls forward the program in case of over generation of LCFS. Do you believe this will be supportive of RD economics once it kicks in in 2025?
spk04: Good morning, Manal. This is Matt. So, first of all, the answer is yes. We do believe that this is supportive to the RD business. As you know, the LCFS is an important component to the margin build. in the RD space. And given that the SREA that was put out a couple of months ago and the expected legislation that is forthcoming, there are several components that we think are supportive for the RD and even the SAF business. So obviously volume is an important part. And then there's the component for a potential of a – an SAF in California of up to, you know, in the neighborhood of 150 million gallons, which will line up very nicely with our SAF project. And there's even the component of timing. There's the possibility of an earlier implementation. Right now it's set for 2025, but there is the chance, and we all have to stay tuned on this, but there is the chance for even sometime in Q3 or Q4, an implementation coming on this. So again, all in all, we are very optimistic and quite satisfied with the LCFS.
spk01: Okay, I'm assuming you're basically referring to the fact that the AAR will pull forward the program into 2024, so the program could actually start in third quarter 2024?
spk04: That's a potential, yes.
spk01: Okay, thank you. Very quick follow-up is on slide 11, you indicate lower fat sales volume were a 32 million year-over-year headwind and lower protein sales volume were a 13 million year-over-year headwind. Given that integration is going well for both Valley and FASA, should we assume this was just a temporary blip and the volumes will come back as we go ahead?
spk18: Yeah, Manav, this is Randy. I mean, what we're seeing in my script, I commented on it, that's directly related to lower cattle slaughter numbers predominantly in North America. And clearly the cattle economics have changed in the U.S. The herd is low but being replenished, and that's just directly related to year-over-year comparisons. You know, if you think of it this way, you know, red meat has the most fat, the most protein, and then pork and then chicken. And so that's what that is. The volumes in South America are relatively flat right now. Europe's in good shape, but that's all pretty much North America.
spk08: Canada's in good shape.
spk09: The next question comes from Adam Samuelson of Goldman Sachs.
spk10: Please go ahead.
spk02: Yes, thank you. Good morning, everyone.
spk00: Good morning.
spk02: Good morning. Um, so I guess, I guess the first question, Randy, I mean, if you think about the updated kind of outlook for, for the balance of this year and you gave kind of a framework for, for 2020, uh, for, for 2024, um, can you first quantify in the quarter the head, there was an illusion in the pre-announcement to a hedge loss at, at Diamond Green. Can you quantify that? Um, and as we think about Diamond Green for the fourth quarter, if there's no scheduled turnarounds, um, we'd be thinking about production a lot closer to where you were in the second quarter, which, if true, and even at third quarter margin levels, would make it pretty tough to get to the low end of the way you frame the full year. So can you just help reconcile that?
spk18: I don't know that I would frame it the way you just finished that sentence, no. Clearly, there's always a timing issue how the fat prices in our core business flow through. And also, remember, a significant portion of the North American portfolio ends up at Diamond Green Diesel as the purchaser. So you had a little bit of a double wham here. Number one, you know, the prices started to accelerate in third quarter again, but we'd already sold Diamond Green before. And so those sales now are coming to be fruition in Q4 for our core ingredient business. On the other side, we saw heating oil spike up. You do get some hedge losses. You can go straight to the financials and the derivative sections on the Valero release, and you can see what that number is. And it was a significant number. At the same time, you had higher fat prices flowing through. Then you had heating oil now coming off. And so at the end of the day, that's my comment about margins are adjusting. You know, if you think about the efficiency of the D4 RIN, you know, when that thing came down, what did it say? It said fat prices had to come down to put, you know, some type of margin back in the business. So clearly the margins in DGD are coming back very nicely in Q4 here. And, you know, they'll finish the year strong, and then that's what gives us then the momentum into next year. I mean, like we said, we're trying to, you know, we've always said, you know, we're not going to guarantee you no volatility in DGD because there's a lot of moving parts there. But at the end of the day, 910 million gallons at $1.02 per year to date, you know, we said coming into the year we'd be somewhere between $1, $1.10. We're using $1.10 for next year. You know, we'll finish up somewhere, you know, within our guided range for the year. You know, it just depends on how everything flows through. But no, you know, from what we see right now, we're right on target.
spk02: Okay, that's helpful. And then just in the feed segment, can you maybe just, maybe the quarter-on-quarter EBITDA decline helped bridge some of that. So EBITDA was down 20%. six or so million dollars versus the second quarter. Can you help bridge how much of that was seasonality, how much of that was commodity prices, maybe some of the weakness in pet ingredients? And if you think about the fourth quarter, kind of with where commodity prices land, can you help us think about some of the key items in EBITDA and in feed moving forward?
spk18: Yeah, and I think you've kind of answered most of your question there. I mean, Typically, the seasonality hits in this business, especially in North America and Europe in third quarter in the feed segment, because the quality of the raw material in the summer times is much harder to process. That's code for it's harder to get the fat out of the product and leave it in the protein, so you kind of have lower quality fat, less fat, and that's how it flows through. It has for 142 years. The pet food business is something to put your finger on right now. Pricing remains good in that area. Demand was weak, but it's picking back up again. You've got a little bit of a trade down going on, it appears, around the world right now on the pet food side. But overall, when we're looking at 24 versus 23, it looks pretty stable there. Protein prices are You know, most products are in pretty good shape. I mean, there's a little bit of trade disruption in the world right now in different areas that are moving proteins around. Matt, what else do you want to add here?
spk04: Yeah, I mean, I would say, you know, the Q3, as you all know, was a typical very hot summer, and our businesses didn't, you know, as expected, feel that. But we are seeing, especially now in Q4, a quick return to the pickup and recovery.
spk18: Yeah, keep in mind, Adam, a year ago today, not sequentially, but a year ago, we still had Ward, South Carolina operating in North America. Ward, South Carolina is going to be key to 24 for us as it comes back online here. The plant is completely rebuilt. We are still landfilling a significant amount of product right now that we can't process in our system. So as we guide higher next year, you know, if you say what, you know, you always have to assume fats and oils prices and protein prices in there and energy. But most importantly for us, it's being able to bring back our system to full strength on the eastern seaboard.
spk09: The next question comes from Derek Whitfield of Seafold.
spk10: Please go ahead.
spk06: Good morning, all, and thanks for the 2024 commentary this morning. For my first question, I wanted to lean in on DGD and focus on the sustainable margins of your business, which really should drive the value of that business beyond 2024. When we analyze your system margins by assessing the value of your feedstock streams relative to a marginal unit of production, there appears to be a very meaningful positive spread with what you own differentially versus industry. As you've optimized the economics of DGD, is it reasonable to assume that that sustainable margin we've talked about in the past at $1.10 per gallon still stands even with depressed B4 rent prices, given your ability to increment tallow at DGD?
spk18: Fundamentally, Derek, that's what we believe. I mean, clearly, the volatility in Q3, the turnaround offline 37 days, you know, we disrupted our logistics both inbound and outbound there and, you know, moved boats to Q4 that should have loaded, you know, et cetera, et cetera. You know, the D4 RIN plays an important part in the value of that business down there. Clearly, we were not a hedger of D4 RINs, and we got caught in the volatility there with higher fat prices, lower a lower green premium, as we say, and you saw that flow through. But overall, our thesis still remains the same. As Sue Ann pointed out to me, she said, you know, even under any situation, our investment case in this was 79 cents 10 years ago on a $3.23 a gallon bill. We still believe in that. We believe it's even better now, given our CI advantages, given our both inbound, outbound benefits, logistic advantages. I mean, keep in mind, why are fat prices a little lower in North America? Because Diamond Green's the largest importer now of fats in North America because it has the logistical capability to convert and pre-treat those fats. So that's phase one. Phase two, as the script alluded, we're working hard with interested parties. We won't say who the interested parties are, so please don't ask. But we're very close. And SAF is real. The demand is real, and the margin opportunities, as we've explained out there, remain very real and doable. So, you know, if you look at this business, you know, in 24, Matt said, okay, I think there's a chance we could get the LCFS implementation online a little sooner. You know, even if it doesn't come, you know, until the back end of the year, just the fact when CARB publishes and everybody says, oh, here is the script, here's the playbook, That's positive, and we'll see an improvement there. Number two, as we look around the world for next year, you know, the SAF side, our plant is progressing nicely. We made it through hurricane season. I know technically that's got another week or two, but it looks like we've made it through hurricane season. We'll be buttoning it up. um, steals up equipments there. And, you know, hopefully as we progress through the winter time and next summer, we'll be mechanically complete and, and do a normal, um, normal startup here. And that's, if you look at it two to three years from now, you know, you'll, you'll have 250 million gallons of SAF and 24, or I mean, 25 for sure. You'll, and then, uh, you know, SAF two is on the drawing board here. Um, clearly as we've communicated to people, um, that decision won't be made until we have complete, you know, proof of concept of both the technology and the margin structure. But, you know, at the end of the day, if you look at 24, 25, 26, you can start to think out that our portfolio will include, you know, substantial gallons of SAF along with RD. And then we'll own that arbitrage again as we go forward. So it's a As we look forward, we don't see any downside from our case. There may be a little lull here that the market seems to want to price in. Matt, anything else you want to add?
spk04: I would just say that one thing to keep in mind is that as this SAF comes online, the feedstock is renewable diesel. And so our plant is boiler-plated for 250 million gallons. And so when we turn on with that plant, That's 250 million gallons of RD that's coming out of the RD market and going into the SAF market. So that's another, let's say, friendly component to even the outlook for RD.
spk06: That's great. Maybe Stan on DGD, I wanted to see if you could offer some additional color on the apparent delay you're seeing in RD capacity expansions, whether delays or simply just difficulty at running a nameplate, which is more challenging than I think we all appreciate. We see the same, but I'd like your views on that as well.
spk18: Yeah, and I'll tag team this with the team in here. I mean, you know, clearly as we look around the horn, we're both buyers and sellers of fats and oils around the world. And when I say buyers, I mean that's the DGD hat, and sellers, that's the Darling hat. And clearly we're not seeing the demand from the renewable guy's in North America. In fact, we're actually, we're buying material back from them. You know, I think, I guess if we say frustration, that might be too strong. Our curiosity and a bit of frustration is that when people started, whether it was Bloomberg or others putting out these S&Ds on D4 RINs, they forget multiple components of it. Number one, they assume if Phillips 66 announces a plan, it's going to be on line jam one and run at capacity. If Vertex, if PVF, I mean, you know, Holly Frontier finally hit 52% capacity, yay. You know, at the end of the day, you know, you just keep reading this stuff. Well, that doesn't generate the level of RINs that they're saying. And then the world doesn't understand when you export material, which a significant portion of Diamond Green, because of its location on the Gulf Coast, goes around the world. At the end of the day, those rims get retired in 60 days. There's a delay there. So, you know, at the end of the day, you kind of have to go back and rebalance this thing with reality. So, you know, we're buying back fat. We're not selling. And selling means they don't have the pretreatment units that they claim they do or they would be buying the cheapest fats in the world. Matt, anything else you want to add?
spk04: You know, as I think many of these are learning, this is not necessarily an easy business to operate. And whether it's, you know, they call it the CI component or the quality of the raw material and the pretreatment component requires more capex. And, you know, if someone tried to cut corners and save on capex, then they find out that, gee – Now this product, we can't process it or it's at the capacities that we want it. So, you know, this is a – it is a complex and not easy business to operate in, and I think some of these people are finding that out.
spk09: The next question comes from Deshyant Alyani of Jefferies.
spk10: Please go ahead.
spk13: Good morning, guys. Thank you for taking my question. The first one I had was on the guidance that you've given for 2024, the 1.7 to 1.8. Could you talk a little bit more about what margins do you expect for the food and feed segment?
spk18: Not really ready to go there yet, Deshaun. As I look at it, when we take a shot at producing guidance here, You know, what you can back into here is you can say, what are you thinking on diamond green diesel? Well, we're thinking that we're going to run it at above nameplate capacity, and we're going to make $1, $1.10 a gallon next year, and it doesn't include any SAF gallons coming on early at this time. It's just too early to make that prediction. And so it's not hard to back into that number. And so at the end of the day, where it lands, whether it's in food or feed, you know, You know, we're thinking that the numbers are going to roll up between a billion, billion one, maybe a little more in the core business, depending on where fat prices recover. And as we've said, if renewable diesel capacity is there and has pretreatability, or even if it doesn't have pretreatability, fats and oil prices can't stay where they're at. You know, if you look at whether it's the soybean oil S&D, you know, we're at a multi, multi-year low. And RVD margins, which most of these guys are running, are now $1,100 over. So that's $0.11 higher than we're operating at. So that's how we kind of cast it looking forward. Matt, Bobby, anything you want to add?
spk19: I think that's right. I mean, we're just at a – it's a generally tight S&D scenario, and we're – A lot needs to happen as far as crop production in South America, and that's really going to determine what we see with respect to certainly protein levels and ultimately oil levels as well.
spk13: Thank you. That's helpful. And then one question I had was just kind of your thoughts on buybacks, given where the stock prices today, or maybe just in general? I know that the goal is to kind of get to that 2.5 leverage, but any thoughts on entertaining higher buybacks given where the stock's trading today?
spk18: You know, it is a discussion point with the board. We have adequate capacity to do that. Clearly, our focus today is, you know, as we said, is to repatriate cash and get the total debt down and get to a at least a discussion point of investment grade as we have some maturities coming in in 26 and 27. So it's not off the table. You know, clearly every year we will buy back any executive compensation or dilution for sure. And after that, then it's opportunistic. And, you know, as the year goes along and as Brad says, I have a little extra cash, we've been given the authority to make those decisions.
spk07: So nothing's off the table here.
spk09: The next question comes from Paul Chang of Scotiabank.
spk10: Please go ahead.
spk14: Thank you. Good morning, guys. Good morning. Randy, trying to understand sequentially from the second to third quarter, the feed ingredient revenue is down, the sales volume is actually flat, and all the market indicators, whether it's UCO, TARLO, all that is actually up. We're trying to understand that what's causing the sequential revenue job from second to third quarter in the fifth business. That's the first question.
spk15: Yeah, Paul, this is Brad. When you're looking sequentially, we have, for lack of a better word, lead and lags. in a lot of our contracts. And so there's timing differences there that will often, and when you get quick movements, where Randy talked about earlier between second and third quarter price movements, and then with the way the contracts work and the lead and the lag, that can cause a little bit of kind of discolor there, I would say.
spk14: And so, Brad, should we, based on that, means in the fourth quarter we should see, compared to the market indicator, your revenue will see more of an upside? Or that the lag effect is going to take longer than that?
spk18: Yeah, typically what you're going to see then is, if you think of it this way, today around the world we have a significant amount of our internal produced fats and oils, whether they're in Europe or Brazil or North America, headed to diamond green diesel. And so as those were, you know, if you want to think about it, what we produced in August, you know, is sold and it doesn't arrive and be processed until October. And September is kind of November and October now is December, January. And so, you know, as we said earlier in the script, so you had a move up of fat prices. in Q3 that then were sold and purchased. And so those will flow through, and those should deliver a pretty good fourth quarter in the feed ingredient segment.
spk09: The next question comes from Andrew Strzelczyk of VMO.
spk10: Please go ahead.
spk05: Thank you, Maureen. Thanks for taking the questions. My first one is on Diamond Green Diesel. I think, Randy, over time you've talked about $0.90 or $1 being the cost advantage or the minimum margin to think about for DGD versus the marginal producer. You talked around this a little bit earlier, but I was hoping if you could be a little bit more specific. Do you think that that number has changed at all with new capacity has come on, et cetera, or is that still the right way to think over time about the baseline DGD margin?
spk18: Yeah, I don't really see anything changing that competitive advantage out there right now. I mean, I'm looking around the table and...
spk04: No, I agree. That's something that we consider as a competitive advantage. We're going to continue to leverage that advantage going forward, trying to stay, let's say, ahead of the game. And that's, again, even with the SAF project, is going to separate us even further from our competition.
spk19: If I could just add, I think one thing to keep in mind is part of that advantage is DGD's ability to blend all different kinds of feedstocks and the price relationship amongst those feedstocks changes a lot from time to time. So the relative advantage is not something that you can pinpoint and is static. But generally speaking, I think that the advantage that we had before continues to be the case today.
spk18: Yeah, and I think, you know, the DGD mixology has become even more complicated given, you know, whether you've got cat 3-fat coming from Rotterdam, from our factories, or you've got, you know, palos and yellow greases coming from Brazil and yucos from the Asian countries. You know, you've got a timing of when those arrive, and then you've got a usage. We don't really run feedstocks neat, in a sense. So we make a mix that meets our customers' needs, that allows us to get the highest yield that we can and the longest catalyst life, And so, you know, it becomes a far more complicated thing. But the competitive advantage, like I said, versus running RBD soybean oil right now is 88 cents a gallon. So that's not even a CI differential there. So, you know, I think, you know, as you've seen through the year, remember Port Arthur is still waiting on its pathway. We anticipate at any time. So Port Arthur has not had the economics that it will have next year again. And then that's Port Arthur pre-SAF. So, you know, I think the advantage is very sustainable and widens out over time. Like I said, I don't want to be somebody that doesn't say there's going to be less volatility due to timing here, but I think the margins are very achievable.
spk04: You know, and on top of that advantage, there's the value of our integration with our feed business. And we're producing, you know, even the the local fat supplies in the U.S. and Canada, that a large percentage of that ends up in DGD. And then, again, one of the other things, back to DGD, is the producer's tax credit going forward. We think that DGD is, again, one more time, more advantaged than the others in DGD. you know, when that calculation comes into place.
spk08: So, again, we like our position. Okay, that was really helpful, Colin. I appreciate that.
spk05: And just my second question, following up on some of your commentary around some integration benefits that remain or opportunities that remain, we know, I think, that there's some valley contracts that go into effect. Jan, is that really what you're talking about, and is there any way to quantify that, or more broadly? Are you seeing, you know, given kind of the bigger asset footprint with all the acquisitions, et cetera, that there's even more opportunity broadly beyond Valley to continue to optimize? Thanks.
spk18: Yeah, you know, and I think those comments were in the script. I mean, clearly, the U.S. operations and procurement teams have made great strides at Valley, and then our international team down in Brazil has You know, taking a private company to public is no small task on either continent here. And then, if you will, making them darling. And, you know, we tend to be conservative. We tend to risk manage. And we have a margin expectation in our core ingredient business that's very well known, and our return standards are, you know, etched in metal there for us. And so at the end of the day, we've made – The success of the Valley integration, as we said, has been the ability to improve the raw material procurement contracts and all the little terms and conditions in there. And then ultimately, as I said earlier, we're still short massive capacity on the eastern seaboard that's ready to come online. But as we've shared with others, we're waiting on motor control gear that's due to be delivered here this winter. Otherwise, we'd have that plant back up. But the supply chain, you know, we're still moving stuff inefficiently to plants just to support our supply base out there. And once Ward comes up next winter or next spring, I mean, in the Q1, we should be back in good shape there. And then we've got capacity expansions going on down in Brazil right now that are just in the commissioning stages that should be accretive to us next year. So, I mean, the world looks pretty darn good next year. It doesn't look like we'll have 3% to 5% growth of raw material tonnage, as we've seen over the last several years. There's a little bit of contraction of animal numbers out there, whether it's disease or whether it was just margin and feeding people. But at the end of the day, you know, the year is setting up pretty nice for next year.
spk09: The next question comes from Sam Margolin of Wolf Research.
spk10: Please go ahead.
spk16: Hi. Good morning. Thanks for taking the question. My first question is on just the fat environment. You've talked a little bit about the relationship to the vegetable oil complex. But is there a scenario where fats prices next year decouple from veg oils just because If the pressure in the system is originating from RINs oversupply, you solve that with lower biodiesel production, which would disproportionately impact soybean oil supply demand versus fats. And then if there's a corresponding LCFS rally, that might further benefit tallow and yellow grease prices relative to veg oils. Is that a scenario that... you think is possible?
spk18: I really don't think so. And I, you know, number one, I think, you know, as we've said all along, clearly the, the, the gen one technology of classic biodiesel would be the one that would become challenged. But the reason it would become challenged would be because there would be RD capacity that then would, would take that supply. You know, it, you just kind of have to do the numbers. If Martinez is really going to run 730 million gallons, that's 3 million tons of raw material. If P-66 can do half of what they think they can, that's another million and a half, 2 million. And then you've still got the PBFs and you've got the Vertexes, you've got RAG, Geismar, all these guys that seem to be new demand out there I mean, you can see the scenario quickly change. Now, the question is, what is D4 RINs do? Bob, you want to take a shot at that?
spk19: Well, I think you're right on, Randy. You know, I think the only way that we would decouple is if our deproduction were to plummet because of challenges in running and operating. But if that were to happen, RIN values should go higher, and that would significantly benefit our broader network. But, you know, we don't really see that happening. What we see is overall RD production having some challenges, but continuing to have a significant demand pull and keeping relative prices in line between fats and oils. Got it. Okay.
spk16: And this is a follow-up, but it's also on the fats outlook. With the LCFS proposal, I mean, obviously a lot of people are looking at that through the lens of RD margins, but it seems like it would impact the Fats market too over time because CI would become more important to values, to intrinsic value of different feedstocks. And so, but of course, it's very regional specific. It's only California. So I was wondering what your thoughts on that are, if you think maybe the LCFS proposal is actually a bigger deal for TALO than it is for underlying RD margins.
spk08: I think we would believe that.
spk18: We would think it clearly favors low CI as does, you know, SAF. I mean, clearly, you know, I think if we sum the whole conversation today down to one thing, it's about timing. R&D is a good business. It's got growing demand globally. SAF is going to be a great business. It's got incredible growing demand. We've got maritime fuels. And, oh, by the way, they all favor low CI feedstocks. And we're stuck in this rut of saying, well, what are margins going to be? Where's D4? Where's LCFS? And, you know, at the long term, as we've always said, you know, the competitive advantage of the Gulf Coast real estate, whether you're shipping SAF by pipeline, boat to Europe, or to California, you know, it's just going to really work out pretty nice. Matt, I don't know.
spk04: The only other thing to keep in mind is that, obviously, the LCFS is specific to California, right? But as we're doing business in other markets, the LCFS is a reference in our valuation when we're using to determine whether a product is sold to another market or to California. So one way or another, that LCFS valuation is built into all of the RD sales, regardless of whether it goes to California or not. So that's an important component not to overlook.
spk09: The next question comes from Ben Bienvenu of Stevens. Please go ahead.
spk10: Hey, thanks.
spk03: Good morning. I wonder if we could talk about 2024. Randy, you talked about $1.7 to $1.8 billion of EBITDA. What do you think that translates to for free cash flow, and then what are your priorities for free cash flow as we start to see CapEx budgets potentially come off a peak at DGD, notwithstanding the SAF expansion that you want to engage in.
spk18: Yeah, and I think, you know, we had this discussion with our board. I mean, as you guys look to valuing the company here, ultimately we can talk about combined adjusted EBITDA, but it's actually what is the dividend plus the core ingredient business, and then how much CapEx are we going to spend, and, you know, what's in the M&A pipeline. And so when we look to DGD and we say above, you know, nameplate you know, $1.10 a gallon, you can come up with, you know, an easy $500 million of dividends there. And then you look at our core ingredient business and if we're at a, you know, if we're at a billion, billion one, you know, there's your number right there, $500 million capex. If we, that's got, you know, probably $100 million of growth projects of the new plants we've talked about building. And then you look at it and you say you got an interest bill of around $230 million. And cash taxes? 160. And then, you know, some limited buybacks in there that could be higher if we're doing a little better or whatever. But, you know, you quickly, you know, quickly pull down debt down to around that 4 billion, 3.9 billion level.
spk04: We do have one pending transaction that's out there on Mirapaz in Poland, which is 110 million euros that is... Um, expected to close likely in, uh, in Q1. Uh, but outside of that, I would say 24 is an M&A light, uh, year on, on new acquisitions. I'd call it an M&A holiday.
spk03: Uh, you've earned a very, very good, very helpful, um, and makes sense. On the third quarter, um, in the seed business, I want to ask about in the UCO segment, um, The pricing seems to be much weaker year over year than, you know, broader UCO quotes would suggest. Is there something discrete or specific that's happening in that third quarter that we should be mindful of as we think about the relationship between pricing in that segment and the pricing of, you know, used cooking oil out in the marketplace?
spk18: You know, this, Randy, year over year, I think prices were 65 down to 55, you know, so off about 20%-ish. Yeah. Remember Q3 a year ago, Diamond Green Diesel 3 was not operational yet. And so we were still trading a bunch of material around the world. So as Brad said earlier, you've got some leads and lags. You've got some quality premiums. You've got some trading that was going on there. But I don't know. Anything else you want to add, Brad?
spk15: No, that's it. Oftentimes when we're exporting in the past, there can be some premiums built in there. with that exporting. So that'll all flush out now that we have all three units on and are going forward.
spk09: The next question comes from Matthew Blair of TPH.
spk10: Please go ahead.
spk17: Hey, good morning. Thanks for taking my questions. I guess the first one is I think in your recent guidance you talked about that you anticipate DGD margins higher in Q4 versus Q3, and I wanted to see if that still held. On our modeling, it seems like you would receive a pretty nice tailwind from the hedging side of things, but we were worried that there would still be some of that price lag impact from your feedstocks versus the low D4 RINs in Q4 that might weigh on margins. So I wanted to check on that first.
spk04: Yeah, I would say that's the reality of the way our book works. We have to manage the pipeline through DGD. There's anticipated purchases, and so we're chewing through that. But I would say that if you think about the progression through the quarter, December will be better than October.
spk17: Yeah, we see that too. And so just to be clear that the guidance is still that – Q4 DGD margins higher than Q3?
spk18: Clearly, we're going to make more gallons. I mean, that's an absolute. And right now, if we had to look at it, as Matt said, you know, as each month goes on, that margin's widening out. Slot margins, as you can see, are much better. We should have a hedge gain coming back, provided there's no major rally again in the heating oil market.
spk08: And that's assuming D4s and LCFS really kind of flat.
spk09: The next question comes from Jason Gabelman of Cowan.
spk10: Please go ahead.
spk12: Yeah, hey, thanks for taking my questions. My first one is on the 2023 outlook, and it's a two-parter. The first part of it is, you know, you had initially or previously got it to 1.875. You reduced that. In hindsight, where do you think you were off from the prior to current guidance? And then as you think about the $100 million EBITDA range for 4Q, how do you think about what's driving the high to low end of that range? And I have a follow-up, thanks.
spk18: Yeah, I think there's three letters that drove most of it. DGD in Q3 clearly didn't deliver what we thought it was and were going to be. And clearly we're being somewhat conservative on DGD Q4, right now it looks like, you know, DGD's got to deliver for us to get to the high end of the range in Q4. And then the FAP prices that didn't get recognized in Q3 because they were sold to DGD in Q4 have to flow through. So, you know, like we just said, there's timing issues here that puts you that kind of range. You know, I continue to look at myself in the mirror and say, why am I even trying to to guide this thing after 20 million years. So, you know, it's just like, you know, but we have a pretty good feel for it. I mean, as we came in, and let's just remind the listeners, as we came in sequentially out of Q2, we said seasonally we would be lower in Q3. And we were. And, you know, so plus or minus 5% is not bad. What we didn't see coming at us was the DGD, you know, all the volatility that hit there due to, you know, whatever you want to call it, the war in the Middle East and D4 RINs collapsing and everything there that could have happened to you happened. You know, the fire took us offline, you know, that was another 10 days or, you know, our minor disruption as we call it. And, you know, the team did a magical job, but it just, you know, you got to power down and power back up. And that's six days with, you know, three, four days of repairs. So those, you know, that took another, I don't know, 20 million gallons or, offline or whatever it was. So that's why we're a little more bullish Q4 than we were in Q3 here.
spk12: All right, great. And my follow-up is on the 2024 outlook. And it seems like there's a decent amount of crushing capacity for soybeans coming online in the U.S. And as we said here, you know, soybean oil pricing is still decently above where it was relative, I So it does seem like there's potential for some downside next year, and I know you touched on it earlier, but I was just wondering if your outlook factors in all that new crush capacity coming online in North America and how that can impact vegetable oil prices. Thanks.
spk04: Yeah, this is Matt. I would say yes, that is factored into our expectations, you know, whether it's oil and including protein. So... You know, these new plants are known projects. Wouldn't surprise me, similar to what we're seeing in the RD space, if some of them get delayed for, you know, a myriad of reasons. You know, one of the other things we really haven't talked about lately is the, you know, with this increase in interest rates that we've seen, you know, CapEx and the money it takes to, you know, to build and operate has gone up. So, I mean, that's just the reality of the business. But at the end of the day, yes, we incorporate that into our expectations.
spk19: Bob, you got any time? Yeah, I think I would just add that near-term imports have had a bigger impact than added crush capacity in the United States for oil seed crush. And the other thing is that we are, overall as an industry, increasing renewable diesel capacity at a much faster pace than we're adding oil production capacity. Short term, we've got a lot of oil in the system and we've seen pressure on prices, but even getting out 12 to 18 months, it's going to be pretty tough for the soybean oil industry to keep up with demand as we see it.
spk09: This concludes our question and answer session.
spk10: I would like to turn the conference back over to Randall Stewie for any closing remarks.
spk18: All right. Thanks, everybody, for your questions today. As always, if you have additional questions, reach out to Sue Ann.
spk08: Please stay safe, have a great holiday season, and we'll look forward to talking to you in the future.
spk09: The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.
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