Darling Ingredients: A Contrarian Buy Amid Earnings Volatility and Free Cash Flow Resilience?

In the ever-shifting landscape of industrial investing, few stories blend complexity and opportunity as vividly as Darling Ingredients Inc. (NYSE: DAR). The company's 2023 financial results, marked by a 12% decline in net income year-over-year to $647.7 million despite a marginal increase in adjusted EBITDA to $1.61 billion, underscore the tension between near-term volatility and long-term resilience. For contrarian investors, the question is whether Darling's earnings fluctuations mask a durable business model capable of weathering cyclical headwinds.

Earnings Volatility: A Double-Edged Sword

Darling's earnings volatility in 2023 was largely driven by its joint venture, Diamond Green Diesel (DGD). While DGD sold 1.2 billion gallons of renewable diesel at an average EBITDA margin of $0.81 per gallon, Darling's share of DGD earnings declined sharply, contributing to a 12% drop in net income compared to 2022. This volatility is emblematic of the company's exposure to commodity markets and regulatory tailwinds in the renewable fuels sector. However, Darling's vertically integrated business model-spanning feed, food, and fuel ingredients-acts as a natural hedge. For instance, its Global Ingredients segment generated $1.11 billion in EBITDA in 2023, demonstrating resilience even as DGD underperformed.

The key for investors lies in distinguishing between transient noise and structural strength. Darling's CEO emphasized that the company's diversified revenue streams and cost-control measures mitigate the risk of over-reliance on any single segment. This is critical: while DGD's performance may fluctuate with diesel prices and policy shifts, Darling's core processing capabilities and long-term contracts provide a stable earnings floor.

Free Cash Flow Resilience: A Contrarian's Edge

Though Darling's 2023 free cash flow (FCF) figures are not explicitly disclosed in its SEC filings, the company's liquidity metrics suggest robustness. As of December 30, 2023, Darling held $126.5 million in cash and cash equivalents, with an additional $832.5 million available under its revolving credit facility. These figures, combined with capital expenditures of $555.5 million for the year, hint at a business generating sufficient operating cash flow to fund growth while maintaining flexibility.

The absence of a direct FCF calculation does not diminish the case for resilience. Darling's leverage ratio of 3.26X (debt-to-EBITDA) remains manageable, and its ability to repurchase $52.9 million of common stock in 2023 signals confidence in its cash-generative capacity. For contrarian investors, this is a compelling signal: a company with strong liquidity and disciplined capital allocation, even amid earnings declines, often represents a mispriced opportunity.

Long-Term Merits in a Cyclical Sector

Darling's long-term investment appeal hinges on its strategic positioning in the renewable energy transition. DGD's renewable diesel production, though volatile in 2023, aligns with global decarbonization trends. With the U.S. Environmental Protection Agency's Renewable Fuel Standard (RFS) and California's Low Carbon Fuel Standard (LCFS) creating tailwinds for low-carbon fuels, Darling's stake in DGD could rebound as demand for sustainable energy accelerates.

Moreover, the company's $163.6 million in cash dividends from DGD in 2023 highlights the potential for upside in its joint venture. If diesel prices stabilize or LCFS credits strengthen, Darling's earnings could see a meaningful boost without requiring additional capital investment. This asymmetry-downside risk limited by operational diversification and upside potential tied to macro trends-makes Darling an intriguing case for patient capital.

Conclusion: A Calculated Bet on Resilience

Darling Ingredients is not a stock for the faint of heart. Its earnings volatility, driven by exposure to DGD and commodity markets, will continue to test investor patience. However, the company's free cash flow resilience, diversified business model, and alignment with decarbonization megatrends position it as a compelling contrarian opportunity. For investors willing to look beyond quarterly fluctuations, Darling offers a rare combination of defensive liquidity and offensive growth potential.

As the renewable energy sector matures, companies like Darling that balance innovation with operational discipline may emerge as overlooked champions. The question for investors is not whether Darling will face headwinds-but whether they are prepared to capitalize on its long-term strengths.