Darling Ingredients Inc (DAR) 2022 Q2 法說會逐字稿

Good morning, and welcome to the Darling Ingredients Inc. conference call to discuss the company's second quarter 2022 results. (Operator Instructions) Today's call is being recorded. I would now like to turn the call over to Ms. Suann Guthrie. Please, go ahead.

Thank you for joining the Darling Ingredients' Second Quarter 2022 Earnings Call. Here with me today are Mr. Randall C. Stuewe, Chairman and Chief Executive Officer; Mr. Brad Phillips, Chief Financial Officer; Mr. John Bullock, Chief Strategy Officer; and Ms. Sandra Dudley, Executive Vice President of Renewables and U.S. Specialty Operations.

There is a slide presentation available on the Investor Relations page under the Events and Presentations on our corporate website. 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 could 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 reported 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.

Thanks, Suann Good morning, everybody, and thanks for joining us for our second quarter 2020 call. Our 2022 second quarter financial results yielded another record quarter, illustrating the tremendous growth and diversity of Darling Ingredients. This quarter's combined adjusted EBITDA of $402.6 million, is nearly equivalent to our entire fiscal year combined adjusted EBITDA just 5 short years ago in 2017. As I reflect on where we've come as a company, I am tremendously proud of the work our teams across the world have done, repurposing animal and food byproducts into the specialty food and feed ingredients to support a growing population and converting waste fats and oils into low carbon fuel to power a growing world.

Going into the quarter in brief here, our Global Ingredients business had a record quarter of $312 million in EBITDA. And the Feed Ingredients segment had a record quarter at $242.1 million, and our Specialty Food Ingredients segment also had a record quarter, posting $65.4 million in EBITDA.

Our Fuel segment ended the quarter with $110.8 million with $90.6 million in EBITDA attributed to our joint venture at Diamond Green Diesel. Starting with our Feed Ingredients segment. Globally, raw material volumes were up 23% quarter-over-quarter or 13% year-to-date. Fat prices continued to climb rapidly, illustrating the high demand for low carbon waste feedstocks for renewable diesel. Protein prices were also strong throughout the quarter with some challenges remaining in container tightness for protein exports though.

Rapidly escalating global energy costs and lower gross margins from the Valley acquisition contributed to a reduction in gross margins for the Feed segment. As we have discussed in the past, our procurement formulas will ultimately recover many of the cost increases in the following quarter.

Since we closed on the Valley Proteins acquisition on May 2, the team has been working hard on the integration efforts with a laser focus on margin improvements. I'm encouraged by our efforts to date and continue to believe Valley Proteins will contribute $150 million of EBITDA in 2023 as we continue to address operational challenges and synergies.

Turning to our Specialty Food Ingredients segment. We continue to see uplift from gelatin to higher-margin collagen peptides. Hydrolyzed collagen demand continues to rapidly grow as consumers turn to these specialty products for joint, ligament, hair and skin health. More resistant to commodity fluctuations, we anticipate to grow this business line in the high single digits in the next 3 to 5 years. We have pioneered and led the way in this space, and we are excited about its potential for the future.

In our Fuel segment, our green energy investments in Europe continue to deliver as predicted with higher sales prices and volumes. Now let's turn to Diamond Green Diesel. DGD2 is running at full capacity, which resulted in record volumes of 209 million gallons in the second quarter and 375 million gallons produced year-to-date. In Q3, Diamond Green Diesel recorded $0.91 per gallon EBITDA, lower than Q1 2022 and our full year estimate. However, higher feedstocks while benefiting our specialty Feed Ingredient business impacted DGD's margins this quarter, along with some lower LCFS prices. Second quarter, LCFS prices averaged $100 per metric ton compared to about $130 in the first quarter of 2022. On August 5, Diamond Green Diesel delivered a dividend of approximately $181 million, of which $90.5 million was distributed to Darling. This should once again provide confidence in the strong cash potential for the joint venture as we start up DGD3.

As we head into Q3, DGD margins are improving. Feedstock prices have moderated. Additionally, DGD in Port Arthur, Texas should be operational in the fourth quarter of 2022, bringing our total renewable diesel production going forward to 1.2 billion gallons annually. Our strategy to procure and process weights, fats and oils as feedstocks and not food-based oils will continue to position DGD as advantaged over other renewable diesel producers in the market.

Our global supply chain augmented by our 2 recent acquisitions, positions our vertical integration second to none in the world. Additionally, we continue to see growing public policy that supports low carbon energy solutions beyond California. We're excited about Canada's clean fuel regulations passed last month and encouraged by the rulemaking currently underway in Washington State and Oregon.

The proposed Inflation Reduction Act, if passed, will represent the most robust piece of climate legislation in U.S. history and bring sustainable aviation fuel closer to reality. These programs give a boost not only to DGD, but to Darling's global specialty Feed Ingredients business as we are the premier provider of low-carbon feedstocks.

With access to inbound water, truck and rail for feedstocks and outbound water and options for either pipeline and rail to both coasts, DGD is well positioned logistically to serve markets well beyond California.

Now before I turn the call over to Brad for details on the financials, I mentioned last week, we closed on the purchase of the FASA Group, the largest independent rendering company in Brazil for approximately BRL 2.9 billion or approximately USD 562 million at the current exchange rates. This acquisition adds 14 rendering plants with an additional 2 plants under construction to our portfolio, and it processes more than 1.3 million metric tons of beef, pork and chicken annually.

Currently, the EBITDA run rate is around BRL 500 million per year.

With that, I'd like to turn the call over to Brad, and then I'll come back and give you a little outlook for the balance of 2022. Brad?

Okay. Thanks, Randy. All right. Net income for the second quarter of 2022 totaled $202 million or $1.23 per diluted share compared to net income of $196.6 million or $1.17 per diluted share for the 2021 second quarter. Net sales were $1.65 billion for the second quarter of 2022 as compared to $1.2 billion for the second quarter of 2021 or a 37.7% increase in net sales. Operating income increased 3.8% to $278.6 million for the second quarter of 2022 compared to $268.3 million for the second quarter of 2021, primarily due to a $98.1 million increase in the gross margin from our Global Ingredients business, which more than offset a $52.1 million decline in our share of the earnings from Diamond Green Diesel, as well as an increase in SG&A and depreciation and amortization, primarily due to the addition of Valley Proteins.

The second quarter of 2022 also included an $8.6 million impairment charge. Additionally, we incurred $5.4 million of acquisition and integration costs primarily related to our acquisitions of [Optibet], Valley Proteins and FASA. Interest expense increased $8.7 million in the second quarter of 2022 as compared to the second quarter of 2021 due to an increase in debt related to the closing of the Valley Proteins acquisition.

Now turning to income taxes. The company recorded income tax expense of $47.3 million for the 3 months ended July 2, 2022. The effective tax rate is 18.8%, which differs from the federal statutory rate of 21% due primarily to biofuel tax incentives, the relative mix of earnings among jurisdictions with different tax rates and excess tax benefits from stock-based compensation. For the 6 months ended July 2, 2022, Darling recorded income tax expense of $73.4 million and an effective tax rate of 15.7%. The company also has paid $72.4 million of income taxes year-to-date as of the end of the second quarter. For 2022, we are projecting an effective tax rate of 19% and cash taxes of approximately $30 million for the remainder of this year.

Total debt outstanding at the end of the second quarter of 2022 was $2.9 billion as compared to $1.5 billion at year-end 2021, and the bank leverage ratio ended the quarter at 2.59x. The increase in debt was primarily a result of the acquisition of Valley Proteins, which included a $750 million issuance of unsecured senior notes due year 2030. We continue to maintain strong liquidity with $1.45 billion available on our revolving credit facility as of quarter end July 2.

Capital expenditures totaled $79.9 million in the second quarter and $151.5 million year-to-date. The company repurchased approximately 700,000 shares of its common stock for $48.7 million during the second quarter, which brought the year-to-date total shares repurchased to $971,000 or $65.9 million. Subsequent to the July second quarter end date, the company also repurchased an additional $29.3 million in shares.

With that, I'll turn the call back over to you, Randy.

Okay. Thanks, Brad. I am very optimistic about the rest of the year as the market environment remains favorable to Darling. We operate a diverse business platform across multiple sectors that allows us to take advantage of our scale, integration and technical expertise to deliver shareholder value. We produce what the world needs, food and energy. We maintain our strategy to deliver a positive impact on our planet and society while also providing superior returns. There is no singular solution to environmental challenges we face nor is there 1 priority to focus on. Darling Ingredients is committed to helping the world avoid carbon emissions by turning discarded animal waste into valuable specialty feed ingredients, specialty food ingredients and low carbon energy. You'll hear more about our efforts in this space in our upcoming ESG report, which will be published next month.

Our vertically integrated supply chain allows us to fully leverage the strength of Darling's platform. with superior access to waste fats and oils, coupled with our technical expertise, pretreatment technology and superior logistics, DGD will continue to be a leader in the North American renewable diesel market for years to come.

While I recognize DGD's EBITDA this quarter was less than our full year forecast, we expect the back half of 2022 to improve. DGD should be able to deliver $1.10 to $1.25 a gallon EBITDA, and it's still a great return, and we remain advantaged over other reproducers relying on non-waste fats and oils for feedstocks.

Looking forward to the back half of the year, our global specialty ingredients business is currently running at a rate well over $1 billion in EBITDA, including the new FASA Group. We believe margins will improve at DGD. Therefore, we are reaffirming our forecast of $1.55 billion to $1.6 billion in combined adjusted EBITDA for 2022.

So with that, let's go ahead and open it up to Q&A.

(Operator Instructions) And our first question will come from Adam Samuelson of Goldman Sachs.

So I guess the first question, Randy, is thinking about some of those forward comments that you just made. So one, a clarification on DGD, so the $1.10 to $1.25 per gallon of EBITDA. Is that your expectation for margins in the second half or the margins for the full year average? Because I mean we look at spot margins today and even with lower LCFS prices, they would seem to be well above that level. And I guess the corollary to that is thinking about the second quarter, was the impact -- it seems like the impact was much more around hedges on diesel and the backwardation and diesel curves than the declines that you saw in the LCFS and increases in feedstock. So I just want to clarify kind of how you're framing the DGD performance.

Yes. And I'll take a stab and let Sandy build on it. Clearly, in Q2 -- clearly, we don't want to dive into derivative hedges and impacts. But clearly, the volatility and the inverses that were there with how you procure feedstock, you put on a hedge and then you lift a hedge, clearly had a significant impact on Q2.

That curve has clearly flattened in Q3, that will be beneficial. Feedstock prices have leveled off. But remember, we own feedstock anywhere 60 days to 90 days in advance. And so as it flows through, you should see improvement in margins. I think $1.25 is still very doable for the full year as an average at this time. Sandy, do you want to add anything?

No, I think Randy, you hit it on the head. We had really high feedstock prices that outpaced diesel prices throughout the quarter. LCFS prices did contribute to the decline versus Q1. We saw that RINs continue to work really hard during the quarter, but the LCFS prices were just off.

Okay. And then if I take a step back to the whole company, I mean, you talked about the ingredients business running at a well over $1 billion EBITDA rate. The full year guidance at the whole company level was unchanged. FASA closed 4, 5 months earlier than you thought, wasn't in the prior outlook. And I think equate to $35 million to $40 million or so based on the run rate you talked about of incremental EBITDA that wasn't in the prior outlook.

So can you talk about some of the moving pieces and what you're thinking for feed and food and fuel on the parent for the full year and how that has changed relative to May?

Yes. I mean, clearly, as Suann read my name is Randall C, the C stands for conservative. And we look at this thing right now with a lot of moving parts, as you said. I mean feedstock prices, number one, have come down a little bit. But oh, by the way, DGD3 hasn't really started buying yet. -- that's a secret out there, right? So, the market knows that we've got to go to market and start buying another 4 billion pounds of waste, fats and greases in the back quarter of the year here.

So we become pretty friendly on where the feedstock prices will either stabilize or rebound a little bit as we start to ramp up that facility. Protein demand remains pretty darn good around the world. So Feed segment should have a pretty solid quarter in Q3 here. Valley is delivering as we expected. I mean there's some operational challenges there. And we're still moving tonnage around from -- and getting the synergies from moving used cooking oil accounts, moving different raw material streams to different plants, trying to make pet grade at 1 plant et cetera. That should pick up momentum in the back half of the year here.

And then the FASA Group, it's currently at the current real rate running $90 million to $100 million EBITDA. And so we'll have it here for the quarter as we go forward or 2 months of it, we'll have Valley for 3 and that for 2. So I mean, overall, if DGD puts on 750 million gallons for the year, and then that doesn't have any gallons in there for DGD3 startup. That's where the C for conservative comes from. So we feel pretty darn good even though there's a lot of moving parts here. Adam, we always -- as you've been around the business a long time, quality -- it's hot all over the world. And quality of animal fats gets challenged in the summertime. We always have to deal with that. But now we've got the machine that can convert those. And so it's a little different kind of set of circumstances than we've had in the past. John Bullock, anything you want to add that you're thinking?

No, I think that's exactly right. If you look at it overall, what you see is Diamond Green Diesel as a result of the expansion of Diamond Green Diesel has gone from a 300 million-gallon to 800 million-gallon and we're set to go to 1.2 billion gallons. Whether we're making $1 or $1.25, that's a lot of money on that number of gallons. And at the end of the day, the impact of low carbon fuels in the world has increased fat prices from $0.20 or $0.30 to $0.60 to $0.75. All that's not bad, especially when we've increased massive scale to our low-carbon vertically integrated supply with the Valley and FASA acquisitions.

The next question comes from Manav Gupta of Credit Suisse.

So a little bit of follow-up kind of on Adam's question here. I mean, we can sit here and debate why the EBITDA was $1 a gallon, not $1.25. Fact doesn't matter is that you are the best in the renewable diesel business. We just saw somebody start up 200 million-gallon facility to end up with an EBITDA of minus 25 million in the quarter. So you guys are class apart. And what I'm trying to get to is, why is the best in business -- what will it take for the best in the business to announce an entry into the sustainable aviation fuel market now that you could actually get like $1.75 BTC on your sustainable aviation fuel. So I know you and your partner had been working very hard on commercializing sustainable aviation fuel. I'm just trying to understand with this inflation Reduction Act, how close are we for DAR and Valero together think about announcing something on sustainable aviation fuels.

Yes. I think, Manav, this is Randy. I'm going to have Sandy comment on. I think we want to comment on a couple of different pieces though I'll have Sandy cover off. I mean, clearly, the Inflation Reduction Act is very positive to Darling, globally. And then the SAF wording in there is very positive also, and it moves us a step closer. But Sandy, why don't you fill in the blanks here.

Yes. So thanks, Manav. This is Sandy. So I think that the inflation Reduction Act, that's probably 1 of the most important pieces of U.S. environmental legislation that we've seen in a long, long time. It's very supportive, not only of our road fuel business, but I think it makes a significant inroad into enabling us to be able to produce SAF.

What we saw is when we were looking at it, there are a number of positives. The first thing is we're excited about the opportunity to have the programs in place for 5 years. That shows significant support for biofuels. Also, as the U.S. biofuel producer, we were really excited to see the change to the producers tax credit starting here in 2025.

And then as a renewable diesel producer that focuses on waste feedstocks, we're really excited to see the new focus on emissions reductions. And I think that, that's really important for Darling, too, and John and Randy had hit on this earlier. From a Darling perspective, that focus on emissions reduction is also very positive, given that we're a low CI feedstock producer.

And then throw on top of that, the FASA and the Valley acquisitions, those couldn't have been more timely in support of that. So all of that's great stuff. And so what we think of when we think of the incentives and SAF is it gets us a whole lot closer to being able to justify SAF production. And we're hopeful that the airlines build that the incentives greatly reduce their burden since I know that they so want to be able to use SAF.

What we're still doing is we're still reviewing the legislation of the economics. And obviously, we have to talk to our partner. But what I can say is that the airline's commitment is there on closing any potential gaps that might exist we look forward to supplying them with SAF.

Perfect. My quick follow-up here is, Randy, we saw the volumes in 2Q. They were extremely high, beating our expectations. So first, can you talk a little bit about how Valley contributed to the overall volumes? And then what I'm trying to get to is, while 2Q had Valley, 3Q will have Valley and FASA. So help us understand how the volumes in the Feed segment will trend in the back half of this year.

Well, Valley by volume relative to the U.S. rendering size is about half the size. We've given that optic out there. So that should grow us. I think overall, Valley net-net is about 2.5 million tons and FASA is 1.3 million tons. So let's round up to 4 and 4 a simple math for me. And then there's, what, about 5 months left here in the year. So I mean, they should add what they're 5/12 of that 4 million tons going forward to the back half of the year, Manav.

The next question comes from Ben Bienvenu of Stephens.

So I want to ask, you've got FASA, you've got Valley. I'm sure you're going through an integration process, but those are in full swing here. You started to buy back a little bit of stock, but there's going to be a pretty meaningful cash build on the balance sheet in the absence of either continued M&A or distributions or share repurchase.

And I know we keep asking this each quarter, but the anticipation keeps building around what are you going to do with all the cash? And is what we saw in the quarter from a buyback perspective indicative of the sort of support that you'd like to allocate to that use of cash?

Yes. I mean -- and I'll have Brad help me out here. I mean, clearly, the dividend that we pulled out of DGD out of the venture here is symbolic of where we're at. And even at the $1.10, $1.25 margin and getting larger shows the cash generation ability. So it's kind of like, hello, it's pretty obvious now.

The second thing is the share repurchases that you saw in Q2 are indicative of the authority that Brad and I have to opportunistically continue to buy back as it makes sense. And clearly, we came under some pressure here post Q2. So we'll just leave it at that.

The third thing is prioritizing is really delevering back to 2.5 over time here, which will happen very quickly. we're always looking for opportunistic M&A that may happen out there, and then we'll decide with it from there. Brad, anything you want to add to that?

Yes. Just to reiterate, Ben, and you know this, I think everyone on the call has heard this, but we closed FASA, we were at 2.59%. So immediately after FASA here, a little higher than that, below 3%. But with the dividends and with No. 3 coming on, paid for the JV, debt-free. Going into, let's call it, going into 2023, the distributions are expected to be material in '23. So to Randy's point of delevering, not to mention just the base business and where it's running with free cash flow going into '23.

Yes. Okay. Great. And then my second question is a follow-up on Randy, your comments on the DGD margins of $1.10 to $1.25. What consideration is there around the start-up of DGD3 and that as a potential kind of margin detriment as you initially ramp it. And I know you guys get better each time you do these ramps, would you expect the impact of that spool up to be less than we've seen over the last couple of iterations?

Yes, I'll take a front-end stab at it and then give it to Sandy here. I mean, clearly, we affirmed 750 million gallons, we ran 200 million plus in Q2. So we're exceeding that already at a $1.10, $1.25. So that has no DGD3 in it. Clearly, that's where we're trying to be conservative. As always, any time you try to start one of these things up. You don't know what you don't know yet, although we've got 10 years of experience in history. And Sandy, do you want to comment on the ramp-up of 3 years?

Yes. So I think we learn a lot every time we do one of these and it was a big step up for us for DGD2. DGD3 will be another big step up. And I think we'll see some flows move around. That said, I think we've also learned an awful lot since DGD2. We've expanded who we source from, both domestically and internationally. And I think that will be advantageous to us.

The next question will come from Tom Palmer of JPMorgan.

I wanted to ask on the expectations on DGD. You paid down debt this quarter, paid distributions to the JV partners. So I guess, this seems like a signal that CapEx winding down, obviously, Port Arthur, just a few months from opening. What are your expectations for distributions for the remainder of this year? Should we start expecting, come later this quarter or fourth quarter further distributions? Or is it more a 2023 event?

Yes, Tom, I'll start. This is Brad. So we do have a distribution policy, obviously, with our partners. So that's what allowed or created the recent distribution. So I would say and Sandy add on to this, really, it will depend on the remaining cadence of the spend as well as really the ramp-up in the feedstock here for DGD3 because that's all taken into account along with the anticipated cash flow. So at the end of the day, could we receive another distribution? Yes, we could. But really, the focus, whether we do or don't, like I said earlier, going to want to be significant distributions beginning in 2023.

Yes, I agree with that, Brad. We've always said that we expect strong distribution starting in 2023, and we'll see what Q3 and Q4 holds for us.

Okay. And then just in terms of the spread at DGD between what's been produced and shipped. It's been a little wider than we've seen in the past. I think you've actually undershipped by about 20 million gallons in the first half. Should we be factoring in some catch-up here as we look towards the second half in terms of that shipment timing?

Yes. I think what you can count on is that we'll get to 750 million gallons by the end of the year. That's what we're projecting. And often, between quarters and things like that, we may have shipments that carry from 1 quarter into the next, and that can impact that, too. And I think that's kind of what you saw in some of those numbers.

The next question comes from Ben Kallo of Baird.

I guess, maybe just -- can we talk about the Fuel business, not DGD and then the Feed business or the Food business, so the Fuel or the Food business. And I know last time you called out for Fuel, just kind of rising the energy prices in Europe. So maybe how we think about that going forward? And then on Food I think collagen is still driving the boat there. But just how you think about that going forward and the mix and how long that's sustainable or any incremental additions you have there? And then I'll follow up.

Well, clearly, Ben, and I'm going to hand it off to John Bullock here in a minute. He's been very intimate in driving the strategy of both the Rousselot business and our European green energy business. The things we like to point out to people is, those are decommoditized businesses for the most part. I mean, they're just really just far more inelastic in the sense of exposure to commodities in that Feed segment.

And so we love growing them. And we think over the last year, we did a Board meeting, of course, yesterday, and we looked back at the growth of Rousselot since 2014, '15. It's just been a tremendous story in that Food segment. And we all have been very open, Rousselot represents the biggest portion of that Food segment, so no surprises there.

The green energy side comes from not only putting growth money into some of existing facilities, but acquiring new facilities and being able to arbitrage different feedstock streams around Europe for benefit and then making more money. So John, do you want to kind of talk where we're at and where we're going a little bit?

Yes. So I think just stepping back for a second, what you see with Darling is essentially a company that has been based on value adding the byproduct range from the animal industry around the world. And what's made us so successful over the last 10 years is we have created Rockstar products and been on the leading edge of that. That uses low carbon feedstock to create renewable diesel, obviously, in the transportation, low carbon fuel segment. And we've also been the world leader in terms of hydrolyzed collagen on the peptide revolution, which has continued and looks like it's continuing going forward.

So both the European strategy decarbonized, low CI energy products for fixed power generation, as well as the improvement because of the investments we made in Rousselot in relationship to the college and peptide fit into that basic theme, we have Rockstar products that we are the leading edge producers in the world. And we are continuing to extend our advantage on those 2 critical trends that we see is moving positively forward.

My follow-up -- and we get this question quite a bit. As whether it's from your rendering or from the used cooking oil as your products become more valuable. Does that change your the protein plants and how they look at it and they want to take value from you? Or how does that negotiation go going forward? Just because now there's this new big, huge end market and they must realize that there is value there.

Yes, Ben, we -- this is Randy. We get that question all the time. And it's a fair question to ask. The model that we built into this thing 20 years ago was a sharing model. We needed to decommoditize or take some of the risk out so that we could put fair credit lines underneath it to build and grow the company. And so with our very large suppliers, these are very transparent agreements that share the upside and protect us on the downside with basically a fixed margin processing fee.

So we're hearing no pushback in a joking sense, if you want, then we get that question where we'd like to have a little more of some of that benefit out of Diamond Green Diesel. That's when John Bullock asked him for $1 billion. So they can be part.

But end of the day, the formula is going to protect us. They share with these guys. And from just a pure philanthropic standpoint, we are obligated to -- in my sense, and my responsibility to give back to the raw material guys as much money as we can to help them grow because if they grow, we grow. And so this thing is a very dynamic thing. We're under no pressure in the world to deliver anything. We continue to be very opportunistic and very aggressive in the used cooking oil business around the world. And I think we're in good shape.

John, anything you want to add that I'm missing there?

No, I think you hit it exactly.

The next question comes from Ken Zaslow of Bank of Montreal.

Did you say that you have yet to buy for the Port Arthur facility yet? And does that mean that the Feed business is still not fully enjoying all the profitability that could come with the higher rendering values? I just didn't understand that exactly. Just trying to make sure.

Yes. No, what I'm trying to say is we're nearing mechanical completion down there. We're not there yet. Logistics will start. We got a fourth quarter start-up. So with the fourth quarter start-up, you'll start buying towards the end of the third quarter. While you may own some on paper until the logistics start to flow, then the market doesn't see it. I mean this is where we're trying to remind people on or about the start of Q4, we will be procuring 70% of North America's waste fats and greases. We're not there yet. We're just starting.

So I think it will end up -- it will move some, then it's going to non-traditional markets and other markets. Clearly, DGD2 is an importer from around the world. clearly, part of our FASA acquisition was already a supplier into DGD2, so I think at the end of the day, it's -- while we've seen palm oil prices come down around the world, we've seen soy and a bit of sympathy to that, our prices are really holding firm. We're working through summertime issues right now, but I'm fairly friendly and at least supportive to that going back into the feed segment. John Bullock, anything you want to add to that?

No, I think that's right. I mean, obviously, and this question was asked earlier as we bring each of these Diamonds on, these are huge businesses that we're starting up, and we go to 0 to 100 really quickly as we're operating those businesses. That's going to have an impact in relationship to the feedstock markets and as the supply chain has to adjust to be able to feed us the product.

But it will happen. We've seen this happen time and time again, we started at 126 million gallon run rate. And we always wonder where was the fat going to come from. We wondered that when we went to 160 million. We wondered when it went to 275 million. We wondered when it went to 400 million gallons. We wondered when it went to 800 million gallons and now we're going to go to 1.2 billion or 1.3 billion gallons. The fat is going to come because we have the best machine in the world to buy the fat.

Okay. My second question is, is there any reason that you don't generate the industry renewable diesel margin and that there's not a parallel between what we see in the market and what you generate and saying ex-hedging? It just seems like -- I understand that you said there's some hedging issues, but it seems a little bit more dramatic than differential. And I'm not sure if maybe we're miscalculating. Just trying to figure out if there's any other disconnect that we don't know about and just trying to figure that out. And that would be very helpful.

So Ken, this is Sandy. So I think that other folks in the industry, they often talk about capture rates and capture rates in my mind, are really looking at the spot market. And that's really not what we do at DGD. So if you think about our supply chain, we're buying our feedstocks months in advance. And what we can choose to do is we can choose to let that ride and not hedge it and when we hedge, what we do is we lock in the feedstock price, and we would sell a heating oil contract to kind of lock in the margin between the 2.

So we can either let it ride or we can hedge it. We choose to hedge it. And what that hedge does is it protects us from downside adjustments in terms of diesel prices. And so what I think you see is that our margins don't necessarily look like the capture rates because we can never look like the capture rates because we're not operating in the spot market. by virtue of our supply chain and the feedstock is having to be purchased ahead of time. And so I think really that's what you're seeing.

And I think what you saw during Q2, as you saw that prices throughout the quarter, diesel prices generally increased. And so what that means is when you unwind your hedge, you're always buying back generally at a higher price. That's okay because you're on the other side of things, when you're selling out your renewable diesel, you're also getting a higher price in terms of your revenue.

Those 2 things tend to offset each other, and so you end up with your hedge price. And so the hedge is not a bad thing. It doesn't look as great during a time when you have high rising prices -- but now as we're moving into Q3, what you're seeing is you're seeing prices, the diesel prices decrease. And so you should see the opposite effect when that happens. So I think that there's a little bit of a disconnect between capture rates and how we actually look at our business.

So right now, you would actually be in third and maybe fourth quarter, you'll be actually higher than the 170-ish that we're seeing? Is that kind of what you're saying? It depends on how the hedges are going? But is that...

It will all depend on where diesel prices end up.

Yes. Clearly, Ken, the heating oil curve has flattened from where it was. And that -- the inverses that we saw in all commodities were as steep as anything ever seen in history. So trying to hedge in that environment was incredibly difficult. And it looks like from what I see now on paper, that's leveled off and spot margins will be -- tend to be closer long term if it stays that way than they've been in the past.

The next question comes from Matthew Blair of TPH.

Could you talk about the expected feedstock mix for DGD3? And how much of this will be sourced internally from Darling? And how much will you have to pick up from external third-party suppliers?

So I think you would tend to see that our feedstock mix would be about the same. We're probably going to be a little bit heavier in terms of your yellow greases your tallows, just by virtue that there's more of those available. And so I think you expect that in terms of internally sourcing, at DGD we don't necessarily rely on Darling or Valero to provide corn oil. And so I don't think that there's a set percentage. It's going to be whatever price is the best price in the market and that's who DGD is going to buy from. So I don't know what that percentage will be.

No. I mean clearly -- Matt, this is Randy. And at the end of the day, as John was reflecting back, a small portion or 1/3 of Darling went to basically 1 and 2 it moved up to a little over half now. And with Valley and FASA, it's probably going to move up more. Clearly, the numbers, the law of big here says it has to go there. It will be the best market.

Now keep in mind, it's an arm's length relationship and the procurement teams are obligated to maximize profits and profits are defined as both output price and quality. And so end of the day, there's always going to be arbitrage opportunities. That's what we love about the business for some of our products. And many of the Valley production was being exported. That's now being redirected into their they weren't set up to load railcars. So when I made my comments about operational challenges and efficiencies, that's what I'm talking about.

And it's easy to send a truck to a tank terminal in Norfolk and now you got to load a railcar. That will all happen over time, and that will put more and more of Darling's product in here. I mean we're not fearful at all of originating to support number 3 here. The team has been traveling the world. And as John has always said, the moat around the business is that we can procure domestically and internationally with the ease.

And so at the end of the day, you'll see probably a lot more come in on the water to us than in the past, and that will help regulate the right product mix for both quality and price into the unit that no one else will have. I mean you're not going to originate Chinese UCO, and move it to RDs in New Mexico. That doesn't make sense. So it's an amazing advantage that the facility is going to have.

Sounds good. And then on the current feedstock mix for DGD it looks like at least on paper, RD from soybean oil actually looks pretty good here. And I know you have your advantages on the low CI feeds. But I was curious, have you been switching to any soybean oil feedstocks currently at DGD.

Yes. So I don't think that we're really going to talk about our current feedstock mix. What we do is we focus on waste stocks. And if opportunistically, it makes sense to occasionally do soybean oil, we would consider doing soybean oil.

Yes, I think that's fair, Matt. I mean at the end of the day, the focus is a super high percentage of waste fats and oils. People always have to remember that 40% of the soybean oil production in the U.S. ends up in energy anyway. So from time to time, we may arbitrage a few trucks or a few railcars in. But at the end of the day, our focus is waste fats and greases driven because of CI content.

This concludes our question-and-answer session. I would like to turn the conference back over to Randy Stuewe for any closing remarks.

Thanks, again, everybody. Appreciate your time and hope everybody stays safe and have a great summer and get the kids back to school. I look forward to seeing you at some of our upcoming events listed in the earnings presentation and look forward to talking to all of you soon. Thanks, again.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.