Tuesday, November 09, 2010

Waste Not

Taking investors by surprise, Darling International (DAR: NYSE) announced its plans to buy Griffin Industries (private), a major cooking oil and food by-products collector in the southeastern region of the U.S., in a deal valued at $840 million. In a conference call with investors Darling management was nearly effusive as they detailed their rational behind the deal that will propel Darling into the number one position in the country as an independent food by-products recycler and give the company a truly national-scale platform.

Darling expects to close the deal by mid-December 2010, assuming the Justice Department throws no wrench in the works in the review required by Hart-Scott-Rodino. The terms will require the issuance of about 10 million shares of Darling common stock and debt financing totaling $870 million (only a portion of a $320 million revolver will be used initially).

Investors will see much higher leverage and some may question the added risk. In our view, Darling is making the right move in acquiring Griffin rather than letting Griffin go to help build the profile of a competitor. Griffin was apparently put up for sale as part of a succession plan and divestiture by the founding family. As our mothers taught us - waste not, want not - and Darling could not pass up this unique opportunity to expand its geographic presence, capture market share, and build its product portfolio.

A map of the Darling and Griffin facilities demonstrates that there is very little overlap or duplication in collection points or processing facilities. While the family that founded Griffin Industries is cashing out through this deal, Griffin management is expected stay on board. Darling CEO Randall Stuewe made the point during Darling’s conference call that integration plans call for a transfer of best practices between both companies. If that comes to be, we expect none of the usual post-closing problems that sometimes torpedo the most compelling deals.

More important than physical presence, the combination creates a more diversified supply chain in the rendering, food by-products sector. Darling has been reliant on the cattle business in the mid-western states. Griffin will offer access to the poultry industry in the southeast and strong relationships in the bakery products supply chain. We note that Griffin also has a growing portfolio of proprietary high-margin finished products.

Investors will have to wait for filings with the SEC to see details on Griffin’s financial performance, but Darling offered revenue and EBITDA figures for the year 2009. Griffin turned out a 21.7% EBITDA margin on $525 million in sales. This compares to Darling’s EBITDA margin of 16.9% on the $638 million Darling reported in the twelve months ending June 2010. Griffin’s higher margins can be attributed to its proprietary finished goods in the sales mix as well as formula pricing arrangements for all its raw materials.

The deal promises to double Darling’s size at the top-line, but Griffin’s profit contribution will be cut by interest expense on the higher debt level and amortization of the inevitable intangibles that get created by purchase accounting. Without relying on revenue growth through economic recovery or capture of market share through synergies in the combination - both of which are expected - we estimate Darling could report an estimated $222.0 million in EBITDA on $1.2 billion in sales in 2011. Allowing for incremental amortization expense and interest charges, we estimate net income of $88.0 million or $0.95 per share (92.5 million shares outstanding following the deal).

At the Company’s current ratio of 17.7 times trailing earnings, our estimate implies a present value of $16.80 per share.
 If the deal closes before the end of the year as Darling plans, the first quarter 2011 will be the first period Griffin is expected to contribute meaningfully to Darling’s P&L although the balance sheet effects will be reported in Darling’s year-end 2010 report.

We believe Darling management is capable of handling the expansion and that the combination will afford substantial growth opportunities as Darling builds out its upstream supply of waste oils and fats for the renewable diesel industry. Darling and its partner Valero (VLO: NYSE) are crafting plans to meet Department of Environmental Protection requirements to qualify for loan guarantees that will support construction of renewable diesel facilities at one of Valero’s refineries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. Crystal Equity Research has a Buy recommendation on DAR.


No comments: