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Quick Take - Darling International (DAR)

Darling International (DAR) is the only nationwide supplier of rendering and grease trap services to restaurants, butchers, grocery stores, and other food service establishments in the United States. Basically, Darling collects waste materials and processes them into products that can be used as inputs to other industries. Finished products include: Meat and bone meal that is used to make pet and animal feed; Tallow and other oils used in the production of feed, soaps, chemicals, and bio-fuels; and hides used to make leather goods. Darling has two main lines of business. Rendering, which accounted for 72% of 2007 sales, is the business of converting waste products into usable raw materials. Restaurant Services (28%) provides grease trap services (pickup and cleaning), as well as specialized equipment for making the job of cleaning frying equipment much easier. The company runs 39 facilities including 25 rendering plants, 6 grease plants, and a number of smaller specialized sites. Darling consolidated the rendering business in a big way by purchasing National By Products (NBP) in 2007, and has driven impressive operating synergies from the acquisition.

MagicDiligence really likes a lot of qualities of this business. First of all, it's disgusting. For anyone that's ever read Peter Lynch's One Up On Wall Street, you know that he loves boring and especially gross businesses. No money manager wants to recommend a renderer to his/her clients. Second, Darling is the only nationwide renderer and grease trap servicer, giving the company scale advantages over competitors. This scale allows spreading fixed costs over a bigger revenue base, and allows it to win large contracts, such as a deal with McDonalds (MCD). Third, increased environmental regulations and a move towards alternative fuels creates a very favorable growth environment. Darling is on pace to increase revenues 30% this year with these tailwinds, increasingly leveraging their fixed costs and expanding operating margins (18% last quarter vs. 11% the year before).

Darling is in reasonably good financial shape also. The net cash/debt balance is just about nil, with slightly over $40 million dollars of each. Interest coverage is a more than comfortable 32x. Darling has used the favorable conditions for business to aggressively pay down debt. Trailing 12-month MFI return on capital is 69%, not eye popping but respectable nonetheless. Free cash margin stands at about 7.6%, again solid but not outstanding. The valuation is excellent, with earnings yield at over 18% and free cash yield close to 9%. That's phenomenally cheap for a company growing revenues and improving margins like this.

Darling just does not quite make it as a MagicDiligence Top Buy, however. The good but not great return on capital and free cash margins reveal that this is a capital intensive business. Darling has to maintain and replace close to 1,000 trucks and trailers that pick up and transport the waste materials, as well as equipment-heavy rendering and processing plants. Also, the ROIC and free cash margins are by far the highest they've been in the past 5 years. 5-year averages are a much more ordinary 29% and 4.2%, respectively. This is because Darling's revenues are dependent on the commodity prices for their output products. While I believe that recent successes can be maintained going forward (the NBP purchase was brilliant and bio-fuels are here to stay), there's no question that high commodity prices in 2007 and 2008 benefitted this company. Last, management has been fairly dilutive, with share count increasing at a 5.4% per year pace since 2003.

Still, Darling is a fine choice for do-it-yourself Magic Formula investors, especially those who like to get down and dirty!

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