Diamond Green Diesel

Diamond Green Diesel (DGD) is a major producer of renewable diesel and a joint venture between two powerhouse companies: Valero Energy Corporation, a giant in traditional oil refining, and Darling Ingredients Inc., a global leader in creating sustainable food, feed, and fuel ingredients. DGD takes waste materials like used cooking oil, inedible corn oil, and animal fats and, through a sophisticated refining process, transforms them into a high-quality, low-carbon fuel. This fuel is chemically identical to petroleum-based diesel and can be used in any modern diesel engine without modification. This makes it a “drop-in” fuel, a significant advantage over its cousin, biodiesel, which often needs to be blended and can have compatibility issues. As one of the largest and most efficient renewable diesel producers in North America, DGD is at the forefront of the energy transition, turning what was once considered garbage into a valuable, cleaner-burning fuel.

The magic of Diamond Green Diesel lies in its brilliant structure, which combines the strengths of its two parent companies. For a value investor, understanding this synergy is key to appreciating DGD's competitive edge.

Think of DGD as the successful offspring of a perfect marriage. Each parent brings something essential to the table, creating a business that is stronger than the sum of its parts.

• Valero Energy (VLO): The refining expert. Valero provides world-class operational know-how, managing the complex chemical processes required to produce renewable diesel at a massive scale. It also brings its colossal logistics and distribution network, ensuring the final product can get to market efficiently and sold at premium prices. Valero's involvement represents a smart pivot by a traditional energy company into the future of fuel.
• Darling Ingredients (DAR): The feedstock supplier. Darling’s core business involves collecting and processing organic waste, including the very fats and oils that DGD uses as its raw material. This provides DGD with a reliable, cost-advantaged, and vertically integrated supply chain. While competitors scramble to buy feedstock on the open market, DGD has a secure line to its most critical input, insulating it from price spikes.

From a value investing standpoint, DGD exhibits several signs of a high-quality business with a durable competitive advantage, or Moat.

The primary moat comes from the partnership itself. Darling's control over feedstock and Valero's operational and logistical muscle create a one-two punch that is difficult for competitors to replicate. This structure leads to:

• Cost Leadership: Access to a secure, low-cost feedstock supply combined with massive economies of scale means DGD can produce renewable diesel cheaper than most of its rivals. In a commodity business, the lowest-cost producer almost always wins.
• Operational Excellence: With Valero running the plants, DGD's facilities are among the most efficient and reliable in the industry, maximizing output and minimizing downtime.

DGD's profitability isn't just about selling fuel. It's supercharged by a cocktail of government incentives designed to promote cleaner energy. Understanding these is crucial:

• Selling the Fuel: The base layer of revenue comes from selling renewable diesel, which often commands a premium price over conventional diesel.
• Government Credits: This is where the real magic happens. DGD generates significant value from environmental credits, including:
  1. The Blender's Tax Credit (BTC): A straightforward tax credit for every gallon of renewable fuel blended.
  2. Renewable Identification Numbers (RINs): Tradable credits created under the US Renewable Fuel Standard. Oil refiners must buy these credits if they don't blend enough renewable fuel themselves.
  3. Low Carbon Fuel Standard (LCFS) Credits: A lucrative credit system, primarily in California, that rewards producers of low-carbon fuels. The lower the carbon intensity of the feedstock (like used cooking oil), the more credits you earn.

No investment is without risk, and DGD is no exception. While the business is robust, investors should keep a close eye on a few key areas.

• Regulatory Risk: DGD's stellar profitability is heavily reliant on the continuation of government tax credits and programs like the LCFS and RINs. A change in political winds or legislative priorities could reduce or eliminate these incentives, significantly impacting the company's bottom line.
• Feedstock Volatility: While the Darling partnership provides a huge advantage, DGD is not completely immune to fluctuations in the price and availability of waste fats and oils. As more companies enter the renewable diesel market, competition for these feedstocks could intensify, driving up costs.
• Growing Competition: The attractive returns in renewable diesel have lured many new players into the market. A future wave of new capacity could lead to an oversupply of the fuel, which would put pressure on both fuel prices and the value of environmental credits.

Here’s the catch: You can't buy shares of “Diamond Green Diesel” directly on a stock exchange because it is a private joint venture, not a publicly-listed company. However, you can gain direct exposure to its success by investing in its publicly traded parent companies. Your choice depends on what kind of business you'd rather own.

• Buy Valero Energy (VLO): Investing in Valero gives you a piece of DGD, but also ownership of Valero's vast traditional oil refining and marketing business. This is a play on a legacy energy giant that is smartly diversifying into renewables. Your investment is a blend of old and new energy.
• Buy Darling Ingredients (DAR): Investing in Darling also gives you a piece of DGD, but your primary ownership is in a global “green” ingredient company. This is a play on the circular economy—collecting waste and turning it into valuable products for food, feed, and fuel.

To decide which path is right for you, an investor should analyze the fundamentals of both Valero and Darling to see which company's overall business model and valuation best align with their investment philosophy.