Turning grease into gold

It's dirty work converting fat and animal carcasses into commodities. Few do it better than Darling International.

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NEW YORK (Fortune) -- The Romans and Phoenicians honed the practice of rendering animal byproducts to make soap, candles, and other goods. But Darling International has turned it into a science -- and a big business.

After six years of aggressively buying up the mom-and-pop shops that collect greases and fats from local restaurants and butchers, Darling (DAR) has become the largest independent renderer in the nation.

Today the Irving, Texas, company picks up grease and animal carcasses at 116,000 restaurants -- including 10% of McDonald's locations -- and slaughterhouses across the country.

"They're the biggest in their industry, as much of an oddball industry as it is," says Steve Scruggs, portfolio manager of the $30 million Queens Road Small Cap Value Fund, where Darling is a top holding.

The 127-year-old Darling boosted sales last year by 25% to $807 million, with profits hitting $55 million, to rank No. 13 on our 2009 Fastest-Growing Companies list. How did Darling find itself in the same league as sizzling tech companies more than a century younger? Thank the commodities boom.

Darling's fortunes have followed the rise and fall of animal feed prices. Farmers use its tallow, yellow grease, and meat and bone-meal products as alternatives to corn and soybeans, accounting for 95% of Darling's sales.

Trading at around $4 in 2006, Darling shares rose to $17 last year during the run-up in corn and soybean prices. After commodities crashed in late 2008, Darling shares plunged to $3 before recovering to their current level of $8.

Now Darling is eyeing a potentially lucrative new market: renewable fuels. The industrial giant Honeywell (HON, Fortune 500) approached Darling 2 years ago offering to license technology to make "green diesel" fuel using animal fats.

For 30 years biodiesel has been produced by combining vegetable oil and diesel. But as analyst Jin-Ming Liu of Ardour Capital explains, the fuel gums up engines and performs poorly in cold weather. Researchers have been studying a more efficient formula using animal fats for the 60-billion-gallon-a-year diesel market.

Since a green diesel refinery costs twice as much to build as a standard biodiesel plant, Darling sought a Big Oil partner for capital and refining know-how. It had little luck courting one. "In 2006 [oil companies] just had ethanol crammed down their throat," says Randall Stuewe, Darling's CEO. "They weren't about to talk to you about a new product that introduced more complexity into their distribution stream."

Now things are different. As part of the latest government energy act, the U.S. Department of Energy is offering loans for up to 80% of the cost to build a renewable-fuel factory. Darling just announced that Valero Energy (VLO, Fortune 500) has agreed to be a partner in its proposed $270 million green diesel plant in Louisiana. The government's final loan decision may come early next year.

"This may not be a game changer for our country, because all the animal fats and greases equate to less than 5% of the diesel we need," says analyst William Bremer at Maxim Group. "But it is for Darling."

Stuewe expects a 135-million-gallon diesel plant to produce about $90 million a year in profits -- depending on the price of crude -- and $500 million to $600 million in sales. Analysts point out that those figures don't include the probably higher market price of animal fats for Darling if millions of pounds are used for fuels.

Founded in 1882 after the Swift meatpacking family teamed up with the Darling fertilizer family, Darling nearly went bankrupt earlier this decade after the 1996 farm bill -- dubbed the Freedom to Farm Act -- cut government subsidies and allowed farmers to plant as much corn and soybeans as they could. The price of a bushel of corn fell 65% from 1996 to 2000, wiping out Darling's profits as livestock farmers bought corn instead of Darling's feed.

"The model was broke," says Stuewe. Darling reworked customer contracts to protect its margins from commodity dips, and then "we looked at the company and said, 'We ought to re-brand as a green company.' And frankly we got the trend right."

Before Darling can open a green diesel factory (September 2011 would be the latest date to start construction if it receives government help), it may face a bumpy road.

Raw material volumes are down as Americans and Asians eat less red meat and visit fewer restaurants in the downturn. The USDA doesn't forecast a recovery in consumption this year. Sales will probably take a hit.

The good news is that Darling can bide its time. "Look, restaurants are going to have to get rid of their grease, and slaughterhouses are going to have to get rid of their carcasses," says Scruggs of the Queens Road fund, who laughs as he continues with a pun: "They're in an industry that is not going to be rendered obsolete." To top of page

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