Tractor Supply Company (NASDAQ:NASDAQ: TSCO) has been on my watch list for a long time, but I never managed to get it back. Just got back from the US, I came across a few stores and naturally felt inspired to Take a closer look at this niche retailer, which consistently shows a strong economy but also, more often than not, trades at a valuation premium.
Who is Tractor Supply Company?
Tractor Supply Company was founded in 1938, 84 years ago, and has served its niche of farmers, ranchers and those who appreciate the rural way of life ever since. The company operates just over 2,000 physical Tractor Supply stores in 49 states and is by far the largest retailer in its niche in the United States, focusing on meeting customer needs in the areas of home improvement, agriculture, animal husbandry, and lawn and garden maintenance. The stores usually contain more than 10,000 different products, showing the range and possibilities of satisfying customers, also operating a number of exclusive brands. Beyond its more than 2,000 Tractor Supply stores, the company also operates 178 Petsense stores in 23 states, where the core segment serves the needs of pet owners. Overall, Tractor Supply’s presence is largest in Texas, North Carolina, Pennsylvania, Tennessee and Georgia, while it is smallest in Nevada, Montana, Idaho, Wyoming and in Iowa excluding states with a very small geographic footprint.
The company itself states that its target group is owners of homes, land, pets and livestock, who generally have above-average incomes and below-average living expenses. The business has seen a shift in demand since the onset of Covid-19 with customers focusing on caring for their home, land and animals which has resulted in an increasing demand on Tractor Supply Company.
Current construction of a new 900,000 square foot distribution center in Ohio, with an additional distribution center planned for Arkansas, is expected to be completed in 2023. In 2020, the company opened eighty new stores TractorSupply. , as well as nine new Petsense stores. Likewise, in 2021, an identical number of Tractor Supply stores were opened, along with seven new Petsense stores. Unsurprisingly, the company expects to have launched 75-80 new Tractor Supply stores in 2022, supported by ten new expected Petsense stores. All of these new stores are the equivalent of expanding the company’s square-footed retail footprint by 4% per year. Of all these stores, approximately 57% are freestanding buildings, with the rest located in shopping malls, while 95% of the stores are leased, meaning the company owns the remaining 5%.
Although we generally classify retailers as either basic or discretionary, my conclusion is that Tractor Supply falls somewhere in between. Many commodities are core expenses (as they support livestock and the like), while others are discretionary in nature (equipment and machinery, as existing assets may last an additional season if maintained) . Additionally, customers can opt out of the more expensive and exclusive brands during tough times. In addition to this, Tractor Supply is exposed to similar risks as other retailers covering competitors, supply chain, brand damage, data security, failed acquisitions and others. However, it is important to keep in mind that Tractor Supply is not new to its field. It has been around for ages and has continued to provide a profitable business ever since.
If we turn to the actual economic performance, it quickly becomes clear that the business has indeed thrived in recent years, with strong development in turnover and earnings, as also mentioned earlier regarding management’s own observations during the Covid-19 period.
- Revenue grew 27% in 2020 and 20% in 2021.
- In both years, net income exceeded revenues as it increased by 33% in both years.
- This enabled strong dividend increases of 10% and 38% respectively.
Forward consensus estimates for fiscal 2022 are, however, well below what shareholders have grown accustomed to over the past two years, with revenue expected to reach $13.98 billion, an increase of 9.8 %. For fiscal year 2023, expected revenue growth is 6.34%. EPS growth is expected to slightly outpace revenue at 11.4% and 8.8% respectively.
I’m a dividend growth investor, and here Tractor Supply is very promising. However, my own threshold for determining when a company is worth adding to the portfolio from a dividend growth perspective is not met in the case of this company. These questions are individual, but I strive to add companies with a starting yield of 2.5%, with a payout ratio of less than 60%. Naturally, I deviate from this rule from time to time, as in the case when I picked up Visa (V) in 2016. I deviated from the rule because Visa has a clear growth track ahead of it at scale , which means that the initial dividend yield of 0.7%, over decades, can accumulate strongly. Tractor Supply also has enough headroom to grow its dividend for many, many years, but being able to only expand its square foot sales footprint by about 4% per year naturally imposes some limitations over time. . Therefore, requiring the initial yield to be higher, in order to meet the inevitable penny hikes down the road with a strong current yield. As such, Tractor Supply’s historical performance does not sit well with me.
To end this section, there is no doubt that having held Tractor Supply lately has been a great addition to his portfolio. While retail is down 26.4% year-to-date, Tractor Supply and the S&P 500 are down almost the same amount, at around 14%.
Strong Q2 performance and FY22 guidance up
The company delivered a very satisfying Q2-2022, narrowly exceeding Wall Street expectations.
- Q2-22 revenue of $3.9 billion, versus $3.6 billion year-on-year, driving revenue growth of 8.3%.
- EPS was $3.53 versus $3.19 a year ago, representing growth of 10.7%.
- In the first half of 2022, revenues totaled $6.93 billion versus $6.39, representing growth of 8.5%.
- Comparable store sales increased 5.5% from 10.5% a year ago, but remain satisfactory.
Based on revenue, management raised the FY22 guidance to $13.95 billion – $14.05 billion, with a Wall Street consensus expectation of $13.79 billion. Operating margin for the first half of 2022 was 11.1%, with management expecting operating margin for the full year to reach 10.2%. If this proves to be the case, it will mean that the operating margin for 2022 will be above the 3-year and 5-year median, at 10.1% and 9.6% respectively.
Quite impressive, showing how management was able to fight inflation through both efficiency and price adjustment means, not the usual picture we saw in the sale segment at detail. However, we may still have the toughest quarters ahead of us this year, but the company is impressing so far in 2022.
Rating – Hair in the soup
Management is running a tight and very profitable ship and I don’t see Amazon (AMZN) going through and stealing the business under Tractor Supply Company. Tractor Supply’s neighbor rewards club grew its membership 24% year-over-year to more than 26 million members. There is a large and loyal cohort of customers who want the presence and information provided by Tractor Supply staff, which is not the business model of a company such as Amazon. Likewise, Tractor Supply has its own digital strategy and channel, catering to customers who expect this type of interaction.
Return on invested capital is 35.6%, never falling below 22% over the past decade. Remember, this is a retailer with real inventory and assets, not your internet software retail giant that can print out software licenses as if nothing happened, with very high gross profit margins as a result. From a financial point of view, Tractor Supply has mastered its niche very well, promoting a company that is deeply relevant to its customers.
Quality never comes cheap, and that’s the case for this company too.
Above is the reason why I never managed to buy Tractor Supply, it rarely trades at a discount, with an average 5-year and 10-year P/E of 22.5 and 25.1 respectively. Quite high for a retailer, whose revenue grew at the same rate as GDP until Covid-19 arrived, and with a forward consensus estimate of revenue once again growing at a mid-digit. This is still very good for a retailer, but also for one with a fairly large presence in their market, allowing them to increase square foot sales by around 4% per year. Even today, on the cusp of a potential recession, the stock continues to outperform its peers, and enough so given the company’s year-to-date performance, but it doesn’t seem be a lot of stress in the current valuation.
Looking at the stock from a price to sales perspective, we see a similar situation. The stock finds itself roughly at its long-term median from a forward-looking perspective.
Tractor Supply will release its Q3-2022 results on October 19, after receiving 6 upward revisions and 16 downward revisions in the past 90 days. The company is doing well, but I believe it will not escape the impact if the current economic difficulties continue, ultimately affecting its customers, causing them to withhold spending.
Tractor Supply is a great company worth owning, but as investors we need to separate the company from its stock, and in my opinion the stock does not reflect the current economic environment in which the world lies.
For now, I will remain patient and see if a better opportunity arises in the later parts of the year.