2023-10-13 12:37:49 ET
Summary
- Tractor Supply Company is outperforming Home Depot due to its focus on rural customers, less cyclical product portfolio, and aggressive expansion strategy.
- TSCO reported growth in net sales and comparable store sales, despite weak consumer sentiment and inflation concerns.
- The company is expanding its addressable market and increasing its store target, while also implementing cost-saving measures and maintaining a healthy balance sheet.
Introduction
This morning, I came across a tweet of someone sharing a CNBC headline from 2021 that brought back some memories.
Remember when inflation and rates were close to zero percent, and central banks were pumping trillions into the market?
It led to people spending MILLIONS on pictures of rocks, so-called "nonfungible tokens."
Here's a quote from the article:
The run-up in sales price coincides with a wider surge in NFTs, which are blockchain-based tokens signifying ownership of a digital asset. For example, some people are buying digital images of apes and changing their Twitter images to signify membership in the Bored Ape Yacht Club.
Fast-forward to 2023, we're in a situation where most of these pictures are worthless again, showing that when money is cheap (rates are low), people tend to make stupid mistakes, especially people who have gotten too rich, too quickly.
Back then, I was buying dividend stocks. In early 2020 and 2021, I was underperforming the market by a mile, as everyone was piling money into hyper-growth stocks, crypto, and pictures of rocks and monkeys.
The good thing is that I never regretted staying far away from these hyped investments, as I have outperformed the market since 2020, thanks to the realization from the market that investing in high-quality stocks is the best way to go.
One stock I wish I had bought back then is Tractor Supply Company ( TSCO ) , a smaller, rural version of Home Depot ( HD ).
Home Depot was one of my first investments in 2020 (when I got serious about dividend investing). While I believe that Home Depot is one of the best dividend growth stocks money can buy, Tractor Supply is outperforming Home Depot.
Since 2018, TSCO shares have consistently outperformed Home Depot, backed by benefits that the big guys don't have. This includes a focus on rural customers, a less cyclical product portfolio, and an aggressive expansion strategy.
In this article, I'll elaborate on all of this. Since I wrote an article titled The Tractor Supply Company; Cashing In On Happiness , we have gotten a lot more data to work with, as the company presented at the Goldman Sachs Annual Global Retailing Conference last month, giving us valuable insights into its strategy to expand and keep outperforming its peers.
So, let's get to it!
TSCO Excels Through Its Rural Focus
In my last article, I used statistics showing that people are the most happy in a place of worship and the outdoors.
The outdoors is exactly the market that TSCO targets.
For the people who are new to TSCO, the Tractor Supply Company is the leading rural lifestyle retailer in the United States, serving the needs of recreational farmers, ranchers, and everyone living the rural lifestyle.
The company operates under various store names, including Tractor Supply Company, Petsense by Tractor Supply, and Orscheln Farm and Home.
Tractor Supply Company
These retail stores are predominantly located in towns surrounding major metropolitan markets and rural communities. Tractor Supply also offers an extended product assortment online through its mobile application and websites.
As of December 31, 2022, Tractor Supply operated 2,333 retail stores across 49 states, including Tractor Supply retail stores, Petsense by Tractor Supply retail stores, and Orscheln Farm and Home retail stores.
Unsurprisingly, Tractor Supply has a comprehensive product assortment tailored to cater to the rural lifestyle. This includes equine, livestock, pet, and small animal products, hardware, tools, seasonal items, clothing, and maintenance products.
USD in Million | 2021 | Weight | 2022 | Weight |
---|---|---|---|---|
Livestock and Pet | 5,984 | 47.0 % | 7,102 | 50.0 % |
Seasonal, Gift, and Toy | 2,674 | 21.0 % | 2,983 | 21.0 % |
Hardware, Tools and Truck | 2,674 | 21.0 % | 2,699 | 19.0 % |
Clothing and Footwear | 1,018 | 8.0 % | 994 | 7.0 % |
Agriculture | 382 | 3.0 % | 426 | 3.0 % |
Furthermore, the company's exclusive brands, constituting a significant portion of its sales, contribute to customer loyalty and offer alternatives to national brands.
So far, this strategy has protected the company against extremely weak consumer sentiment.
This is what consumer sentiment looks like:
While we're off the lows, the situation remains dire - especially as 80% of households have run out of excess savings in an environment of elevated inflation.
Nonetheless, TSCO keeps performing well.
In the second quarter, Tractor Supply reported a 7.2% growth in net sales and a 2.5% increase in comparable store sales.
This growth was driven by a 1.8% increase in transaction growth and a 0.6% increase in ticket growth. Notably, comp transactions turned positive, and this trend continued into Q3.
During its earnings call, the company made clear that it was negatively impacted by shifting consumer spending towards services and a pullback on discretionary purchases due to inflation concerns.
Abnormal seasonal trends, notably in June, further affected the business.
Despite this, Tractor Supply anticipates a solid 2023, with healthy customer metrics and a focus on gaining market share.
As a result, the company's 2023 outlook projects low-single-digit comp sales growth and mid to high-single-digit earnings growth, which is very good in this environment.
Having said that, during this year's Goldman Sachs conference, the company elaborated on all of this, giving us new insights and comments to work with.
The company started by making the case that Tractor Supply made substantial progress with its Life Out Here strategy, including store remodels, integrating the Orscheln acquisition, supply chain improvements, and digital enhancements.
TSCO also mentioned that bigger ticket categories account for approximately 15% of its revenue. Now, it is witnessing a shift in consumer spending from goods to services, fueled by declining savings rates, higher credit balances, student loan payments, and higher mortgage rates.
Bloomberg
The future of discretionary spending remains uncertain, with various pressures potentially affecting the growth trajectory.
In addition to offering a larger variety of non-cyclical items compared to other retailers, Tractor Supply emphasized its commitment to offering everyday low prices and being competitive in the market.
It pointed out that the recent inflation was unique, driven not only by commodity prices but also by factors like rising freight and fuel costs, wage pressures, and declining productivity in the manufacturing sector.
The company experienced high inflation due to the large volume of consumable products it sells but is seeing signs of moderation. The primary challenge now is focused on units per transaction as consumers become more cost-conscious.
With that in mind, while TSCO is adjusting to a challenging economy, its addressable market ("TAM") is rising, thanks to its strategy on unique consumers.
The TAM expanded to approximately $180 billion from $110 billion in a span of 18 months. This increase was attributed to growth in the market and the strategy of building garden centers and adding new categories like live goods and pet services to the TAM.
The company's TAM now represents roughly 8% of the market, and the potential for further growth remains substantial.
In other words, by using its existing base to offer complementary services and products, the company is attracting a much bigger crowd.
Related to this, the company decided to increase its long-term store target from 2,800 to 3,000 stores in the United States. This decision was based on analyzing customer data, especially the influx of new consumers embracing a rural lifestyle.
Regarding cannibalization risks, they've seen positive results from adding stores near existing ones, often resulting in the rebound of the original store.
In order to expand more efficiently, Tractor Supply Company unveiled a strategic shift in its real estate approach, incorporating a blend of fixed fee development alongside the conventional build-to-suit model.
This change was fueled by the goal to mitigate risk and reduce costs associated with store construction. The fixed fee development model involves in-house expertise and lower capital infusion, resulting in a 10% to 20% cost reduction in new store construction.
The reduced costs enable the company to effectively lower rents, aligning with their commitment to being competitively priced in the market and enhancing overall operating margins.
Additionally, Tractor Supply Company announced a sale-leaseback strategy involving a small portion of its owned stores, approximately 5% of the total store count.
This innovative strategy is designed to align with the company's asset-light retailing approach.
By leveraging these owned stores and converting them into liquid capital through sale-leaseback agreements, the company can fund the development of new stores, particularly under the aforementioned lower-cost fixed-fee model.
Essentially, companies who engage in sale-leaseback strategies sell buildings to a landlord and then lease these buildings back. It frees up cash for new projects. However, it also means the company is adding fixed monthly recurring rent costs.
Shareholder Returns & Valuation
Despite its aggressive expansion, TSCO has a healthy balance sheet. The company is expected to end this year with $1.5 billion in net debt and gradually lower this number to $1.4 billion in 2025.
This translates to a consistent net leverage ratio below 1x EBITDA.
Thanks to this healthy balance sheet, the company has ample room to distribute cash to shareholders.
Currently, TSCO pays a $1.03 per share per quarter dividend. This translates to a yield of 2.1%. This dividend is backed by a 4% free cash flow yield, implying a cash payout ratio of roughly 50%.
Leo Nelissen (Based on analyst estimates)
Although one might make the case that a 2.1% yield isn't very high (it isn't), the dividend has grown by 28% per year over the past five years.
On top of that, over the past five years, TSCO has delivered outperforming total returns, beating its peers and the market by a wide margin.
Another factor of consistent outperformance is buybacks.
Over the past ten years, TSCO has bought back 22% of its shares.
Valuation-wise, TSCO remains attractive. After dropping 12.5% this year, the stock is now trading at 12.2x EBITDA.
Over the past ten years, the median valuation was close to 13-14x EBITDA.
Given that TSCO is expected to maintain high-single-digit annual EBITDA growth, I believe that a longer-term multiple of 13x is justified.
Leo Nelissen (Based on analyst estimates)
Applying a 13x multiple, we get a fair value of $248 per share. This is 26% above the current price and roughly in line with the current consensus price target of $246.
Leo Nelissen (Based on analyst estimates)
While I will give TSCO a buy rating, readers need to be aware that this is a longer-term rating.
I do not rule out more stock price weakness, especially in light of a renewed rebound in inflation and elevated oil prices.
The Fed is likely to do more damage, which could result in a steeper correction to the $160 to $170 area.
If that happens, I'm very tempted to buy TSCO, as it would make a great holding next to my HD investment.
Takeaway
In the realm of prudent dividend growth investing, Tractor Supply stands out.
Their dedicated focus on rural markets has proven to be a winning strategy.
Offering a wide range of products tailored to the rural lifestyle, including livestock and pet supplies, seasonal items, hardware, and clothing, has fortified its position in the market.
What's noteworthy is TSCO's astute attention to its Total Addressable Market, which has expanded significantly. By strategically adding new categories like live goods and pet services and building garden centers, they've attracted a broader customer base.
This has led them to increase their long-term store target, aiming for 3,000 stores in the United States.
Additionally, their sale-leaseback strategy, balanced financials, consistent dividend payments, and robust buyback initiatives make TSCO an appealing choice for long-term investors.
Considering the company's growth prospects and attractive valuation, TSCO emerges as a promising investment, positioned for potential long-term outperformance.
For further details see:
Dividend Investors Take Note: It Doesn't Get Much Better Than The Tractor Supply Company