2023-09-12 03:09:05 ET
Summary
- Founded during the Great Depression, Tractor Supply has endured countless recessions, wars, and pandemics.
- The company's sustainable dividend payout ratio is going to remain largely unchanged from 2022 to 2023.
- The niche retailer has posted solid financial results through the first half of 2023.
- Using my assumptions in the discounted cash flows model and dividend discount model, I estimate that shares of Tractor Supply are trading at a 3% discount to fair value.
- Tractor Supply's 1.9% dividend yield, high-single-digit annual earnings growth potential, and reasonable valuation could offer strong returns for dividend growth investors.
As an almost entirely dividend growth-focused investor, my goal is to fill my portfolio from top to bottom with steadily growing businesses that possess robust fundamentals. That's because such characteristics support my goal of building a portfolio that can consistently deliver growing passive income to yours truly.
Among the 100-plus businesses that I own in my portfolio, Tractor Supply ( TSCO ) is one holding. Let's further examine the company's fundamentals, risks, and valuation to understand the buy case for dividend growth investors.
A Robust Dividend Growth Track Record
If you are focused on income over growth, Tractor Supply's 1.9% dividend yield doesn't make it the flashiest dividend stock. This is because the 1.5% yield of the S&P 500 index is nearly as much.
However, if you're looking for slightly above-average income with exceptional growth, Tractor Supply may be right for you. In the last 10 years, the company's dividend has compounded at a blistering 24%+ rate annually .
Growth of this magnitude is likely in the past. But there's no reason respectable dividend growth can't continue. The retailer generated $9.71 in diluted EPS in 2022. Against the $3.68 in dividends per share that were paid during this time, that equates to a 37.9% diluted EPS payout ratio.
After its most recent 12% dividend raise, Tractor Supply's dividends per share paid in 2023 will rise to $4.12. When compared to the analyst consensus diluted EPS of $10.30 for 2023, this is equivalent to a still viable 40% diluted EPS payout ratio.
Because the company is retaining ample earnings to expand, Tractor Supply's current payout ratio could still slightly expand over the long run. In addition, analysts expect 7.7% annual diluted EPS growth from the company for the next five years. Given that Tractor Supply has a reputation for beating analysts' expectations, this growth forecast could be a cautious one. For these reasons, I believe that an 8% annual dividend growth rate is a justifiable assumption for a business of Tractor Supply's caliber.
The Business Is Chugging Along Just Fine
Tracing its roots back to the Great Depression, Tractor Supply was formed in 1938 . Selling a wide variety of livestock feed, pet care products, agricultural products, and home improvement products to farmers, pet owners, and landowners has paid off immensely for the company. As of July 1, the company operated 2,181 Tractor Supply stores and 192 Petsense pet supply stores in the United States (per Tractor Supply Q2 2023 earnings press release ).
In the first two quarters of 2023, Tractor Supply reported $7.5 billion in net sales. For context, this was up 8% over the first half of 2022. Low- single-digit comparable store stores growth was partly responsible for this topline growth. This raises the question: How was Tractor Supply able to post such comparable store sales growth?
The answer is the company's member rewards program known as Neighbor's Club. In the past twelve months alone, Tractor Supply has added five million members to its membership base, bringing the total to 31 million as of July 1. This is helping to get more customers in its stores. Along with an additional 179 stores that have been opened since the end of the second quarter of 2022, this is fueling net sales growth for the company.
Tractor Supply's diluted EPS increased by 5.8% year over year to $5.47 through the second quarter of 2023. Since growth in expenses slightly outpaced net sales growth, the company's profit margin contracted by nearly 40 basis points to 8.1% in the first half of 2023. This downtick in profitability couldn't be entirely offset by the lower share count, which was due to share repurchases.
Expecting just under $15 billion in total sales for 2023, Tractor Supply still has room to grow. The company believes that its total addressable market stands at over $180 billion, according to CEO Hal Lawton's remarks during Tractor Supply's Q2 2023 earnings call transcript. This is why the company has upped its total Tractor Supply U.S. store count target to 3,000 - - up from 2,800.
Tractor Supply is also a financially healthy business. The company's interest coverage ratio through the first half of 2023 was over 32. This means that the retailer could easily withstand a significant downturn in its profits and remain a going concern (all details in previous paragraphs sourced from Tractor Supply Q2 2023 earnings press release unless otherwise noted).
Risks To Consider
Tractor Supply is a business that is doing quite well operationally. However, risks remain for the company.
Though not likely with the size of its market and its slow and steady approach toward store openings, Tractor Supply could oversaturate itself through too many store openings. This could weigh on the company's results in the long term.
And while consumer spending remains healthy so far, that soon may not be the case with many economists predicting a recession. This could also impact Tractor Supply's operating results in at least the near term.
A Fair Price For A Wonderful Business
Tractor Supply is a great business. But as is the case with any top-notch company, investors need to pay a rational valuation to do well. This is why I will use two valuation models to appraise the fair value of the company's shares.
The first valuation model that I'll utilize to assess the value of shares of Tractor Supply is the discounted cash flows or DCF model. This is comprised of the following three inputs.
The first input for the DCF model is trailing 12 months of diluted EPS. Tractor Supply's diluted EPS in the last 12 months is $10.
The second input into the DCF model is growth assumptions. Factoring in a 6.5% annual diluted EPS growth rate for the next five years arguably builds a cushion into the valuation because it is meaningfully below analyst predictions. And the same can be said of a deceleration to 5.5% annually in the years thereafter.
The third input for the DCF model is the discount rate. This is simply the annual total return rate that an investor requires from their investments. I will use 10% for this input.
Plugging these inputs into the DCF model, I get a fair value output of $244.87. That suggests that Tractor Supply's shares are trading at a 10.8% discount to fair value and could offer a 12.2% upside from the current share price of $218.32 (as of September 11, 2023).
The second valuation model that I will use to appraise shares of Tractor Supply is the dividend discount model or DDM.
The first input into the DDM is the expected dividend per share. This is the annualized dividend per share paid by a company. Tractor Supply's annualized dividend per share is currently $4.12.
The next input for the DDM is the cost of capital equity. Once again, I will use 10% for this input.
The final input into the DDM is the annual dividend growth rate. As alluded to earlier, I will use 8%.
Using these inputs for the DDM, I get a fair value of $206.00. This means that Tractor Supply's shares are priced at a 6% premium to fair value and pose 5.6% capital depreciation from the current share price.
Averaging these two fair values together, I compute a fair value of $225.44. That implies that shares of Tractor Supply are trading at a 3.2% discount to fair value and offer a 3.3% upside from the current share price.
Summary: Tractor Supply Deserves A Spot In A Dividend Growth Stock Portfolio
Having upped its dividend for 12 consecutive years, Tractor Supply is a Dividend Contender . Better yet, this dividend growth streak looks like it can continue for quite a while longer due to the company's manageable payout ratio and solid growth prospects.
My somewhat conservative inputs into the above valuation models demonstrate shares of Tractor Supply range from slightly overvalued to moderately undervalued. This makes the stock an interesting enough buy for investors seeking healthy dividend growth and capital appreciation for the foreseeable future.
For further details see:
Tractor Supply: A Proven Blue Chip Dividend Stock For Your Dividend Growth