2023-10-06 17:41:09 ET
Summary
- Tractor Supply Company has implemented a successful strategy to cater to rural customers, staying ahead of competitors like Amazon and Home Depot.
- The company has maintained its gross margin despite rising raw material costs, but headwinds such as increased competition and climate could impact future profitability.
- Tractor Supply Company plans to open 80 new stores, support its omnichannel strategy, and integrate its recent acquisition of Orscheln Farm & Home stores to maintain its competitive advantage.
Tractor Supply Company (TSCO) has positioned itself to be a leader in the rural retail marketplace. They have implemented an effective strategy to cater to their rural customers for DIY items perfect for farmers, horse trainers, mechanics, and more. This focused strategy has allowed them to stay ahead of competitors such as Amazon (AMZN) and Home Depot (HD) who are broader in the customers they target.
Aside from this strategy to increase sales, Tractor Supply Company has also continued to look for cost savings opportunities to be a cost leader. As inflation has risen so has the raw material costs for pet food and livestock feed, Tractor Supply’s main product accounting for fifty percent of its sales. Even with these increased costs, Tractor Supply Company has maintained its gross margin on its products. This continued growth and reduced cost strategy continue to position the company well, even though challenges continue to present themselves.
Headwinds that could impact the long-term potential of the company must be considered when determining a proper valuation. The retail market for DIY and pet food continues to get more competitive. Amazon, Chewy, and Home Depot all pose a major threat to Tractor Supply Company. Raw material prices and increased costs throughout the logistics network could potentially eat into the company’s gross margin numbers in the future. Climate change can also impact the timeframes of the raw material delivery which will impact the food and livestock product supply for their customers. So far, these headwinds have not impacted Tractor Supply Company’s growth, however, these could eventually impact long-term potential gain in the stock.
The recent financial guidance from the company continues to suggest a strategy for growth. The company plans to open 80 new stores in 2024, eventually hoping to reach its goal of 3,000 stores in the future. Tractor Supply Company will continue to support its omnichannel strategy to compete with Amazon, which it sees as its biggest competitor. Finally, Tractor Supply Company is looking to complete the integration of its recent acquisition of Orscheln Farm & Home stores into the company brand. Aside from these strategies, the company will continue its cost reduction efforts and has made a sizeable commitment to becoming more sustainable with water as well as zero emissions goals. These goals should help Tractor Supply Company maintain its competitive advantage against its increasing competition in the industry.
When considering these current stories about Tractor Supply Company, we need to determine which news topics will have a long-term and ongoing effect on the company and its share price. Tractor Supply Company has many strengths supporting its continued growth and excellence. Impactful strategies and effective market understanding have insulated Tractor Supply Company from competition. Though these competitors still pose a threat, if the company can maintain its cost leadership and brand for its niche customers, Tractor Supply Company should be able to maintain its growth.
Rising inflation impacting material costs seems to have not hurt the gross margin of the company yet, but still poses a threat to future cost increases impacting profitability. Current guidance continues to be strong in an environment of customer spending decline, showing the resilience of the company to recession. Overall, there seems to be more potential for growth at Tractor Supply Company.
While current news stories, good or bad can sway our opinion about investing in a company, it's good to analyze the fundamentals of the company and to see where it's been in the past and in which direction it's heading.
This article will focus on the long-term fundamentals of the company, which tend to give us a better picture of the company as a viable investment. I also analyze the value of the company versus the price and help you to determine if Tractor Supply Company is currently trading at a bargain price. I provide various situations which help estimate the company's future returns. In closing, I will tell you my personal opinion about whether I'm interested in taking a position in this company and why.
Snapshot of the Company
A fast way for me to get an overall understanding of the condition of the business is to use the BTMA Stock Analyzer’s company rating score. Tractor Supply Company shows a great rating, a score of 87 out of 100.
Before jumping to conclusions, we’ll have to look closer into individual categories to see what’s going on.
Fundamentals
Aside from an outlier year in 2017, the stock price has risen year over year. The continued sales growth and profitability of the company are drivers of Tractor Supply Company’s stock growth over the years. Even with consumer purchases declining in the current macroeconomic environment, sales continue to grow at the company. Overall, the share price average has grown by about 274.68% over the past 10 years, or a Compound Annual Growth Rate of 14.12%. This is a great return.
Earnings
Earnings have also seen a steady rise like that of the stock price. Profitability and sales continue to improve for the company, driving EPS higher. Tractor Supply Company continues to plan store openings, which should foster further growth for the company in the future.
Since earnings and price per share don’t always give the whole picture, it’s good to look at other factors like the gross margins, return on equity, and return on invested capital.
Return on Equity
The return on equity has risen in the last 5 years and shows Tractor Supply Company to be very good at generating profits. The company has repurchased some of its own shares, inflating the number some, but the overall increase is most likely driven by its net income increases over the last 5 years. For return on equity ((ROE)), I look for a 5-year average of 16% or more. So, Tractor Supply Company far exceeds these requirements.
Let’s compare the ROE of this company to its industry. The average ROE of 78 retail special line companies is 24.16%.
Therefore, Tractor Supply Company’s 5-year average of 43.84% is way above its industry peers.
Return on Invested Capital
The return on invested capital seems to be the only fundamental metric that has seen a decline since 2018. Due to the expansion plans of the company, capex has risen steadily over the last few years. The declining return on this invested capital is most likely due to diminishing returns from new stores and increasing costs to modernize as well as integrate acquisition stores. Return on invested capital could see an improvement by the year 2025 as the need for capex is reduced and the new stores begin to generate better sales growth. For return on invested capital ((ROIC)), I also look for a 5-year average of 16% or more. So, Tractor Supply Company exceeds this.
Gross Margin Percent
The gross margin percentage ((GMP)) has remained steady over the last five years. Tractor Supply Company’s cost reduction strategies seem to be paying off because of the consistency its gross margin has had even in an inflationary environment. One could argue the company has shifted its raw material costs to its customers, but it is hard to believe the sales growth could continue at the company’s pace if this was true. I typically look for companies with gross margin percent consistently above 30%. So, Tractor Supply Company makes the cut.
Financial Stability
Looking at other fundamentals involving the balance sheet , we can see that the debt-to-equity is greater than 1. In fact, it has about twice the amount of debt when compared with equity. This is a negative indicator, telling us that the company has a higher risk of not being able to pay its payments or raise capital in times of stress. However, proponents of TSCO would argue that the company still uses debt reasonably. This demonstrates the company’s very conservative use of debt.
Tractor Supply Company’s Current Ratio of 1.32 indicates it can pay off short-term debt with its current assets.
Ideally, we’d want to see a Current Ratio of more than 1, so Tractor Supply Company exceeds this amount.
Tractor Supply Company shows a mix in its financial health. The company currently has large debt compared to its current equity, indicating that it could be over-leveraged. This is most likely due to the scaling the company is doing by opening new stores and modernizing existing stores.
Tractor Supply Company pays a regular dividend and has done so for 13 years.
This analysis wouldn’t be complete without considering the value of the company vs. share price.
Value Vs. Price
The company’s Price-Earnings Ratio of 24.57 indicates that Tractor Supply Company might be overpriced when comparing Tractor Supply Company Ratio to a long-term market average P/E Ratio of 15.
The 10-year and 5-year average PE Ratio of TSCO has typically been 25.4 and 22.7, respectively. This indicates that TSCO could be currently trading at a fair price when comparing to its average historical P/E Ratio range.
The Estimated Value of the Stock is $180.32, versus the current stock price of $206.01. This indicates that Tractor Supply Company is currently selling above its value.
For more detailed valuation purposes, I will be using a diluted EPS of 9.71. I’ve used various past averages of growth rates and P/E Ratios to calculate different scenarios of valuation ranges from low to average values. The valuations compare growth rates of EPS, Book Value, and Total Equity.
In the table below, you can see the different scenarios, and in the chart, you will see vertical valuation lines that correspond to the table valuation ranges. The dots on the lines represent the current stock price. If the dot is towards the bottom of the valuation range, this would indicate that the stock is undervalued. If the dot is near the top of the valuation line, this would show an overvalued stock.
According to this valuation analysis, TSCO is undervalued overall.
However, when considering the analysts’ forward growth forecasts, the valuation range is between $180 - $190, compared to the current share price of $205. This would mean that TSCO stock is overpriced.
Summarizing the Fundamentals
After analyzing the fundamentals of Tractor Supply Company, I believe this company has solid long-term fundamentals. The company continues to grow sales and maintain its profitability even during price increases from inflation. Even in a competitive industry, the company has maintained strong growth and positioned itself as a leader with its customers. The company’s long-term debt could pose issues if a significant revenue decline is seen, although with the number of stores Tractor Supply Company continues to open, the liquidity needs make sense.
All the fundamentals show strong growth over the last 5 years except for the return on invested capital. The declining ROIC could be from diminishing returns from new store openings. Overall, the fundamentals show strong growth and continued rising trends.
Tractor Supply Company Vs. The S&P 500
Now, let’s see how Tractor Supply compares versus the U.S. stock market benchmark S&P 500 (SP500) over the past 10 years. From the chart below, we can see that Tractor Supply Company saw a shift after the pandemic. Before the pandemic, the company either matched or fell below general market returns. After 2020, the company has seen returns greater than the overall market. I believe that the tech sector decline has impacted the overall returns of the general market considerably. This industry should rebound in the next few years, and I expect the general market will continue to outperform this stock.
On the other hand, because of COVID, there was an increased push of populations to more rural areas. This may have helped to increase the amount of Tractor Supply’s customers and sales in the years since COVID. It’s hard to determine if this shifted population will remain in these rural areas or return to more urban areas.
Forward-Looking Conclusion
Over the next five years, the analysts that follow this company are expecting it to grow earnings at an average annual rate of 7.73%.
In addition, the average one-year price target for this stock is $246.46, which is about a 19.6% increase in a year.
The Expected Annual Compounding Rate of Return is 11.58%.
If considering the actual past results of Tractor Supply Company, the story is a bit different. Here are the actual 10 and 5-year return results.
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10 Year Return Results if Invested in TSCO:
Initial Investment Date: 10/05/2013
End Date: 10/05/2023
Cost per Share: $68.53
End Date Price: $205.17
Total Dividends Received: $16.38
Total Return: 223.29%
Compound Annualized Growth Rate: 12%.
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5 Year Return Results if Invested in TSCO:
Initial Investment Date: 10/05/2018
End Date: 10/05/2023
Cost per Share: $87.65
End Date Price: $205.17
Total Dividends Received: $12.02
Total Return: 147.79%
Compound Annualized Growth Rate: 20%.
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From these scenarios, we have produced results from 12% to 20%. I feel that if you’re a long-term patient investor and believer in TSCO, and its existing products (livestock, equine, and agricultural products), you could expect TSCO to provide you with around at least 10-12% annual return over the long haul.
As a comparison, the S&P 500’s average return from 1928 – 2014 is about 10%. So, in a typical scenario with TSCO, you could expect a similar return to the market benchmark. The pro is that TSCO and its niche target could be a hedge against the general stock market, but the con is that TSCO does not offer the wide diversification as the market benchmark S&P 500.
Does Tractor Supply Company Pass My Checklist?
- Company Rating 70+ out of 100? Yes (87)
- Share Price Compound Annual Growth Rate > 12%? Yes (14.12%)
- Earnings history mostly increasing? Yes
- ROE (5-year average 16% or greater)? Yes (43.84%)
- ROIC (5-year average 16% or greater)? Yes (19.69%)
- Gross Margin % (5-year average > 30%)? No (34.83%)
- Debt-to-Equity (less than 1)? No
- Current Ratio (greater than 1)? Yes
- Outperformed S&P 500 during most of the past 10 years? No
- Do I think this company will continue to successfully sell their same main product/service for the next 10 years? Yes
Tractor Supply Company scored 7/10 or 70%. The company shows solid fundamentals and should be considered for any portfolio.
Is Tractor Supply Company currently selling at a bargain price?
- Price Earnings less than 16? No (24)
- Estimated Value greater than the Current Stock Price? No (Value $180.32 < $206.01 Stock Price).
Tractor Supply Company has seen great growth over the last five years, even during the pandemic. Most of the company’s fundamentals are increasing due to the growth in net sales and continued improvement in profitability. The company continues to expand with more store openings and plans to reach 3,000 stores soon.
On the downside, Tractor Supply Company currently is over-leveraged. This is to be expected due to the continued store growth, but it does pose a risk if the company experiences a significant revenue decline. Especially since the company currently owes fifty percent of its sales to the pet and livestock feed it sells. Any customer preference shift or demand reduction would have a very negative impact on the company. Tractor Supply also faces competition from many competitors including Amazon and Home Depot, which could eat into their growth. On another note, the company’s growth potential seems to be partially baked into the current stock price leaving minimal gains for future investors.
In conclusion, I will keep an eye on Tractor Supply Company and it will be on my watch list. However, I won’t consider taking a position in this company until the price would fall to around the $180 mark.
For further details see:
Tractor Supply Company And Its Real Value