2023-12-24 23:57:17 ET
Summary
- Tractor Supply Company has strong growth potential and is expected to rebound in the latter half of 2024.
- Q3 sales were lower than expected, but the company's strong margin projections demonstrate strength in cost control and customer loyalty.
- The company's aggressive store opening plan and expansion efforts are expected to drive sales growth and increase its customer base.
Thesis
I remain positive about Tractor Supply Company ( TSCO ) due to its strong growth potential. Although the company has posted mixed results in the recent past as the demand has continued to be affected by seasonal factors, I believe a rebound is on the cards in the latter half of 2024. The company has managed to post strong margins despite the current challenging environment, which makes me positive about prospects of higher profitability in the long term in a more normalized demand environment. The current stock price is appealing, with the stock trading at around its five-year average P/E; hence, I assign a buy rating to the stock.
Q3 Review & Outlook
TSCO's third quarter results were mixed, and the outlook for the fourth quarter was a bit disappointing. Although the weak quarter’s performance was not surprising, it adds to the uncertainty about where sales might stabilize and what next year would look like. Q3 sales increased +4.3% year on year (lower than consensus estimates; however, Gross margins grew +101bps, which led to a higher-than-expected EPS for the quarter.
Looking ahead, I like that Q4 guidance appears to have been reset and incorporates more conservatism. Tractor Supply's lower 2023 guidance reflects a drop in demand this year, but I believe long-term growth prospects remain strong. The adjusted operating margin forecast is less dire, with guidance indicating only a modest decline in 4Q vs. 10% in 3Q. I believe Tractor's strong margin projections, which are consistent with 2021-22 highs, demonstrate strength in cost control and customer loyalty. The management commented on the uncertainties surrounding 2024 demand, stating that it expects pricing to remain stable and GM to increase and that it would explore more aggressive cost management based on demand.
Despite weaker-than-expected demand in 2023, I believe new store openings and better penetration among the rural customer group should continue to push sales to $18 billion by 2026. In 2023, weather and a bad economic environment hampered demand and sales growth. I expect a demand revival in 2H24 with new locations improving Tractor Supply's client reach.
Room For Growth as Footprint Increases
The rural client cohort is rising, and as a result, Tractor Supply estimates that its addressable market is approximately $180 billion. This represents an increase of more than sixty percent from the company’s estimate in 2019. TSCO’s aggressive store opening plan amidst a weak demand environment underscores the fact that new locations remain key to capturing more shoppers and expanding the basket size. The company has plans to open 3,000 locations in the United States, 25% higher than the stores in the third quarter. The company is also remodelling existing stores and establishing outdoor garden centres, which I believe will extend the customer base and boost lifetime shopper value and be accretive to long-term sales and margin growth. Moreover, Tractor Supply's customer base, which includes more than 31 million loyalty members (up from 28 million at the end of the fiscal year), has tremendous room to grow with a larger store fleet and improved digital capabilities. Loyalty members increased by 20% each year in 2021-22, and I expect strong growth to continue through at least 2026.
Financial Outlook & Valuation
Tractor Supply's gross profit per store continued to increase in 2023 through 3Q, even though demand was weaker than anticipated. This likely reflects its loyal customer base, a key factor behind Tractor's above-average gross margin of 35-36% -- topping that of Lowe's and Walmart. This, plus the possibility for a resurgence in demand in 2H24 could support further gross margin improvement next year. Some cost tailwinds, including lower transportation costs, may also extend in 2024. Longer term, the management is targeting an operating margin of 10.1-10.6%. I believe the upper half of this range is achievable, given its stronger digital and supply-chain capabilities and a rebound in demand.
Coming to the valuation, Tractor Supply has traded at an average of 15.5 times EV/EBITDA from 2018-2022. The stock price has not moved this year owing to a difficult demand environment, which I believe will improve going forward in 2024. The stock is currently trading at forward EV/EBITDA of 14.6x, which I believe provides a good opportunity for long-term investors to get in at a reasonable price. Moreover, on a forward P/E basis, the stock is trading at its five-year average forward P/E of 21x as per Capital IQ, which further suggests that the price is more than compelling at the moment. Hence, I am currently positive on the stock and assign a buy rating to TSCO.
Risks
If the demand environment remains weak for the whole of 2024, that could cast further downside in the stock. It is worth noting here that TSCO’s business heavily relies on varying weather conditions by quarter. Because TSCO is a needs-based retailer, the company cannot promote during these instances to drive engagement. Moreover, there is a risk of company’s big-ticket sales staying soft, which may pose further challenges. Additionally, any shift in population migration from rural areas to suburbs or cities, which is a key driver for this industry, can cause a downside in the stock price.
Conclusion
I maintain a positive outlook on Tractor Supply Company due to the company’s growth potential following a weak 2023. The company has continued to maintain its margins in a difficult demand environment, thanks to its loyal customer base. The stock is trading at its five-year average PE, which I believe provides an attractive entry point for investors. Hence, I assign a buy rating to the stock.
For further details see:
Tractor Supply: Current Price Provides A Good Opportunity