2023-09-07 02:59:40 ET
Summary
- Tractor Supply has seen strong growth in sales per share and EPS, but its high valuation is a risk factor encouraging high short interest.
- The company's sales are not highly correlated with economic trends, making it less cyclical than other retailers, but its sales should slow down in the slower economic environment.
- TSCO faces less e-commerce competition and has the potential for continued growth through share buybacks and store expansion.
- The company has benefited significantly from "self-reliance" buying activity since 2020. A reversal of this trend could harm Tractor Supply's same-store sales.
The retail sector has seen varying trends over the past year, with many bracing for declining consumer discretionary spending. Many retail stocks remain relatively expensive after seeing strong income growth over recent years. Certain retailers are particularly interesting due to their apparent strength and high valuation amid growing retail spending volatility. One notable example is Tractor Supply ( TSCO ), which remains above 140% above its pre-COVID level and has stagnated around its peak valuation since early 2022.
Tractor Supply is a prevalent investment within the consumer discretionary sector due to its ample growth since 2020. From the end of 2019 to today, Tractor Supply's sales per share has risen by ~92% while its EPS has increased by ~114% (both TTM). The company has seen both same-store sales growth and has pursued significant store expansions since 2020 , the opposite trend as most retailers. However, its positive EPS trend has also caused its "P/E" valuation to elevate at ~21.8x, 70% above the median level for consumer discretionary stocks.
Of course, around a third of the company's sales come from staples such as animal feed, which are less volatile. However, the stock's valuation is a risk factor as the stock's short interest is currently 7.5%, which is relatively high, though not indicative of a short squeeze. For TSCO to maintain its current price, it must expand its EPS at a solid pace, which I do not believe is necessarily guaranteed in the current environment.
How Cyclical is Tractor Supply Company?
Tractor Supply operates in five segments: livestock & agriculture (~29% of sales), seasonal & recreation (~25%), companion animal (22%), truck tool & hardware (16%), and clothing & decor (8%). Of these segments, livestock & agriculture is likely to be the least cyclical since businesses generally consume those items. The other segments will vary, but we can expect that more significant, durable items such as vehicle items and hardware will be the most cyclical. The correlation between Tractor Supply's sales growth and relevant economic trends is not too strong. See below:
Periods where real retail sales and strong manufacturing activity correlate to higher revenue growth for Tractor Supply; however, the relationship is not as strong as I see in most retailers and cyclical firms. Periods of lower manufacturing and retail spending growth are roughly associated with slower growth for Tractor Supply; that said, the firm has entirely avoided negative sales changes over the past twenty years. Thus, we have a solid indication that Tractor Supply is not as "cyclical" as expected, likely due to its dual focus on staples and cyclical.
Again, the company's operating margin is correlated to the cyclical trends but is not extremely sensitive. See below:
Based on the historical data, we can expect Tractor Supply's operating margins to slip to ~9%, given a recessionary economic trend, while its sales may stagnate. However, that is hardly notable compared to the consumer discretionary sector at large. Although the firm has a high valuation for consumer discretionary stocks, typical TTM "P/E" ratios in consumer staples are currently around 23.4x. Tractor Supply is not as defensive as most consumer staples but is nearly more similar to that sector than consumer discretionary. Still, the company negatively adjusted its guidance as the outlook for durable goods sales declined .
One excellent factor for Tractor Supply is that it does not face significant e-commerce competition, unlike most retailers. For the most part, Tractor Supply sells heavier items that are not as economical for e-commerce giants like Amazon (AMZN). Since many stolen items are sold on Amazon, Tractor Supply is less exposed to the retail theft epidemic . Furthermore, most of Tractor Supply's products are items that buyers will want to see and feel in person before purchasing, requiring in-store sales.
Can Tractor Supply Continue to Grow?
A few key factors are benefiting the company's EPS growth. One, it has repurchased shares at a steady pace over the past decade. Two, the company has seen decent comparable store growth, at a staggering 23% in 2020 , though currently projected at just 1.3% to 2.5% . Lastly, the firm's total store count has risen by around 8% over the past year, and is planning to continue that trend until its store count increases to 3,000 (26% above current levels). Looking forward, we should not expect similar growth to the 2020-2022 pattern but more "low and steady" growth like before 2020.
A massive increase led to the comparable store sales spike in 2020-2022 in "needs-based" shopping , which is essentially "prepping," homesteading, and "rural revitalization." In other words, since 2020, many Americans have become more interested in self-reliance and working with the natural environment, having experienced a mass breakdown of most economic and social systems in 2020-2021. Tractor Supply has ideal products to cater to this demand and continues to see elevated same-store sales due to this demand factor.
I believe Tractor Supply could become more cyclical due to this abnormal factor. Indeed, the company is historically not too cyclical; however, should demand from "needs-based" shoppers falter, Tractor Supply's same-store sales will also. Interestingly, we can roughly measure this subjective trend through Google search volumes. The terms "How to grow food" and "homesteading" see similar search interest levels, spiking in 2020 but remaining elevated today. See below:
Google Trends Search Volume for "How to Grow Food" and "Homesteading" (Google Trends)
Of course, there will not be a one-for-one relationship between these Google search terms and changes to Tractor Supply's same-store sales. Still, general interest in these terms has not changed dramatically, even with COVID and lockdowns being a non-factor today (in the majority's perspective). Thus, the events in 2020 may have triggered a permanent shift for many Americans, increasing interest in self-reliance. If this trend falters, as we may see in "How to Grow Food," then Tractor Supply's same-store sales could also. Although I expect elevated "needs-based" shopping levels to continue, it seems more likely the trend will slow than continue to grow unless a new black swan event occurs.
The Bottom Line
Overall, there is a lot to like about Tractor Supply as a company. Its balance sheet is clean, with over $1.3B in positive working capital and a healthy debt-to-EBITDA ratio of around 1X. The company has stellar management, having grown consistently over the years without compromising profit margins for debt leveraging. Essentially, all of its growth has come from the reinvestment of profits. Further, its product mix is diversified, exposing it to beneficial cyclical patterns and more resilient staples.
The most apparent issue with Tractor Supply is its high valuation. TSCO is much more expensive than most retail and consumer discretionary stocks. It is valued more similarly to consumer staples but is not as defensive as most in that sector. Still, Tractor Supply has solid growth to back up its elevated valuation. The company's strong growth trend from 2020-2022 is slowing dramatically as "needs-based" shopping is not rising. I expect that a recession and/or a decline in "needs-based" shopping demand will cause some negative pressure on the company's EPS; however, that is offset by its historical resiliency.
For now, I am neutral on TSCO but am slightly more bearish than bullish on a short-term basis. For me, its valuation is just a bit too high considering the changes to the cyclical outlook and the possibly more significant decline in same-store sales should "self-reliance" shopping patterns fade. Still, even with that risk in mind, its valuation is sensible enough that I am not overly bearish on TSCO and would not bet against it. Investors should be cautious about TSCO today since its valuation does not account for shifting trends. Interested buyers are likely best waiting for an ample dip that pushes the stock back below the $170-200 range.
For further details see:
Tractor Supply: Surprisingly Defensive As 'Self-Reliance' Retail Trend Continues