Tractor Supply Co. (NGS: TSCO). Tractor Supply opened 80 new stores in both 2018 and 2019, and expects to open a roughly equal number in 2020, compared to about 100 in previous years, which will weigh on earnings growth. In addition, weak pricing for agricultural commodities may pressure Tractor Supply’s customer base. On the positive side, we are encouraged by the success of the company’s ‘Neighbors Club’ and ‘Buy Online, Pick Up in Store’ programs; private-label credit card and in-store kiosks; website and mobile app enhancements; and accelerating online sales. TSCO continues to make technology and supply-chain investments, and is also benefiting from government stimulus as well as from a lower tax rate. We see further COVID-19-driven demand in the near term given current consumer shopping trends, which favor spending on home improvement projects, in-home activities, and hobbies; however, we also see risks from rising unemployment. In addition, it is uncertain how much of the recent shift in consumer behavior will be sustainable once the pandemic recedes.
On October 22, Tractor Supply reported that third-quarter EPS grew 61.1% to $1.62. Net income rose 56.1% to $191 million. Revenue increased 31.4%. Comparable sales rose 26.8% on 12.5% growth in the average ticket and 14.3% growth in the transaction count.
With growth across all geographic regions in the third quarter, Tractor Supply benefited from favorable weather and new customer growth, in addition to changes in consumer spending related to COVID-19; management believes that about half of the second- and third-quarter comp growth was structural and the other half is likely transitory. Pet food, feed, agricultural fencing, and outdoor seasonal items were among the best-performing categories in the third quarter. Big-ticket items, including zero-turn mowers, trailers, safes, and generators, as well as ‘consumable, usable and edible’ products, posted 20% comp growth. The company’s digital business also performed well, with triple-digit growth from the prior year.
The 3Q20 gross margin improved by 138 basis points to 36.4%, reflecting less discounting and lower transportation costs. SG&A expense, including depreciation and amortization, increased 14 basis points to 26.7% of sales, reflecting leverage in occupancy, wages and other operating expenses, offset by COVID-19-related impacts, higher incentive compensation, and higher advertising costs.
In April, Tractor Supply withdrew its 2020 guidance (which called for EPS of $4.90-$5.10 and revenue of $8.75-$8.90 billion) due to economic uncertainties related to COVID-19. However, it projected overall 4Q sales of $2.6-$2.7 billion on 15%-10% comp sales growth. It expects net income of $163-$175 million and EPS of $1.37-$1.47, implying full year EPS of $6.60-$6.70. It also expects the gross margin to be flat to modestly higher. Management noted that rising transportation costs in the fourth quarter will raise e-commerce shipping costs. It expects COVID-19-related costs of $17-$20 million. In the fourth quarter, it also anticipates an incremental $13 million in wage and benefit costs as well as a 40-50 basis point increase in incentive pay. Despite moderating sales, the company also expects higher fourth-quarter comp sales than it projected early in the year.
During 3Q, the company opened 23 new Tractor Supply stores, and three Petsense stores. In 2019, it opened 80 new Tractor Supply stores, unchanged from 2018, and 8 new Petsense stores, down from 18. It plans to open 75-80 Tractor Supply stores and 10 Petsense stores in 2020.
Tractor Supply continues to integrate its physical stores with its e-commerce business, which has led to higher customer spending. E-commerce sales had been growing at a double-digit rate prior to the pandemic, and have also risen strongly in recent months. Customers continue to respond positively to the company’s ‘Buy Online, Pick Up in Store’ program, which offers curbside delivery, and to its Neighbor’s Club program, which has growth to 17.8 million members.
On January 13, 2020, Hal Lawton, the former president of Macy’s, became Tractor Supply’s new president and CEO. He succeeds Greg Sandfort, who retired after 12 years at Tractor Supply.
FINANCIAL STRENGTH & DIVIDEND
In October 2020, both Moody’s and S&P assigned TSCO’s debt investment-grade ratings. The company borrowed $200 million in March 2020 under its existing credit facility, and an additional $350 million in April, which management said was to increase liquidity during the pandemic.
In 1Q, the company repurchased 2.9 million shares of its common stock for $263.2 million. However, it suspended buybacks in March to conserve cash.
The company does not currently intend to reduce or eliminate the dividend, and expects to return to a 30% payout ratio.
MANAGEMENT & RISKS
The company is less subject to changing consumer trends than most retailers given the nature of its product line, but is still vulnerable to overall shifts in the farm, garden supply, and animal care markets. As such, the company would likely experience lower sales from any extended or severe changes in those markets (such as widespread animal disease or prolonged drought conditions).
Tractor Supply is expanding both its store count and its geographic reach. The company could experience much lower-than-anticipated returns from new operations if its product mix is not properly tailored to new markets.
TSCO shares are likely to move with the overall retail sector, but with greater-than-average volatility due to the company’s size.
Tractor Supply Co. offers a broad range of items for the farming, ranching and gardening markets, as well as for small enterprises. The company sells maintenance supplies, clothing, animal care supplies, hardware and lawn products, garden products, and truck and trailer products. The company’s 1900+ stores are geared toward the needs of rural America. Formed in 1982 from the assets of a catalog company that had been selling farm supplies since 1938, Tractor Supply is converting its older stores to larger formats (17,000-19,000 square feet) and opening new smaller-format stores and distribution centers beyond its core Southern and Midwestern markets. With a market capitalization of approximately $10.4 billion, TSCO is generally classified as a mid-cap growth company.
We have a positive view of the company’s customer focus and brand-building initiatives, its omnichannel investments, strong traction from its loyalty programs, and accelerated online sales. We see further COVID-19-driven demand in the near term given current consumer shopping trends, which favor spending on home improvement projects, in-home activities, and hobbies. However, we also see risks from rising unemployment. In addition, it is uncertain how much of the recent shift in consumer behavior will be sustainable once the pandemic recedes. Our rating remains HOLD.