Tractor Supply (NASDAQ:TSCO) was one of the largest detractors from our first quarter performance, as the stock retraced some of the gains it had posted after we purchased it last quarter. We think a large portion of both the Q4 spike and the Q1 decline in the stock can be attributed to political and energy-related noise, with the stock correctly viewed as a potential beneficiary from a possible reduction in U.S. corporate tax rates and a recovery in U.S. energy production. On the tax front, the Company’s business is entirely U.S.-based, leaving it with a relatively high tax rate in comparison to companies with multinational operations; this means that it would be a greater relative beneficiary than these other companies if the U.S. corporate tax rate were to decline. As the market quickly moved from optimism to pessimism on the potential for such a tax cut, the stock moved accordingly. Our stance is that we would be perfectly happy to see a lower tax rate for Tractor Supply, but that is not a tenet of our long-term thesis. On the energy front, we estimate a minority of TSCO’s end-markets are in regions exposed to the fortunes of the energy industry. As we discuss elsewhere in this letter, we see clear indications that U.S. production activity has moved positively, and we expect Tractor Supply’s exposure to energy-producing regions to benefit from the recovery for the foreseeable future. However, confusion over temporarily high U.S. oil inventories at the beginning of 2017, which led to shorter-term pull-back in oil prices, weighed on Tractor Supply’s stock in the first quarter, just as the bounce in oil prices in Q4 had provided a boost.
Setting all this shorter-term noise aside, we saw much to like in the Company’s earnings report during the quarter. The Company demonstrated its impressive operational capabilities by wrestling a decent report out of a quarter that had started off weakly, hampered by unhelpful weather, harnessing a nimble supply chain to work with vendors to minimize exposure to struggling categories while quickly building exposure to categories that were working. More importantly, management highlighted the emerging recovery in energy-related regions within the quarter and mentioned that their prior worries about weakness in agriculturally-focused regions may have been due to weather, rather than due to broad problems in agriculture, as they had speculated in the prior quarter. You may recall that when we purchased Tractor Supply last quarter, we noted that the market already was baking in recessionary conditions in these two important industry exposures for the Company; in fact, we thought the market was nearly pricing in a full-blown domestic recession. Since our purchase, we have seen the beginnings of an expected recovery in energy, and the weakness in agriculture may have been illusory, after all. With fundamentals showing clear signs of improvement, and with the stock still trading at relatively depressed historical valuations, we took advantage of the opportunity to build our position during the first quarter.
From David Rolfe (Trades, Portfolio)'s Wedgewood Partners first-quarter 2017 shareholder letter.
