Why does guru David Rolfe (Trades, Portfolio) like Tractor Supply Co. (TSCO, Financial)?
He wasn’t shy about explaining in the Wedgewood Funds' second-quarter 2020 shareholder letter:
“Tractor Supply shares also rallied as the Company saw a sudden and striking acceleration in revenue and earnings growth. As the COVID-19 pandemic has evolved in the U.S., consumers have reallocated budgets away from travel and entertainment, and shifted spending toward both land and home improvement retail, which is the core value proposition of Tractor Supply offerings.”
With everything from fencing to lawnmowers to animal feed, it reports it is positioned to serve its own niche market:
“Our target customers are home, land, pet, and livestock owners who generally have above average income and below average cost of living. We seek to serve a customer base that primarily lives in towns outlying major metropolitan markets and in rural communities. This customer base includes recreational farmers, ranchers, and all those who enjoy living the rural lifestyle, as well as tradesmen and small businesses.”
In announcing its second-quarter results, Tractor Supply provided some robust numbers:
- Net sales up 35%.
- Comparable store sales increased by 30.5%.
- E-commerce grew by triple digits.
- Diluted earnings per share were up 61.1%.
That kind of news, from both the first and second quarters, drove up the share price:
But is this the kind of company you might want to buy and hold, for five to 10 years, when there may be no pandemic keeping rural lifestyle consumers at home? We address that question by analyzing its fundamentals, its dividend and its share repurchases.
Financial strength
With a middling mark of 6 out of 10, there appears to be a wrench of some kind in Tractor Supply’s financial gears. Judging by all the red in the table, debt seems to have lowered its rating. That’s confirmed with this chart, showing how debt has grown in the past few years:
However, we can put the new, higher debt levels into context by reviewing the 10-K for 2019. The company wrote, “In fiscal 2019, we opened 80 new Tractor Supply stores in 29 states and eight new Petsense stores in four states. In fiscal 2018, we opened 80 new Tractor Supply stores in 33 states and 18 new Petsense stores in 14 states.”
At the end of 2019, Tractor Supply operated 2,024 stores in total, 1,844 Tractor Supply and Del’s retail stores and 180 Petsense retail stores.
The company also reported it had an outstanding debt of $396.5 million—after returning $696 million to shareholders through dividends and stock buybacks. It finished 2019 with $84.2 million in cash.
We can also see a strong interest coverage ratio, which shows operating income is almost 40 times more than interest expenses. Part of that surplus of operating income is the result of strong operational management, with its return on invested capital more than double its weighted average cost of capital.
Profitability
The company has been able to generate excellent profits on its large and growing retail operations, setting it apart from much of the retail industry.
The operating and net margins are not that high, but that can be attributed to being in the highly competitive retail cyclical industry. As we see, its margins are at least above-average among its peers and competitors, and not far off its own best efforts in the past decade.
While the operating margin is down in recent years, the net margin has recovered from the dip of 2018:
Tractor Supply has an enviable return on equity of 45, and its return on assets is into double digits.
Revenue, Ebitda and earnings per share (without non-recurring items) have all shown positive growth over the past three years, and it must be remembered they are generating this growth in the retail industry.
Valuation
Tractor Supply’s valuation rating is low, suggesting the stock is not available at a fair price or is overvalued.
As the orange and yellow bars after the price-earnings ratio suggest, the company is more expensive than its competitors, and is not as cheap as it has been in the past. Still, as this GuruFocus screenshot shows, its current price-earnings ratio of 25.24 is only marginally higher than its median over the past 10 years:
Similarly, the discounted cash flow calculator indicates it is only marginally higher than the fair or intrinsic price:
Taken together, these metrics offer a more favorable valuation than the rating generated by the GuruFocus system. Slightly overvalued would seem a reasonable description.
Dividends
Our first impression of a dividend yield of less than 1% would mean a low dividend. But we must remember, the share price spiked recently and pulled the yield down with it:
Looking at the payout ratio of just 24%, this seems to be a company that plans to grow a lot more, and that’s backed up by its growing free cash flow:
While the dividend may seem small, regardless of context, the dividend growth rate has been high over the past three years: an average of 13.9% per year.
That kind of growth contributes to a five-year yield-on-cost of more than 2%, double the current level.
Finally in this table, we see the company has been buying back its own shares. The green bars next to the ratio show it has been repurchasing more aggressively than its competitors, and than it has in the past. As a result, it has been reducing its share count, which helps increase the earnings per share:
Gurus
Despite Tractor Supply’s exceptional first and second quarters, the gurus have been reducing their holdings:
At the end of the first quarter, seven gurus held positions in Tractor Supply. The biggest single investment was that of Pioneer Investments (Trades, Portfolio). Although it reduced its holding by 55.51%, it still held 925,551 shares, representing a 0.80% stake in the company.
Rolfe held 390,178 shares after reducing his position by 35.34%. And Lee Ainslie of Maverick Capital held 101,442 shares at the end of March.
Conclusion
Tractor Supply is well placed to be a short-term success, but it also well positioned for investors who like to buy and hold for five years or more. The company has found a niche without too much competition and has taken advantage of it to grow quickly. It appears to fit the bill for growth investors.
Income investors will likely find the company’s yield and forecast yield (five-year yield-on-cost) too low unless they have a long time horizon and faith in the company’s ability to keep growing the dividend at the rate of the past three years.
Value investors will not find a bargain here. Those who like the Tractor Supply story and fundamentals, and there is much to like, will want to wait for a share price pullback.
Disclosure: I do not own shares in any companies named in this article.
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