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David Rolfe Comments on Tractor Supply

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Jan 14, 2022
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Tractor Supply (

TSCO, Financial) contributed favorably to performance during the quarter. Demand from the Company’s niche, affluent rural customer base continues to surge in a post-COVID world with comparable store sales running over +40% higher compared to pre-pandemic (2019) levels. Tractor Supply is seeing growth across all channels, from its website to e-commerce that is fulfilled by its 2000-store fleet to regular in-store traffic. The Company is also managing inflation and supply chain disruptions extremely well, passing through nearly +7% of inflation on consumable goods and managing a quarterly inventory in-stock rate that was actually higher than pre-pandemic. Tractor Supply is an exceptional retailer, and we continue to hold it as a top position.

Tractor Supply Company

We have now owned Tractor Supply (

TSCO, Financial) for more than five years, and we continue to be very pleased with the performance of the business and the superior quality of the management team as well as the performance of the stock. We originally were attracted by the Company’s ability to grow at a healthy pace while generating impressive and steadily improving returns on invested capital – basically what draws us to any company. See the table below for a sampling of key metrics demonstrating the performance of the business in the period leading up to the COVID pandemic, both before and after our purchase in 2016.

For a traditional retailer, however, as we pointed out when we first bought this stock, the ability to grow while generating and maintaining healthy returns is rare. Almost universally across brick-and-mortar retail, a retailer’s new stores open at lower levels of sales productivity and margins than established stores, causing constant pressure on these two metrics for the overall Company. Furthermore, in a normalized environment, the costs involved in opening the stores, including lease costs and construction costs, tend to rise, further pressuring profitability. Therefore, in order even to maintain steady margins and returns, a growing traditional retailer needs its established stores to pick up the slack in terms of sales productivity and margins. Since the advent of an overhauled management team beginning 15-20 years ago, Tractor Supply has been very effective in building this Company while doing exactly what we have described.

Our cash-flow-based calculation of return on invested capital in the table above is the key output from our statistical analysis. We’d note the steady results in the sales/lease $ line and the steady improvement in EBITDA margins, despite the Company opening nearly 1000 net new stores (increasing its store base by 87% over the time period) have been essential components driving the quality of the business model.

While COVID has been an unanticipated interloper during our ownership of Tractor Supply, the pandemic has created both short and long-term opportunities for the Company. We refer you to our Client Letter from this quarter last year, when we described management’s impressive initial response to the pandemic. As 2021 saw the world starting to head back toward something resembling normalcy, evidence is emerging of beneficial secular trends for the Company that we believe will prove sustainable. The most important of which are increasing pet ownership, increasing rural migration, and increasing Millennial interest in the Company’s key product categories, and the rural lifestyle.

We are certain our readers have heard multiple anecdotes of all these trends; unfortunately, with the pandemic less than two years old, it is still difficult to find anything one might consider solid, reliable data this early in what we believe will be a long-term trend. That said, we offer the following data points:

Pet ownership:

  • A biennial American Pet Products Association survey of pet owners recorded significant growth in the number of households owning key pet categories for Tractor Supply. Between their 2019-2020 and 2021-2022 surveys: households owning dogs grew +9%, cats +6%, and households owning horses – in Tractor’s sweet spot – up a whopping +119% over the course of two years. Pet owners, and especially livestock owners, are key customers for Tractor Supply because they generate recurring demand (in feed, for example) that is persistent in nature; someone who just bought a horse can’t decide to save money next month by failing to feed it or failing to maintain their fencing.
  • The Insurance Research Council’s October 2020 report, “Consumer Responses to the Pandemic and Implications for Insurance,” found that 30% of Americans had adopteda pet during pandemic – and this was only around six months after COVID lockdowns began.

Rural migration:

  • A February 2021 study released by the Cleveland Federal Reserve (https://www.clevelandfed.org/newsroom-and-events/publications/cfed-district-data-briefs/cfddb-20210205-did-the-covid-19-pandemic-cause-an-urban-exodus), using data from the Federal Reserve Bank of New York/Equifax Consumer Credit Panel (CCP), found early evidence of an acceleration of what had been a pre-COVID trend of population migration away from urban centers, including both more people moving away from cities and less people moving in.
  • Furthermore, the same study demonstrated that the youngest age group had seen the greatest change in behavior, with the 18-34 age group going from migrating into urban areas pre-pandemic to leaving in significant numbers during 2020.

Millennial engagement

  • In addition to the chart above showing increasing rural migration among younger age groups, the Company has provided some anecdotal support for the trend, reporting that the average age of its customer base has been declining for several quarters in a row

Although it should be clear that the impact of moving your home, or owning a horse, will be more pervasive than only a couple of quarters, we would note that Tractor Supply’s reported results already are showing persistence in these underlying secular benefits, with the company’s reported same-store-sales results still looking very healthy despite extremely difficult comparisons to last year.

So, we believe these emerging trends have expanded the Company’s long-term addressable market. We have been pleased by the way management first competently managed the unexpected flood of pandemic-driven growth, then very deliberately established new growth initiatives, and accelerated planned future investments to further enhance its competitive position, to retain new customers, and to plot to claim more of the future opportunity arriving in its rural markets (see table below). We note that this acceleration of growth investments comes at a time when it has been able to fund these investments from its unexpected surge in profits. Therefore, current and future shareholders get the long-term value of the enhanced opportunity set, without current shareholders having to take a hit in shorter-term results. Or, putting it another way, management doesn’t use the pursuit of long-term opportunities as an excuse to constantly fumble current opportunities.

We have seen in few periods of consolidation in the stock during the COVID era, as investors try to determine what the new normal may look like. Many no doubt have assumed there will be some form of "give-back" in the Company’s results as conditions normalize, in terms of sales, profit margins, or both. We too have expected some moderation in results. We have been very pleasantly surprised, for example, that the company was still generating double-digit percentage same-store sales growth in the last quarter (Q3), seven quarters into the pandemic, and against the very difficult comparison of +27% growth in the prior year.

We are most confident that the longer-term systemic drivers we noted above, as well as management’s accelerated investments for the future, have done nothing but enhance what already was an excellent business model before the pandemic, and we anticipate no meaningful "give-back" as the world heads toward whatever will be normal in the post-COVID world. Furthermore, given management’s performance both during COVID and historically, we expect the company to pursue this enhanced opportunity in a way that will not sacrifice profitability and capital returns. Whenever the world reaches the new normal, we believe Tractor Supply will have emerged with a greater long-term revenue growth outlook, and at higher levels of margins and returns on investment, all of which will deserve a healthier valuation than in the pre-COVID world. In short, the Company is not at the end of an exciting opportunity, but at the beginning.

From

David Rolfe (Trades, Portfolio)'s Wedgewood Partners fourth-quarter 2021 letter.

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I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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