Description

Imagine the traditional local hardware store where everyone knows your name and actually has the expertise to help you with selecting the product that is right for you. Tractor Supply opened its first store in 1939 in Minot, North Dakota and is close to celebrating their 80th year anniversary.

Tractor Supply is a niche retailor servicing the “out-here” life style. Their customers are often recreational farmers who enjoy a non-urban life and fit specific criteria:

•       Middle income

•       More than 60% own a full-size truck

•       Own their own home

•       Nearly 50% own livestock, and 75% own a pet

•       Customers average a 16 minute travel time to Tractor Supply

•       Average customer visits 6 times per year.

•       Best customers visit 12-16x per year.

The majority of Tractor Supply’s sales are consumable and useable products, which drive traffic into their stores. This class of product makes up ~40-50% of sales and is focused on pet and livestock feed with pet food making up a quarter of each stores selling space. A portion of these sales are exclusive brands. Exclusive brand penetration has grown over the past several years and now represents 32% of total sales, which adds a stickiness factor that keeps customers coming back. Tractor supply also sells general hardware items, tools, truck accessories, seasonal items (at times specific to locations), clothing and footwear, garden and agricultural items.

The company operates 1685 Tractor Supply stores and 168 Petsense (acquired in 2016) stores. Most stores are located in rural parts of the country and are concentrated in the Southern portion of the U.S. JP Morgan estimates that online sales near 1.5-2%, which is well below most retailers who have high single digit online sales.

Total number of stores has increased 58% over the past 5 years and 136% over the past 10 years, but the Midwest and western parts of the country are still underpenetrated. Management believes they have a total opportunity for 2,500 Tractor Supply stores and 1,000 Petsense stores. As a part of this plan they intend to open 80 Tractor Supply and 20 Petsense stores in 2018. Tractor Supply focuses on geographies with populations of ~22,500 or less for their stores.

Store Expansion Opportunity and Growth

Management’s belief in the opportunity to increase Tractor Supply stores by 48% is very reasonable. This is supported by the number of small/dense that would support a Tractor Supply location. The 22,500 population target is an average, and there are stores in cities with many more and fewer people. Also, the calculation is somewhat skewed by the definition of city, where there may be a sizable population in a small county but the city parameters restrict counting it in the above data.

Rural household incomes are still in recovery from the Great Recession. Rural median household incomes bottom in 2013 and still have not recovered all the way to 2007 levels. Also, commodity prices have been depressed. Both of these factors may lead to more discretionary income for Tractor Supply’s clientele and in turn higher sales for Tractor Supply. With total store growth of around 5% and same store sales growth of 2% their long term goals of 7-9% sales growth seem achievable.

Competition

The focus on the rural portion of the country has lessened the effects of competition. Home Depot and Lowes are greater than 10 miles away from nearly half of Tractor Supplies stores and about a third of stores do not have a Petco and PetSmart within 10 miles. Tractor Supply’s main competitor is Walmart. However, Tractor Supply is focused on giving the customer an experience and building a relationship with them to keep them coming back rather than the chore of going to a Walmart. Part of Tractor Supply’s differentiation is carrying more specialized products such as dog food brands that cannot be purchased at large box stores.

The entry of online competition will likely be a headwind for Tractor Supply, but should be manageable. The rural areas of the country trail urban areas in internet usage and access, which lessens the effect of these competitors. Also, Tractor Supply is starting to offer veterinary services and dog wash stations to continue to drive traffic into their stores. The low penetration of online sales for Tractor Supply might suggest that their customers are less apt to purchase in that fashion.

Petsense

Acquired in 2016, Petsense is a specialty pet food retailor that focuses on the same rural geography as Tractor Supply and sells to a differentiated customer who wants hands on experience rather than what they receive at a big box retailer. This opportunity is tougher to value, but with 82.5 million or 65% of households now owning a pet, the market opportunity seems interesting. Households not only have more pets, but also pets are living longer and the organic/raw revolution is spilling over to pets diets as caretakers want their pets to eat like they do.

Historical Operations

Same store sales growth has been in decline over the past several years, but remains positive and margins have generally increased. The margin expansion has been driven by higher sales of exclusive brands and operating leverage from an expanded store footprint. Margins may decline in the near term as the company deals with increased freight costs, and invests to build out their new store concept “ONETractor”, logistics, and technology. However, at the present moment operating margins do not seem to be excessively high relative to competitors Home Depot (14.5%) and Lowes (9.6%), so after investments are made they should be able to at least return to margins in the 10% range if not higher.

10 Year Average

•    Same Store Sales: 4%

•    Sales Growth: 10%

•    Gross Margin: 34%

•    Operating Margin: 9%

2017

•    Same Store Sales: 3%

•    Sales Growth: 7%

•    Gross Margin: 34%

•    Operating Margin: 9%

Long Term Goals

•    Same Store Sales: +3%

•    Sales Growth: 7-9%

•    Improve margins

•    Double digit earnings growth

Balance Sheet

Tractor Supply maintains a reasonably conservative balance sheet which no public debt but $271 million of term loans and $150 million of private placement senior notes. Egan Jones has them rated A. Stores are 93% leased which do add to obligations, but free cash flow is ample each year and was still positive during the most recent economic downturn. Also, they have enough room from their covenants to deal with a decline in earnings, which leads me to believe that financial strength is not an issue.

Risks to Consider

• The profitability of stores going forward
• The low growth of rural populations
  • Rural populations have grown very little over the past century, while urban populations have nearly tripled.

• Competition from online retailers and the acquisition of Blue Buffalo by General Mills which will likely increase the distribution of that brand.
• Geographical sensitivity to commodity prices (good and bad)

Catalyst

Tractor Supply is a long term opportunity that will continue to add value through growing store locations, and margin expansion. They have a niche in the retail space due to the location of their stores and focus on a specific customer that should help shield them from competitors. They have a solid balance sheet and will be able to endure any downturns in the economy and have the flexibility to continue on their growth path.