Despite the relentless trend toward urbanization across America, some Americans remain resolutely rural.
And, despite the trend away from brick-and-mortar retail across America, at least one company is bucking the trend and plans to increase its store count by at least 50% in less than a decade.
The retailer is Tractor Supply Company (TSCO, Financial), a Brentwood, Tenn.-based specialist in meeting the needs of hobby ranchers and hobby farmers, suburban homeowners, and anyone who might need a welder, a log splitter, or horse feed. Fewer than 10% of its customers now describe themselves as full-time farmers; instead, the company describes them as "self-reliants."
Image source: 2013 Annual Report
TSCO currently appears on the Buffett Munger screener at GuruFocus, thanks to its fair valuation (based on P/E divided by 5-year EBITDA growth), and for its 4.5-Star predictability (consistency of revenue and earnings growth).
Based on the analysis that follows, I suggest that buying on pullbacks may be the best strategy for buying TSCO stock.
History
1938: Mail order tractor parts company established by Charles E. Schmidt Sr.
1939: Adds first retail store, in Minot, North Dakota
1958: Begins trading on the New York Stock Exchange with symbol TSC
1966: Opens first international store in Canada
1969: Merges with National Industries
1978: Acquired by Fuqua Industries, Inc.
1982: Five managers take the company private with a leveraged buyout
1994: Company goes public again, this time on NASDAQ with symbol TSCO
1999: Launches a website to provide information to customers
2002: Acquires 85 leases from Quality Stores, Inc., which had gone bankrupt
2002: Sales exceed $1 billion for the first time
2004: Named by Fortune magazine as one of America’s 100 fastest growing businesses
2006: Adopts a continuous improvement program, based on LEAN principles, called Tractor Value System ("TVS")
2013: A major upgrade of its e-commerce website
2014: Operates more than 1,300 stores in 48 states
History based on information provided at the company website, Wikipedia, and Funding Universe.
Takeaways: A company with a bumpy ownership history, but at the same time, one that has solidly established itself in a world that has not been kind to retail. The company is not acquisitions-oriented, but has been nimble in grasping opportunities.
The Tractor Supply Business
The company operates what it calls "rural lifestyle retail stores." Within those stores (which typically provide 15,000 to 24,000 square feet of indoor retail space and a similar amount outside), the company sells selected products, including:
- Clothing and Footwear
- Dog, Cat and Pet Supplies
- Trailers and Accessories
- Lawn and Garden Supplies
- Propane and Heating Supplies
- Tools and Gun Safes
- Fencing
- Welders and Welding Supplies
- Lawn Mowers and Power Generators
I say ‘selected products’ because the company chooses merchandise that sets it apart from the big box retailers, such as Home Depot (HD, Financial) and Walmart (WMT, Financial). In fact, Tractor Supply has leased space within Walmart facilities, taking advantage of the latter’s foot traffic with its complementary product lines.
Nor does TSCO compete directly with agricultural companies, big or small. As it notes on its website, its biggest customer segment does not farm at all. Instead, that label goes to rural or suburban homeowners, or "self-reliants." Many of its customers describes themselves as hobby farmers or hobby ranchers.
It has just one reporting segment, "the retail sale of farm and ranch products." As we see in this chart, from a presentation at the William Blair 34th Annual Growth Stock Conference, Livestock and Pet products generate the biggest proportion of sales:
The following graphic, from its 2013 Annual Report and 10-K report (December year-end), shows at a glance its sales and net income over the previous five years:
Competition
While we’ve noted that Tractor Supply distinguishes itself from big box retailers, it does operate in a competitive retail environment. It describes its competitors as, "general merchandise retailers, home center retailers, specialty and discount retailers, independently owned retail farm and ranch stores, numerous privately-held regional farm store chains and farm cooperatives, as well as internet-based retailers."
It says merchants within this group compete on the following factors: location of stores, price and quality of merchandise, in-stock consistency, merchandise assortment and presentation, and customer service.
Further, it attributes its ongoing success to its ability to focus on its specialized market niche, providing products that meet the needs of the rural lifestyle, and especially those who describe themselves as hobby farmers and hobby ranchers.
Growth
As we’ve seen above, the company has now grown to more than 1,300 stores, and in its 2013 annual report, the company notes, "We are a growth company, and our research indicates we have an opportunity to grow to 2,100 domestic Tractor Supply store locations." More specifically, it expects to grow by about 100 new stores per year.
To achieve that, it adopted a strategy comprised of six elements:
- Expand geographic market presence through new retail stores
- Improve financial performance through comparable store sales growth
- Increase product margin through several retailing initiatives, as well as brand management and pricing optimization
- Leverage operating costs through continuous improvement
- Expand market opportunities via e-commerce and internet-supported sales
- Expand through selective acquisitions, as opportunities arise
In its third quarter, 2014 earnings release, TSCO offered updated guidance for the full year: near $5.7 billion in sales and $2.62 in earnings per diluted share. These numbers represent the high end of its previously announced guidance range for the year.
Takeaways: A solid growth company that’s been steadily building out its retail footprint, through both organic growth and acquisitions. It has an articulated strategy for continued growth in place, and there’s no reason to believe it will not be able to hit its target of 2,100 stores.
Management
President, Chief Executive Officer, and Director: Gregory A. Sandfort, age 58; previously served as President and Chief Operating Officer. Has been with TSCO since 2007, before that he was President and Chief Operating Officer at Michaels Stores, Inc.
Chief Financial Officer, Executive Vice President, Treasurer: Anthony F. Crudele, age 57, has been with the firm since 2005. He previously held similar positions with Gibson Guitar, Xcelerate Corp., and at The Sports Authority
Independent Executive Chairman of the Board: Cynthia T. Jamison, age 54, has held this position since January 1, 2014. She is also a director of Office Depot, Inc., B&G Foods, Inc., Cellu Tissue Holdings, Inc., and Horizon Organic Holding Corporation. Ms. Jamison was Chief Financial Officer of AquaSpy, Inc. from 2009 to 2012; she is a Certified Public Accountant in the state of Illinois.
Board of Directors: Nine members which consist of CEO Sandfort and eight independents. Directors bring to the board experience and expertise in the areas of auto retailing, legal, consulting, forest products manufacturing, restaurant management, and optical retailing.
Takeaways: Both the CEO and CFO have extensive experience in the company and their positions, and given their ages, could stay in place for several more years. The board has high representation from independent directors with a wide range of backgrounds.
Management and board descriptions based on information provided at Reuters.
Ownership
Gurus: Tractor Supply stock is held by seven of the investment icons followed by GuruFocus: Joel Greenblatt (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), First Pacific Advisors (Trades, Portfolio), Mario Gabelli (Trades, Portfolio), Pioneer Investments (Trades, Portfolio), Chuck Royce (Trades, Portfolio), and Ron Baron (Trades, Portfolio). The biggest holding is that of Ron Baron (Trades, Portfolio), 585,741 shares, representing 0.43% of shares outstanding.
Institutional Owners: Here’s how nasdaq.com sums up ownership by pension funds, mutual funds, banks, insurance companies, and other big pools:
According to nasdaq.com, the largest single institutional holder is T. Rowe Price Associates, with almost 19 million shares.
Short Interests: GuruFocus puts the current short interest at 5.93%, which is near the low end of the range established over the past decade:
Insiders: About 3% of the company’s shares are held by insiders, according to GuruFocus; former CEO James F. Wright holds the most among insiders, with 583,437 shares as of last December 31, while current CFO Anthony F. Crudele is in second spot with 189,284 shares as of November 6 of this year.
Takeaways: Strong showings by gurus, institutional investors, and the former CEO suggest this company has been well-vetted, and found safe for a long-term hold.
TSCO by the Numbers
Takeaways: A relatively low dilution of shares outstanding, share price nearing the 52-week high, return on equity nearly 30%, low dividend yield and payout (target for payout rate is 20% to 25%).
Financial Strength
GuruFocus gives Tractor Supply a 7/10 for Financial Strength and an 8/10 for Profitability & Growth:
As we look at the chart, two red or reddish spots attract our attention in a sea of green. One is Cash to Debt in historical context, and the other (an orange icon) is Revenue Growth, again in historical context.
Turning to long-term debt in the 10-Year Financials at GuruFocus, we see debt has indeed jumped exponentially, from virtually nothing at the end of December 2013 to $153 million at the end of September 2014. But while the increase is dramatic, it’s small in terms of revenue and EBITDA: $5.7 billion and $670 million respectively. And, TSCO has a Cash to Debt ratio of 0.31, meaning it could pay off its debt with cash on hand, as of September 30 (a ratio of more than 1 for Cash to Debt means a company could not pay off its debt with cash, and TSCO is well below that point).
The GuruFocus system also alerts us to something happening in Revenue Growth. Clicking on the Revenue Growth line brings up the following 20-year chart:
The chart shows a distinctive sawtooth pattern, typical of a company with a seasonal business. As Tractor Supply notes in its 10-K for 2013, "Historically, our sales and profits are the highest in the second and fourth fiscal quarters due to the sale of seasonal products."
This information alleviates our concern about the Revenue Growth Warning.
We see the same bumpiness in the company’s free cash flow, both on a year-over-year and quarter-over-quarter basis. The 10-Year Financials show the following annual results:
- Fiscal 2010: $126 million
- Fiscal 2011: $88 million
- Fiscal 2012: $225 million
- Fiscal 2013: $115 million
- Trailing twelve months (ttm): $216 million
As we say, bumpy, but moving in the right direction in the longer term.
Takeaways: The two warnings generated by the GuruFocus automated system may be discounted or ignored. Long-term debt has risen, but not significantly within the bigger picture, and Revenue Growth is currently down, but this is to be expected in a company driven by seasonal sales. Finally, cash flow is volatile, both quarterly and annually, but moving up in the longer term.
Valuation
Tractor Supply won a place in the Buffett Munger screener because of its predictable revenue and earnings growth, and because it’s currently considered undervalued or fair valued.
Consistency of growth matters a lot to investors who focus on value stocks. It means the odds are high that price will be pulled higher by earnings, making today’s purchase price relatively safe. To illustrate, here’s a five-year chart showing EBITDA per share (blue line) and price (green line):
While short-term views on a couple of metrics showed us sawtooth patterns, the longer-term view of EBITDA (typically less volatile than earnings or revenue) show a steady increase. Because of that, Tractor Supply earns a 4.5 (out of 5) rating. Backtesting by GuruFocus found that 4.5-Star companies average growth of 10.6% per year, and only 10% of them remain in a loss position if held for 10 years.
In examining Buffett Munger stocks, we also take a close look at a company’s earnings growth. More specifically, we want to know the company’s PEPG or PEG ratio; that is, the P/E divided by the earnings growth rate (five year EBITDA). For TSCO, the ratio stood at 1.12 (on November 18, 2014), which ranks it as fair-valued (PEG ratios below 1.0 indicate undervalued, 1.0 to 2.0 indicate fair-valued, and greater than 2.0 indicate overvalued). A ratio of 1.12 is at the low end of fair-valuation, so we would consider this company a strong buy prospect.
GuruFocus finds TSCO’s PEG ratio more attractive than 90% of the other 1354 companies in the Global Specialty Retail industry. It also notes, "Peter Lynch thinks a company with a P/E (NRI) ratio equal to its growth rate is fairly valued."
Takeaways: Tractor Supply has a P/E of 29.50 and a five-year EBITDA growth rate of 26.30% (for a PEG of 1.12), so it qualifies as fair valued by that definition (as of November 18, 2014) as well. And, as we’ve noted, it has the ability to grow its EBITDA consistently. Taking another look at the Earnings/Price chart just above, we note the share price fluctuates above and below the earnings line, suggesting a prudent investor would wait for a pullback to invest.
Opportunities & Risks
As the following image from its Fourth Quarter 2014 Investor Presentation lays out, the company believes it has opportunities to improve each of its key metrics -- and grow its earnings per share in the mid-teens as an annual percentage:
In addition, the company sees opportunities to leverage its strong cash position:
Overall, the company expects to open about 100 stores each year, with a longer-term target of 2,100 stores (about 50% more than the current count).
Risks
While TSCO has carved out a unique identity and market niche, it still can feel the effects of trouble in the American economy. Note in the following chart how net income (blue line) dipped in 2008, and how the share price limped downward for about three years, starting in 2006:
The company may not be able to open new stores at the rate it has predicted, or may not be able to grow same store sales. Many internal and external elements could affect these objectives, including failure to execute on internal plans, competition, and even the weather.
Many retailers, we know, have struggled to survive the growing strength of online stores and other Internet initiatives. Tractor Supply has an online channel, which it uses to both inform and sell, but new online competition could increase or emerge at any time and from any place in the world (witness the recent ascent of Alibaba).
And, with the emergence of the online world comes security and reputation concerns.
Outlook
While risks certainly exist, they’re common to just about all retailers, particularly brick-and-mortar retailers. So, there’s no compelling reason to think that Tractor Supply will not competently execute its plans. If it does meet its targets, it should mean profits for investors, including (as outlined in the Fourth Quarter 2014 Investor Presentation):
- Earnings growing 13% to 17% a year, and subsequent share price appreciation
- Dividend growth of 15% to 20% a year (while keeping the payout ratio between 20% and 25%)
- Share buybacks totaling $170 million - $290 million annually
Conclusions
Tractor Supply Company has a history of rapid and sustainable growth, and appears prepared to build out even further. It found a niche, serving the rural lifestyle, that complements rather than competes with the big box stores. Unlike some other retailers, it hasn’t yet been slowed by online retail competition from companies like Amazon.com.
From an investor’s perspective, this is not an income stock since its yield is less than 1%; however, the dividend should grow over time as the company has indicated it plans regular increases every year (a result of increasing earnings while keeping the payout ratio within a relatively narrow range).
TSCO should get the attention of investors seeking capital gains; with average EBITDA growth of 26.30% over the past five years, and no indication of a slowdown, the share price should continue rising.
As we’ve also noted, though, Tractor Supply metrics often show a sawtooth pattern, which means investors might want to wait for a pullback.
