Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Good morning, everyone. Thanks for joining us. I'm Peter Benedict, senior retail analyst here at Baird, and I'm pleased to welcome the team at Tractor Supply back to the Baird conference. Tractor has been a key participant in the physical version of this conference for over a decade, and we really appreciate their willingness to join us here in this virtual setting. For those of you who are not familiar, Tractor Supply is the leading rural lifestyle retailer in the United States. They operate around 2,000 stores across the country. Now they don't sell commercial-grade tractors, and they don't really serve the commercial farm or agricultural sectors. Tractor's really more of a go-to provider of needs-based products to households that are looking to tender their animals, their land and their other rural lifestyle needs, and the stock currently carries a market cap of around $15 billion -- $14 billion, $15 billion. With us today, we have CEO, Hal Lawton; CFO, Kurt Barton; Tractor's Head of IR, Mary Winn Pilkington, and her teammate Marianne Denenberg. So thank you guys for coming. Tractor provided a bullish update on their 2Q trends last week, and we'll get into some of that. But first, Hal is going to start off with some few brief remarks, and then we'll kick in to the Q&A. Hal?

Great. Thanks, Peter, and good morning, everyone. It's great to be with you today, and we appreciate everyone taking the time to be with us. And I hope everyone on the call is doing well and safe. Certainly, these are certainly unprecedented times. As we turn to the next slide, we've got our safe harbor statement here. Before we get started, I just wanted to note that any forward-looking statements that we may be making this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. If we turn to the next slide, just a little overview of Tractor Supply, and thank you, Peter, for the introduction on our business. And I'd start with our culture. And Tractor Supply is a business that's over 80 years old. And our mission and values are truly our secret sauce to the business. And I've been with the company about 5 months, and the reputation of Tractor Supply's kind of culture, mission and values really preceded my joining, I knew well about it. It was kind of well-known in the industry. And I'd say it's been my biggest surprise since joining. I've really seen the culture and the mission and values in action, and I had incredibly high expectations before joining, and it's exceeded all of those. In addition to our culture and our mission and values, we serve a very unique customer and lifestyle. We talk about it as the Out Here lifestyle, and I think the rural renaissance that we're seeing in America right now and the kind of safety of your backyard, Tractor Supply kind of really speaks to that, our business model does. We have a very unique business model. It's very purposeful, built to that kind of rural outdoor, Out Here lifestyle. And we look forward to talking to you about our business today. As we flip to the next slide. As I mentioned, I've been with Tractor Supply almost 5 months now -- or over 5 months, excuse me. And it's really been a tale of kind of 2 very unique time period. My first kind of 6 or 8 weeks were very scripted with overlap with Greg Sandfort, our previous CEO, and we did numerous store walks together. We took time with vendors. We did an overlapping earnings call, an overlapping board meeting. We had our annual sales meeting, where we bring about 4,000 individuals to Nashville to talk about our priorities for the year. But a very well-scripted first kind of 8 weeks. And then as we all know, the COVID-19 pandemic started to really take hold in the United States in early to mid-March. And that became kind of our sole focus and really it's been the kind of the second half of my first 5 months. It's been almost the core focus of my time and our company's focus. And we've really been focused on 4 main priorities. The first has been the health and wellness of our team members and customers. We -- both the work environment of our team members and the shopping environment of our customers is paramount and having a safe and healthy environment. And we've taken over 100 actions in the last couple of months, 3 months, really all focused on this priority. Kind of example, actions are everything from a 2-hour or $2 per hour appreciation bonus for all of our frontline team members to things like PP&E and plexiglass at our registers or the rollout of a greeter role in the front of our store that's responsible for sanitization of carts as well as things like social distancing, monitoring social distancing in the store and kind of keeping customer counts so that we can have the right ratio inside of our store. Highly fluid situation, every day close inspection of what's happening, but we're very pleased with our efforts in this area. The second priority, as noted here on the slide, has really been around managing our business operations. It's incredibly volatile environment right now, and we've been very focused on trying to manage through that volatility as best we can. We've been fortunate to have had a business model that's demonstrated significant resilience during this time, and I'm just really proud of our team members for everything they've done during this time and all they've accomplished during this time, including things like hiring 4,000-plus team members, rolling out a national ad campaign, ramping up our purchases and our inventory levels to fulfill against this kind of unprecedented demand we're seeing, or all the back-office activities that we've been executing while working at home. And as Peter mentioned, the last week, we provided an update on our business and the outlook that we gave was for comps in the second quarter to be in the range of 20% to 25% and total revenue to be in the range of 24% to 29%. So really pleased with all the efforts the team has been taking to manage our business operations in this highly volatile period. The third thing that we've been focused on is investing in our strategic initiatives. I firmly believe that the strong will get stronger through this period of time, and we are committed to capitalize on the opportunities that this crisis presents. And we've announced a number of things recently, including the rollout of curbside pickup, the rollout of same-day, next-day delivery, the doubling of our mobile point-of-sale hardware that we have in the store. Last week, we announced the relaunch of our website. We had 100% of our site traffic on our new website now. And we announced the upcoming launch of our mobile app, which we expect to be live in the app stores in the next 2 or 3 weeks. And then the fourth priority that we've been focused on early on, in particular, Kurt and our finance team are really leaning in here has been around cash, liquidity, solvency. We kind of operated, particularly early on, in the theory of kind of hope for the best, but plan for the worst, and wanted to make sure that under any scenario, the solvency at Tractor Supply was not a concern. We have over $1 billion of cash on hand now and kind of feel very good about where we are on this front. Just stepping back, if we look back and kind of early thoughts, turning to the next slide. We shared some of these items in our kind of a mid- March update that we did with the analyst community kind of concluding my first 60 days in the role. And I guess what I'd say is that these early thoughts that we shared are equally relevant right now in our current environment, in this current period, as they were in mid-March when we shared these. And these are the areas that we really are focusing our investments. I referenced some of the ones that we've announced in the last couple of months that have really been focused on digitization. But we have a whole range of initiatives that we are investing in and continue to lean into during this time. The first is around taking a very customer-first approach. We have a strong Neighbor's Club membership, and we are leaning into that. A Neighbor's Club program, over 16 million members, and we're leaning into that to be able to do kind of robust CRM activities and digital execution and personalization and kind of just fostering that relationship with our customers, but we're also adding significant amount of new customers into our business at this time spurred by the launch of our national ad campaign. Digitization, whether it's the digitization of things like e-commerce or whether it's other kind of more back office type areas like digitization of our stores and digitization of our supply chain, that's a big opportunity for us. Maximizing the productivity of our core. We've got a lot of opportunity both to drive improved space productivity in our existing stores as well as look at other opportunities to really drive kind of comp store improvement. And really, we've used the term a bit kind of sweating our assets that we have more. As Peter mentioned, we have almost 1,900 Tractor Supply stores and 200 Petsense stores, almost. And so a big opportunity to just make sure that the assets that we have there are maximized from a space and productivity perspective. The fourth is around investing in our team members. They are absolutely a competitive advantage for us. They're a strategic asset. The heart and soul of our company. And really, our relationship with the customer is firmly grounded in customer service, and we are spending a lot of energy and investment both in wages and benefits with our team members. But also in areas like our Tractor Way program to drive productivity and reduce tasking for our team members, and we have a number of other areas that we're working on right now to drive the productivity of our team members and allow us to spend as much of our team members' time on customer service. And lastly is around robust cash flows and healthy balance sheet. Both Kurt and I firmly kind of acknowledge the importance of capital allocation and resource allocation. We're committed to having a very healthy balance sheet, and that has served us well during this time. We also know we have robust cash flows. This will be our first year of over $1 billion of operating cash flow. And that's a very much competitive strength for us, but also comes with an accountability of how we allocate that. And so these are kind of some of the emerging themes and areas that we're investing. We know there will be significant -- we know there will be continued change as we continue to evolve Tractor Supply, but it really will be much more about an evolution versus a revolution. Tractor Supply has a very proven business model that -- and with a track record of success, being that dependable supplier of relevant products and services to the rural lifestyle. And we know we've got a lot of opportunities still through some of these various strategic focus that I just mentioned, to continue to evolve our business model and exceed the ever-increasing expectations of our customers. So I'll just close with -- our core areas of unique and differentiated strengths are really grounded in the legendary customer service that we provide to our customers. It's grounded in the knowledge that our team members represent. We hire our customers. And the vast majority of our team members are very grounded in the Out Here lifestyle. We are an everyday low price retailer, and we've used this -- the pandemic crisis to double down on that effort. We've had, I think, one print ad in the second quarter, and we've been very focused on everyday pricing through this time. And it's always been a core component of our business model, and it's one we've leaned into even more so right now. We have convenient locations, 15,000 to 20,000 square feet typically, great, very convenient locations, and we think that convenience orientation has really served us well during this time. We have a very robust supply chain, and that complements the unique product assortment that we have and allows us to serve the customer when, where and how they like. So Peter, that's just a quick kind of overview of the company, how we respond to the coronavirus, some of the areas that we're investing. And I think maybe we'll just turn it over now for some questions.

Great. Great. Hal, thanks so much for that. And for folks listening in, if you have any questions, you can use the icon in the upper left corner of your screen to send them in. We'll do our best when we have a minute in the conversation. Hal, just let's step back for a second. I mean given your background at Home Depot and eBay, most recently at Macy's, I mean, you've got one of the most unique perspectives on how companies are positioned and equipped to deal with the rapidly evolving consumer environment. So just quickly, how does Tractor stack up? And how do you -- where do you see the most opportunity to maybe expand Tractor Supply's reach, given your history of these other companies?

I'd start with consumer behavior. And consumer behavior is different than it was a year ago, 5 years ago, 10 years ago, and it's going to continue to evolve. And retailers have to evolve with that ever-changing consumer behavior. I think now more than ever, we're seeing really strong bifurcation in retail between those that have a concept and a business model that's adaptive and agile and able to be reflective of the customers' needs, and other retailers who are struggling to evolve and have a business model that perhaps is a bit more fixed and difficult to really stay out ahead of kind of customer expectations. At Tractor Supply, we feel incredibly confident in our business model. We have a concept that's 15,000 to 18,000 square feet that's well suited to convenience. We've got almost 1,900 Tractor Supply locations across the country that are typically very convenient to our customers. We've got a playbook around great products at everyday pricing afforded by fantastic customer service. We continue to evolve that. We're continuing to build new stores. We're continuing to evolve our assortment. We're getting much more focus on space planning. We're bringing in new brands, and we're expanding our technology footprint. And we see a significant opportunity ahead for us and are excited about the future.

That's great. And you mentioned convenience. And I think there's still a perception out there, at least among some, that Tractor Supply is behind the curve with digital and therefore, exposed to losing share to the Amazons or the Chewys of the world. But I think the definition of convenient in rural markets can be a little different than maybe in urban settings. And so maybe talk about how you guys are delivering convenience, enhancing your convenience to your consumers. And then maybe from a merchandising standpoint, how private label plays into the defensibility of some of your businesses?

Yes. So start with -- I think I'll hit convenience in a couple of different ways. First off, to -- just from a structural perspective, the size of our store we think has been advantageous for us during this time at a 15,000 to 18,000 square foot format. It's -- we think it's not intimidating, perhaps like some of the larger boxes out there are. And we've also been -- we've kind of tried to lean into that with really strong execution around safety and kind of health of our team members and customers, the shopping experience during this time. And then in terms of making the in-store shopping experience even more convenient, we recognized, with the strong volume, that we needed to increase our customer service levels to continue to provide that convenient purchasing experience. And that's when we've hired over 4,000 team members in the last 6 weeks. And to put that perspective, that's over a 10%, almost 15% increase in our team member count in the last 6 weeks. In addition to kind of that walk-in traffic, which has been very strong [Audio Gap] commented last week that we've seen. So we are seeing strong [Audio Gap] put depth in the store, and we do think that speaks through just the general peak strong growth in our buy online, pickup in store. It's somewhere around 65%, 70% of our total online business. Another 15% to 20% [Audio Gap] we'd pick up in store. When we ship it, [ it's long ], and our online business is running well ahead of its historic penetration rates. And we think that speaks to a lot of the [Audio Gap] ONETractor strategy that we've been executing for the last 2 or 3 road map. For the rest, balance of this year and next year from a technology perspective and continue to drive kind of an omnichannel -- our omnichannel capabilities, but I feel like the foundation we have and also the initiatives we've rolled out have really served us well during this time.

Okay. Great. And I'm getting a lot of questions coming in from the field here around new customers. And we've written that this experience has kind of been a customer trifecta for Tractor Supply. You're expanding your wallet with existing customers, you're reengaging with previously lapsed customers and you're obviously attracting new customers. If this had happened 3 to 4 years ago, I'm not sure Tractor would have been equipped to really understand what's happening. But now with Neighbor's Club, as you alluded to earlier, 16 million-plus members, you're really in a great position to do just that. So maybe talk about the new customers that are coming in, maybe how they look relative to your existing base. What are your plans for leveraging the customer data? And then are there any loyalty programs out there in the market that you guys benchmark against to help kind of lay out a road map and say, here's what's possible over the next 3, 4 years?

Yes. Thanks, Peter. [Audio Gap] on things that were kind of more behind the scenes, in terms of all the customer data kind of tooling and platform to allow us to understand and better serve the customers that join our Neighbor's Club program. And we now have over 16 million [indiscernible], and we're able to both target them digitally via CRM activity inside of the stores just through engagement at our point of sale [Audio Gap] leveraging all that data and driving a variance. We have our mobile app, as I mentioned earlier, that will launch in a few weeks' time, and a core emphasis of that mobile app is our Neighbor's Club program as we anticipate that our most loyal customers will be the fastest adopters for that. So that's kind of contributing to our comp growth this quarter. And as we look at those transactions, we -- the dataset is that it's not just our existing customers that are driving those but also a wealth of new customers. And we've seen a kind of unprecedented level of both new customers and also reacquired customers. And the good news on the new customers is they're also coming back to us and shopping with us a second time and more at a higher rate than they have historically. So not only are we're seeing an unprecedented level of new customers, but the frequency of reshop is higher. When we look at the dataset, they -- generally, those new customers look very similar to our existing customers. The first category that they purchased from us reflects generally our mix. It's not one category that's really driving it more than another. A slightly over index on things like buy online, pick up in-store and curbside and ship to store, but it's just a slight over index. Generally speaking, they look very similar to our existing customers from a footsteps perspective. Perhaps a tiny bit more suburban, but I think that speaks a bit more towards our brand awareness a bit as you were implying in your opening comments, Peter, the more rural our store is, the better our brand is known, both who we are, but also what we carry and sell and what we're known for our value proposition. And one of the big things, our national advertising campaign, the first of which we've done in the lab, it's the first time we've had one in 10 years, has really been focused on is driving that awareness in consideration of a new customer set. And we have fortunately been able to identify the vast majority of those new customers, either through the datasets they've given us or that we've been able to match to that are kind of third-party publicly-available datasets. And we're doing a number of kind of CRM activities to kind of lock those customers in as well as digital marketing with them. And so really focused on our existing customers, but also locking in our new customers and trying to kind of exit the pandemic as a stronger business, more scale, than a larger customer base.

Okay. Good. Great. Kurt, maybe we'll bring you in here. I mean you guys don't have formal guidance out at the current time, but maybe some qualitative thoughts even around the longer-term P&L, capital allocation. I'm curious, your view on kind of how the volatility in commodity prices plays into your business, how investors should be thinking about that, maybe some of the major puts and takes on your gross margin. We'll start there.

Yes, Peter, thank you. I appreciate that. I think the first question you asked, commodity pricing. We've seen over the last year to some modest level of inflationary pressure. And then this is certainly a bit of volatile time. But at this point, we see that dissipating to a bit. Don't necessarily anticipate inflation for the back half of the year and the near term being a driver or tailwind of it. At this point, the best we see it could be more of a -- from a commodity standpoint, flattish to even potentially some deflationary pressure from commodities such as corn, oil as well as some of our C.U.E. items such as lubricants and transmission fluid, et cetera, that has some of the oil-based/petroleum-based product in there. In regards to gross margin, the puts and takes, I think at this point, it's probably best to just be able to frame it up like this. At this point, there's a -- today, in the current environment, there's a lot of shifting and changing in the puts and takes on the gross margin side. Generally, as we indicated in our business update, to a net favorable to us, we anticipate continuing in second quarter to see gross margin expansion. But we really need to look to see when the -- when we get back to some level of normalcy, that's where we're looking for to say, what might be the new norm? And with the new norm, what's the gross margin impact to that? We continue to be focused on productivity in our gross margin. That's the supply chain, our negotiations and the strength of Tractor Supply in being able to drive gross margin improvement. But as we get to a bit of more normalcy, I would expect that Hal and I'll be able to give a little bit more guidance as to what we think both the near-term and long-term opportunities are on the gross margin side of the business. But as we've said, we've been really proud of how the business has been able to manage in the merchants, in particular, gross margin. Maybe just wrap up your question with capital allocation. We still are very committed to our capital allocation strategy, focused first on investing in our business with over 65% of our capital spend on growth in the business. That's new stores as well as investments in the business. And even in the current environment, we've shifted a little bit to some of the new technology advancements to really move closer to what the new customer demands are. And so we'll continue a good, robust level of investment and anticipate to be in the range that we set for this year. But as Hal has said, we're going to invest in the business. Our plans are coming out of this stronger than we went into it. And maybe lastly, just to wrap up, we're still very committed to returning the robust free cash flow back to our shareholders. While we're paused today on share repurchases, for purposes of just preservation of cash and liquidity, we do anticipate for the long term, that to be part of our capital allocation. And we'll continue to evaluate the need for the liquidity and cash preservation throughout this year, and likely in the back half of this year, we'll give an update on our plans for reengaging in share repurchases.

Thanks, Kurt. And I guess 1 -- 30 seconds here left. How does M&A fit into that capital allocation plan? And does the current environment maybe pull forward any potential opportunities on the M&A front?

Yes. Certainly, it's still part of our capital allocation strategy in there. And I'll let Hal maybe speak to the -- how he views M&A.

Yes. Great. Thanks, Kurt. So to Kurt's point, we're absolutely committed to investing in the business as kind of capital allocation principle, number one. We've got a certain kind of debt level that we're looking at to kind of maintain kind of an investment-grade kind of set of ratios, kind of number two, although we don't have public debt now, we kind of do our own proxies around that. And then the share buybacks and dividends. And then we definitely look at acquisitions kind of right in the middle of that. I'd say we're very open-minded to them. We both had kind of -- just like all companies, kind of our chessboard that we look at. And it's always a matter of actionability versus the attractiveness of the opportunity. And when those 2 intersect, where something is actionable and we think it's attractive and we think it's the right move for our shareholders and the right return for the business, then we're very open-minded to it.

Okay. Great. Well, listen, guys, I think we have to wrap up there. Thanks so much for your time. The companies that are on deck for the 10:15 session include Dunkin' Brands, Pitney Bowes, Pluralsight, Petrotech and Heidrick & Struggles. Thanks again to the guys of Tractor Supply, and I hope everyone enjoys the rest of the conference.

Thanks, Peter.

Thank you.