Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Yes. Those returns have been great, and I think that's part of it. I mean you're right, one day, there's a merger that probably makes sense. But if your stores are good, why mess with it, right? It's almost strange. It's strange to me sometimes that the new asset has a dramatically better effect, but retrofitting stores is just beastly work sometimes. There's another thing that's interesting in terms of this kind of response that we've thought about, which is if stores continue to be an opportunity for growth, the other part is segment growth. And we've noticed that, obviously, in other moments in other segments, kind of this nesting behavior or kind of versions of this independence have been very powerful. And I think the key notion is how sticky is that. And so I'd just love to get your guys' sense of like is there kind of this benefit that you guys kind of help people in a serious mood? You certainly have $150 metal chicken if someone's feeling happy and quirky, but you also have these things that you deal with when you're fixing a real problem or you're nervous about something. And just curious how you might think about the stickiness of that kind of nesting or serious protection of your family.

Yes. So I think the way we look at it, we talked about this on our last couple of earnings calls, is that we estimate about half of our gains appear to be more structural with the other half being more transitory. And I'll give you a couple of examples and then give some caveats to this at the end. On the structural side, you think about things like pet and animal ownership. We've seen pet ownership kind of reach all-time highs. We've seen things like birds, chickens, those sorts of things. We've seen significant increases in purchases of those sorts of animals. Those things have 7-, 10-, 12-year life spans. They're going to be around for a while. And that annuity stream that goes along with them is going to be there, whether it's in food, whether it's in some of the more durable pieces of those business on the hardline side. We're also seeing these new and reengaged customers consolidating across their trips to one retailer and the shift of people moving more into the suburbs and the rural area, and we think some of that's structural as well. What I would say on the transitory side, we certainly are conscious that there was stimulus and favorable weather in Q2 and Q3 that help benefit our business as well as this shift out of entertainment and leisure and travel into home and backyard. And some of that might be a little transitory. What I would say, though, is the longer the pandemic lasts, we think the more the potential is for it to be sustained and structural. Customers are forming new habits, new hobbies. We're getting customers who are becoming more and more loyal to Tractor Supply. Our new customer counts are running very similar to what they were 4 and 5 months ago. The reshop rates of these new customers is holding strong at all-time highs on kind of a 30-day measurement. And we feel really confident in our ability to retain these new customers and keep them engaged. And we're investing in those sorts of things, whether it's either marketing programs around them or whether it's in tactical things like the cleanliness of our stores and making sure we have high customer service marks. I mean we started the year at 32,000 team members. We're now at approximately 42,000 team members. So we've increased our team member count by almost 25%, 30% just to meet this incremental demand and ensure we're providing great customer service. And so our focus is all about retaining these customers, keeping them engaged and then implementing our initiatives to help us kind of achieve our goal of just retaining this increased market share we've had.

Yes. And I mean, obviously, something has to roll over. But I think that we think about this kind of idea in the retail apocalypse, there have been some sectors that have just been shielded. And there's no question that people who won have been good, right? The leadership has been good. The teams have been good. The work in the field has been good. But it doesn't matter what segment you're in, right? It's not a trivial issue. And for as long as home improvement has been a run, my version of shifting people out of the cities into the suburban area, and I think as retirements go, I think more people will think about going further out, right? It will be exurbs or rural. Then you guys are in that space, which I'm very encouraged about. If you guys -- this is something I ask to everybody, so I'll let you both answer this one, which is if you had to take your same team and move it to another sector, it can't be home improvement, that's cheating, because you already left it, where would you go? If you had to take the whole team, shift to another sector, what would be one you think you'd have a similarly good shot at? Anyone? Kurt, whoever stealing it?

Yes. I'll start with it. Certainly, I'm taking the management team. And I'm going to start by saying I've got a bias. I've been here 21 years and worked with most of them for a good chunk of those. And I think the way this team has rallied around the new strategy, our new CEO and what we've -- what we're doing to not only survive but thrive in this environment, it's a real testament to the culture and the team. I would say that the 21 years, I would have a hard time leaving anything that was needs-based and lifestyle-oriented. Being able to serve the customer and not be transactional, it is a blessing to be in a retail environment where it is very defensible. It's needs-based. We've been through a number of crises and fared well in those. And it would definitely be focused on lifestyle and service-oriented, which is right where Tractor Supply is, Brandon.

That's great. It's helpful. It's discouraging to lots of other retail places that don't have either of those, but it is helpful. What are you thinking, Hal?

Yes. I'll just maybe tell a bit of a personal story on this, rather than just repeating what Kurt said. But I've had the opportunity to work for a number of really excellent companies. I started my career out of business school at McKinsey and then went to work for Home Depot, and I spent 10 years there and saw the home improvement category up close. It was during that time that I got introduced to Tractor Supply and started kind of watching it from afar and really took note of the company and all the positive attributes around it and just marveled at its execution and focus and performance. Then I had an opportunity to go out to work for eBay, kind of large-scale e-commerce, no brick-and-mortar at all, a business model that even is just proportionately attractive relative to the vast majority of e-commerce, given that they don't own inventory and it's a marketplace. Then I had a chance to go to Macy's, iconic retailer, fashion, softlines but highly discretionary. And Kurt -- I mean, I think I'll start with the mission and values of Tractor Supply, first and foremost, was what attracted me to the company. But secondly, before having a chance to meet the leadership team and getting to know the culture, really from an outside-in perspective was exactly what Kurt said, the needs-based, demand-driven, strong, loyal customer base, product at everyday low price, the business is a minimal discretionary. It's a -- and it's an industry segment that's very attractive. There's not heightened -- the competition is local, not national in its level. While it is shifting to digital, the dominant digital means is still with and through the stores and I think will always be, which creates a very attractive profitability profile as well. So I think I had that opportunity to answer that question for real about 12 months ago, Brandon. And I'm super excited to be at Tractor Supply, and there's not a leadership team I'd rather be working with.

Yes. I mean that's -- and the reason I ask this question is to just help people know that retail is a hard game to invest in, especially when you put your human capital into it. But the reason we do it is, in my opinion, fascinating business to be in, phenomenal impact you can have on people as associates as well as customers. But you've got to pick well because the business can just eat you up, and so we like these structural winners. The way you guys have framed it, the way we frame it is service and assortment. If you've got a service and assortment operation, you win. And if you want to play the long game, you either need to commit to being a price and assortment or pricing convenience leader. And that's kind of about it. I mean there's others that will come from time to time, but that's kind of about it. And you did. You live that choice, and I think you did really well. And guys -- remember, we can have some questions. I got a couple of e-mailed to me, so I'll be sure to pivot to those as well. Let me just get one more of mine out of the way, and then we'll go to that, which is there has been a opportunity with services. You guys have done, I think, a lot of very real services. But when the stores "shut down", they didn't shut down, but when they use essential services, but when people stop coming as often, that services business just disappear. Like did anybody still show up to need to wash their [ camel ] or its equivalent?

Yes. So to your point, I mean, we're dominantly a product business, but we do provide services, particularly on the pet side of things with pet washes as well as pet clinics. And then more recently, we've launched some things like pet Rx as well on our website. We did, at the beginning of the pandemic, stop the pet clinics, and we also closed the pet washes just that of -- in the kind of the abundance of caution and making sure that we avoided the queuing of lines and trying to minimize -- trying to have as clean of an environment that our customers can shop in as possible. As the pandemic has evolved, we've gotten more facts about how it transmits, and we've also been able to put in place plans to effectively execute these programs. We've opened then back up. And so we now have pet clinics and operating in their normal cadence, and our pet washes are back open as well. And we're seeing very good traffic through both of those. The only comment -- like I said, we're operating each one of them a little differently than we did pre-pandemic, but we're back and running with all those programs and seeing strong customer kind of reengagement with them.

Yes, that makes sense. I mean it is not trivial, the risk for those exposures. I mean we saw the human jump to [ Minson ] back in Norway in the Nordics. I mean there are real -- there's real things, right? I mean these do come from animals. That's usually how viruses start. One of the things I wanted to shift to a little bit or so just kind of some of the more kind of, I'll call it, investor business case questions, and I'll start with one that I got, which is whenever you guys are thinking through capital allocation decisions, is there kind of a force rank? Do you -- Kurt, do you literally like have this is the highest IRR thing we can do, and this is the one that's just above the hurdle? Or how crisp is that decision-making? Because I think that's one that I think retail is unique in because you tend to have hundreds, if not thousands, of investment decisions to make all the time, and I'm always fascinated about how our companies approach them.

Yes. I'll tell you a little bit about the challenge and the art that's there and how we approach it, and then we can go from there. One, when it comes to capital allocation, we've consistently seen and been able to experience, have confidence in the ability of our new store growth to have good solid IRR. And so that would be our first priority, and we continue to see solid returns from that. After that, it really is a mix of, to your point, we've got good opportunities, omnichannel and brick-and-mortar and other areas. It's a balance between what is it that's growing the market share in the long term. And we've always said we're going to go after market share, certainly, with disciplined focus on our profitability. So what -- it's a balance for us between how can we continue to grow and grab market share. Sometimes, that's the investments in our supply chain, where we know that it's going to be critical to grow the supply chain, to have our product in quicker than anyone else, have the biggest vendor sourcing group, which I believe has really played out to be a strength for us this year. So those can be things that we balance between. Well, if we could grow in areas like fusion and side lot, where we're very excited about the return on that level of invested capital in the long term as well as the near term, so it's -- for us, it's a great opportunity to really have that balance between both of those. Certainly, when we're making investments, minimally, we're saying, what's our weighted average cost of capital? We've got to be able to get a return that well exceeds that. But for us, we've got the opportunity to balance between return and what's actually helping us grab market share that we believe will really give the shareholder return in the long term.

Okay. I'm going to broaden a little bit on how you may want to take this version of branding as well. So there was a case -- a world view that people have that CapEx might come down a fair bit. And again, partially this is because anybody doing a model to make a bull case just shrinks CapEx at some point. It's not a surprise. There's a lot of free cash flow. But I would just want to give you guys the open-end conversation to talk about kind of CapEx plans. And obviously, you have lots of things to invest in that makes sense, but how should investors think about when, from a base run rate, more capital gets deployed versus less? How should they kind of read those wave movements that are broader than just a year or a quarter?

Yes. So first off, if I'd start out with -- we're conscious that we have a very attractive business model that produces strong, stable, growing cash workflows. And we know that our really #1 responsibility is the allocation of that capital. And it's -- that's the top priority we have as it relates to our shareholders and how we create returns for them. We create growth, and we create value over time. And you can go back through all the various people that have done incredibly well and all the failures and I think -- of companies, and it almost always comes back to capital allocation. And so it's a huge focus of Kurt and I. We talk about it numerous times a day, both strategically, philosophically as well as tactically and operationally. And we first start out with -- we think about our prioritization. We start out with we want to invest in the business. And if we've got value-creating opportunities to invest in the business, that's what our shareholders want. That's why they own Tractor Supply stock. But there's expectations around IRRs, return on invested capital that come along with that investment. Secondly, after investing in the business, we have kind of a debt ratio, that kind of liquidity that we're looking at that we say, okay, and we just recently refinanced a bunch of debt at great rates over -- for a 10-year period. We feel really good about where we are there. We're roughly running at about 2x, a little less actually now. We've talked around 2x as a threshold there, not to exceed 2.5x on EBITDAR. And then once we've got invested in the business and we're maintaining the right debt-to-equity and EBITDA ratios, then we start to think about some opportunistic M&A if that's out there. And then ultimately, we're looking at then how do we return value to shareholders either through dividends or share buybacks. We have a history of payout on both of those, payout on dividends and also share buybacks. We just restarted our share buybacks last -- 2 weeks ago in concert with our dividend announcements. And so that's just from a thematic perspective how we think about capital allocation and philosophically. And then specifically, it relates to our capital expenditures and kind of looking out over the next few years, we historically spent between $250 million and $300 million a year. And it would vary a little bit based on our technology plans for the year and our supply chain plans for the year. And the rest of the business was reasonably same year-over-year. As kind of with me new coming in, we took it as an opportunity to relook at our strategy and say kind of what's the next phase in evolution of our strategy. And then you compound that with COVID and us seeing kind of the size of the opportunity ahead of us and us wanting to invest from a position of strength. And we announced a few weeks ago our Life Out Here strategy, which is really an evolution of our ONETractor strategy and kind of the C.U.E. strategy from before that. And we think there's significant opportunity to create value for our shareholders within the context of that Life Out Here strategy. And we gave estimates and said we're going to be taking our capital expenditure up by a couple of hundred million dollars a year for the next few years. The bulk of that capital is focused on investments in our existing store base or in technology. And if you think about the first investment in your existing store base, the thing that we're excited about is all retailers that are about our level of maturation have to go invest in their existing stores, right? You go look in the history of all retailers, pick your retailer Home Depot. You pick Walmart. You pick Target. Everyone has had to go at some point when they reach 2,000 stores, thereabouts, and they start to invest in their existing stores. The good news for us is we have really compelling sales growth ideas when we invest in our existing stores. It's not just kind of maintenance capital, so to speak, right? We're able to go in and do a big space productivity program inside of our stores and elevate the sales there kind of in a math and science like way. And then with our side lot -- and that's what we call Project Fusion, and then in our Side Lot, we've got the opportunity to really rethink the productivity of this 15,000 square feet of concrete pad that's outside of our stores and do things like garden centers and drive-thru feed stores. So it's very exciting that we've got compelling ways to invest in our existing stores and actually grow them and drive their sales per square foot versus just kind of maintenance capital to keep them refreshed and at customer expectation. And then the other half is really in technology. And that's where all omnichannel retailers are having to lean more and more into their technology. And so we're really excited about our Life Out Here strategy. We think there's really compelling growth opportunities and value-creation opportunities. And there's incremental capital that goes along with that, but we're confident in the return that will be generated.

Okay. That's great. And one of the -- why I wanted to put those 2 together is when I've seen retailers start to fall apart, it's when people essentially cook the remodel numbers, right? So I'll just put it that way. And I don't mean in like a fraudulent way. I just mean that the internal pressure for people to go, "Our project worked." Now I lived through one of the worst of those, which is Walmart's project impact, where it was just impossible to get people to like shake them and go please look at the actual results. So it always makes me nervous people do that now because it can't be done successfully because it can. What operationally are you guys doing to make sure that you guys at the top don't go this project must be successful, and then magically, everything they bring to you looks perfect? How do you make sure that your team understands your guidance, which is give me an awesome thing? If it's not awesome, tell me, and we'll keep going until we get the awesome thing. How do you make that real in the daily behavior of the home office?

Yes. So I mean a variety of things go into that. First off, I think you've got to have a real compelling business case that has some pilots and tests that inform it, and that's certainly been -- that's certainly the case with us. We've had Tractor Supply as a track record of testing and iterating and piloting. And so whether it's our Project Fusion or project side lot, that was also the case there. So once you've got this business case, then you put the resources against it, you start to execute and then you're maniacally tracking and looking at the results. And you're also maniacally tracking and looking at the process. Are we effectively executing the way we want, on the pace that we want, at the cost that we want and ultimately getting the results? And so one of the things we've done in the last few couple of months is stood up a new structure, a process, governance really around this incremental investment that we've got in place. We've gone through that with the Board. And then next year, we will be putting in place an incentive program that reinforces execution against those initiatives, and we started to talk about that internally with the team. So that way, we're all aligned, and we've all got skin in the game on the execution against these initiatives. And the reward and incentives won't be on as much on the -- it's a combination of both input, meaning did we do what we said we're going to do; and then also an output, meaning, did we get the results that we said we would get. And Kurt, myself and others are very committed to that process and maintaining that rigor. And to the extent that we don't see the results, we will iterate. We'll pivot, but we won't -- we're committed to not putting money into investments that aren't paying -- getting the results we want.

That's great. And it's a hard thing to do, and everybody means it the best when they start out, but I'm excited to hear that you guys have got that rigor. Last one, EPS algorithm. So one of the things that's always tricky with this is your core business. There's so much growth inside of it, and there's so many ways to grow that every time I look at this business, I'm like stores could go 5, and comps could be 3 or 4, and dividend could be 2 or 3, and then anything operationally and some are at 10% or 11% or 12% or even 13% or 14% EPS growth. Help me contextualize what folks should expect. And I'd love for both of you guys to kind of pitch in here. And we'll start with you, Hal, in terms of where that's going. And then, Kurt, if there's any color you want to provide, we'd greatly appreciate it. And the reason I say this is, at the end of the conversation, that sounds a lot like this, that I have with investors all over the world, which is really positive, and they're like, "What's it going to grow again?" And that's why I just wanted to end with that because it is the most common question I get from investors when they're trying to really go, wow, this is a phenomenal story. And I get why this financial is going to work for me as a quality compounder.

Yes. So I'd say a few things about our business and our future. First off, our -- if you take our Q4 guidance and add that to our year-to-date results, you can kind of get a proxy for the full year. So our sales will eclipse $10 billion this year for the first time. They'll be up roughly 20% year-over-year. Our earnings are up even more than that. And so -- and then if you look and you say, okay, sales up 20%-ish, earnings up significantly more than that, and then you go -- and then we go, hey, we've got a strategy that can build on top of that and have mid- to high single-digit sales growth, high single-digit earnings growth and realize, as we said, we're in the early days of that multiyear strategy. So we're going to approach it from a conservative perspective and on both the amount of share buybacks we assume but also on the results of the investments we make and -- but be bullish on the potential for those to outperform. And so we think it's a very compelling story. We're a much bigger business than we were at the beginning of last year, and there's still tons of opportunities still out there ahead of us and not -- I don't think there's a lot of businesses that could almost -- could increase their sales by 20% and their earnings power at the rate that we did and still have that much opportunity out there. Kurt, do you want to talk a little bit about the earning -- the EPS algorithm and kind of have sales and margin and then buybacks?

Yes. Definitely. Brandon, let me start with just kind of the -- it's important to know the time frame. We very purposely, in our enhanced earnings call, walked through the next few years. And we gave targets for that period of time that's a normalized post-COVID, a year after this COVID pandemic period of time, which we don't know exactly how long that is. But we see what the investments we're making with the tailwinds from a macro perspective that we just talked about that there's a 6% to 7% revenue growth stream there, which is an elevated 4% to 5% comp growth coming from the investments we're making in the business. If you tack on to a 6% to 7% revenue growth, a slight maybe 1% operating margin growth rate in there, and then you add on to that the share repurchase program, we believe this model can drive an 8% to 10% earnings per share with also dividends that we've committed to be very consistent with. And even as our Board supported us in the statement recently that we are targeting to get back to a 30% payout ratio, certainly, the earnings growth causes us to put through a process where we anticipate our dividend year-over-year growth will outpace earnings. So you tack that on to it, and it really gives us a real strong total shareholder return over the next 3 to 5 years. All of this on a much higher base of revenue, as Hal mentioned, all of this during a time where we are committing that we believe we can launch this multiyear, chain-wide rollout of investments, maintain and grow operating margin and, at a much higher revenue base, have an 8% to 10% earnings per share is what's exciting about our ability to come out of this pandemic stronger, invest from a strategic position of strength, so that not only are we growing revenue and earnings per share, but we're positioning us for the long term.

That's perfect. Thank you, guys, so much. I appreciate it. Remember guys, there's Procensus poll for results of this stuff. Thanks for the time. Like I said, everybody knows, I'm Super Bowl on Tractor Supply. I hope this illustrated some of why. And I think it's an exciting story, and it proves that retail is investable, if anybody doubts it. All right. Cheers, everyone. Stay safe.

Thanks, Brandon. Thanks, everybody.

Appreciate it.