Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Yes. Thanks, Daniel. As you referenced, and I mentioned earlier, at our enhanced earnings day, we kind of publicly communicated an evolution of our strategy, and we introduced kind of the Life Out Here Strategy. There's 5 pillars. The first is really around our customer and delivering legendary customer experience. Everything starts with the customer, certainly in retail and definitely at Tractor Supply. And we talk every day about delivering those legendary customer experiences. The second is we want to continue to evolve and grow our ONETractor capabilities. That's been an area of focus for us for several years. As Kurt said, we want to allow our customers to shop anywhere, anytime, any way they want. And then we're going to do that with the -- kind of in The Tractor Way with kind of the excellence and execution that we're known for. And then that's going to be backed by our hallmark customer service and really leaning into our team members and their wellness and their well-being and investing in them and to allowing, empowering them to do what they do great, which is deliver that customer service. And then lastly, we're committed to generating healthy shareholder returns. And so those 5 pillars were kind of our Life Out Here Strategy, executing in a very Tractor-like way. And then that third pillar around operating in The Tractor Way, which we've got a track record of doing that all the way back to 20 years ago, when Jim Wright was joining the company and we put in place a Lean and Six Sigma thinking, and that's really continued on. And as Greg joined the company and really brought in this kind of strong merchandising acumen and the art and the science coming together, and really what I'd say is that pillar is really just a continuation of those efforts. And the components in there are around store labor productivity, around DC, our distribution center and being productive in there but also on space productivity. And the 2 initiatives that you mentioned, Daniel, kind of ladder into that space productivity piece. Our Project Fusion and our Project Side Lot. Project Fusion is going to be inside of the store and a series of changes and kind of remodeling that we're doing to kind of drive the space productivity inside the store. And then the Side Lot project is focused on the outside of the store, where we've got about 15,000 square feet of concrete pad that we have an opportunity to convert into more sellable square footage and really drive the sales productivity up out there. Both are kind of tried and true approaches to retail. We're very confident in their potential. We've got a number of early pilots we've done that also help us have that confidence. And we've done all the business modeling, and it's -- they're very compelling investment opportunities for our shareholders. On Project Fusion, it really is about taking all the best of what we've done in the past with ONETractor plus all the other tests and pilots we've done. And then combining that with some of the latest analytical tooling that we've invested. So we've invested in some store clustering technology in the last 1.5 years. We've invested in-store specific planogram technology in the last 1.5 years. We've invested in kind of this CAD technology that allows us to have store-specific kind of bird's eye views and look at where our heat maps are from a sales per square foot. And we'll be able to take all of our past learnings plus these new capabilities we've built. And then that's what led to the Project Fusion. And we're really pleased it has macro space productivity improvements like reducing the apparel square footage and increasing pet square footage, where we've got very different sales per square foot. It's got within certain categories, it's got space trade-offs. And then also at a kind of large overall level, we're doing things like consolidating in our customer service desk and our cashier stand area, which frees up about 300 square feet that we can merchandise for. So it's got a whole series of moves, all focused on driving productivity. And then the Side Lot, as I mentioned earlier, is a 15,000 square foot pad out on the side of our store. We dominantly use it for the storage of agricultural and garden equipment, things like stock tanks, fence panels and fencing and others. And we're able to kind of put that up on racking, consolidate it, almost like kind of cleaning your closet up and getting that into a more consolidated area. No reduction of SKUs or inventory though, just merchandise in a more efficient way. And then that frees up space for us to do things like add about a 4,000 square foot garden center. It allows us to create a drive-through Buy Online Pickup in Store area. And it also allows us to create a drive-through feed yard. All those are incremental programs focused on where the customer is going. Garden, our customer tells us, is the #1 category that we don't completely fill their needs -- fulfill their needs for. Drive-through feed allows us to really go after one of the last remaining kind of criteria that we are -- we don't have a competitive advantage on around kind of the speed of load with your feed and food. And many of the regional local mom-and-pops in the farm and ranch have a drive-through area or you can kind of back right up. And so that really helps address really one of the last remaining criteria that we don't -- we're not best-in-class on. And then the curbside -- the drive-through pickup for Buy Online Pickup in Store just leans into digital more and more, which is where we know the consumer is going. So anyway, in summary, long answer, but Life Out Here Strategy, we're very excited about it. It's the next evolution of our previous strategies. All of our past learnings have gone into it. We're very bullish on our space productivity efforts and namely through the Project Fusion and Side Lot initiatives.

Got it. And I think I know the answer to this. That was helpful. Thank you for the color. But Kurt, as you guys think about success from these programs, is it more on comp and sales driving from productivity improvement? Is it cost savings and margin from some of the more efficient stores? Kind of how do you guys measure success? And as the pilot, can you maybe shed some color on, I doubt you can, but any kind of uplift or how those projects have gone relative to your initial expectations?

Yes, sure. Let me -- I'll start with the Life Out Here Strategy overall has got a great balance between prioritizing, grabbing and sustaining market share, growing the top line and the comp sales with initiatives and focus on cost saving, profit improvement. How do you fund and make sure that during a time of investment where we see a great opportunity, as Hal said, really going to where the customer is at and transforming the box and really making that level of investment. How do you do that and make sure that you've got good solid disciplines around the operating margin? And so the Life Out Here Strategy overall has that. For instance, and I'll talk a little bit about the focus on the comp sales drivers. But you've got areas like Hal mentioned, manage The Tractor Way, the field activity support teams and the work we're doing in both DCs and stores to focus on how do you take task work out or increase the DCs, your units per hour, by implementing efficiencies and labor standards in the distribution centers. So our strategy has a good balance of efficiency and productivity initiatives that help us over these 3 to 5 years be able to be very disciplined and focused on operating margin. But most of what you're hearing and the exciting opportunities are being able to sustain this market share opportunity gain that we see during this pandemic. As Hal mentioned, these new customers that are finding Tractor Supply, some of it might be transitory. How do you -- how are you able to meet their needs and change and go in the direction of where the customer is going on convenience? And in a product assortment like the lawn and garden, garden, in particular, and so we believe the opportunity with Side Lot and Fusion, in particular, are the biggest contributors of why we believe post-pandemic, that the comp sales trajectory can step up from that roughly 3% to a 4% to 5%. Those 2 initiatives, in particular, are the biggest drivers. And while those investments will drive added costs in capital that will flow through as depreciation, and then some other investments, investments in our people and the hours to man it, those burdens on SG&A can be offset through some of the savings that we have through efficiency. So the key is these investments give us the opportunity to sustain a new stepped-up growth well beyond what we predicted in our previous strategy and long-term targets and then have a higher level of trajectory and comps, while being able to maintain and even grow our operating margin over this period of time. And we believe that's the right balance, that sweet spot for us for the long term, and which is what we're doing. We've said a number of times in the strategy. We're going to come out of this pandemic stronger, and we're going to invest from a position of strength.

That's great. That's great. Maybe shifting a little bit to the competition and competitive outlook. How has that evolved this year? Are you seeing any evidence that some of your smaller competitors in rural markets are closing? And in the flip side, as your business has gone online and the world has gone online, has that brought any new competitors maybe like into your markets that maybe weren't there previously, but now your consumer is shopping there? And how do you defend that business, Hal? Can you help us talk through that?

Yes. So in our last earnings -- in our enhanced earnings call, we talked about our TAM. We introduced kind of our total addressable market. It's the first time we've talked about that publicly, and we said it's about $110 billion in size. And we said we had roughly a 10% share of that market. And so I think what that speaks to is it's a large market. It's an attractive market. It's one where we have a nice share, but there's significant opportunity still to grow. And as I said earlier, we are a lifestyle retailer. We're not a category-specific retailer. But -- and we compete in a very fragmented market against that kind of -- all those categories that come into play in our lifestyle. And so I'll kind of go around the store a little bit, maybe just talk about the competition briefly. At the highest level, what I'd say is we're winning and gaining share in every one of our categories right now in apparel, and we talked at the last earnings call that all of our businesses are performing -- had comps above 20% in Q3. So if you look at apparel and say, okay, above 20% comps in Q3, you look at the U.S. retail census surveys that have come out, the October 1 just released yesterday had apparel at kind of a minus 13% from October. And that's the best-performing month that apparel has had in 6 or 7 months, so far exceeding the growth rates of that business. You look at pet food, a category that's performing well right now given pet adoption and pet humanization, kind of probably mid to -- mid-ish single comps. Again, if you use the proxy at 20%, we're far outperforming the market right there. Pet food also is one of our larger categories online. We've talked about our online business being up over 100%. So as a proxy there, that gives you a sense of how strong our pet business is online. We certainly compete in pet against a number of companies. We compete against specialty, kind of specialty kind of bigger box, like a PetSmart, especially smaller box. We also compete against mass and food. And certainly, again, some of the pure-play players. But there's no doubt in pet, we are gaining share and both online and in-store. And importantly, we think our omnichannel approach sets us up to have the most compelling customer value proposition. I can speak more about pet, it's an area of significant investment for us on marketing and services and elsewhere. Animal food, we have the largest share of animal food in the country. No one sells more bagged animal feed than we do. Our growth rates there, we talked about our C.U.E. business in the third quarter being kind of mid-20% comps. Our animal feed business is a huge piece of that, that gives you kind of a proxy for how strong it is. There's not more horses in the market. There's -- horse count in the United States is stable. Livestock count in the United States is stable. They're not eating more food. When our sales are growing at that rate, it just speaks to the share gain that we're taking. Agricultural fence, doing great there. Again, trailers and truck tool and hardware, no one sells more trailers than we do, gaining share there for sure. And then garden is one of our best-performing businesses. It's an area that we think we can more fully address our customers' needs. And we lean into it some this year, and we'll be leaning to it more going forward. But highly attractive market, fragmented, one we have a strong share, compelling opportunity for growth and one where we're already gaining share. And as Kurt said, we want to invest from a position of strength and continue to gain share.

That makes a lot of sense. And then a quick follow-up. You mentioned you're at about 10% of the market. I mean, to give the crowd or audience a sense of how fragmented, when we think about the #2 and #3 player in your TAM, maybe where do you guys fit in that competitive? And what is the kind of delta within the bigger players? And how quickly do you get to very small fragmented players?

Yes. So I'll kind of break some of the competitors up, core farm and ranch is very -- we very much compete there at a local level. So when you're in a market, it's usually us and one, maybe 2 other farm and ranchers -- in farm and ranch stores. And we're competing at that local level on service, convenience, price, and the next largest farm and ranch store behind us is about 180, 200 stores. And so with us nearing 2,000, we're significantly larger in size. And that affords us a lot of competitive advantages in our scale on technology, in our website, mobile app and all those sorts of things, our scale with our vendors to make sure we're getting our fair share, if not more, of inventory and thinking about flow that through our supply chain at this kind of very elevated volume levels time. And then also -- the investments we made in our distribution centers and having a -- plus our mixing centers gives us a lot of competitive advantage there as well. But we also compete, as I said, we compete against mass, certainly compete against Walmart on certain categories, certainly compete against Home Depot or Lowe's on certain categories or ACE Hardware or Harbor Freight on the tools and hardware side and then certainly compete on the pet side, against like a PetSmart or a Petco. But so it's very fragmented, and most of those other competitors really only compete on one category with us. And that's why we stay really focused on the lifestyle. And the trend towards one-trip consolidation, Kurt talked about that earlier. People -- we're seeing -- we've seen roughly, call it, in the last 2 quarters, 14% to 15% average ticket growth. And the vast majority of that ticket growth is units per transaction. People are buying more in each one of their baskets. And it really speaks to us addressing that lifestyle, that one-stop shopping mentality and pulling together all those categories that are really what our customers want and need and making sure we're not competing against an individual retailer.

That's helpful. One from the audience that came in here, Kurt. At the enhanced earnings event, you raised the long-term comp outlook. You raised the midpoint of the EBIT margin outlook, but you did slightly lower the long-term earnings outlook from low double to about 10%. Can you help us walk through the different parts that got you there? Kind of what changed in your model to bring you to that lower earnings growth? And how do you think about capital return becoming a bigger piece of the total shareholder return within that?

Yes. Let me just use the opportunity to just summarize our financial outlook and the algorithm that gets to it. From -- starting with the top line with this step-up in growth, we'll grow this year at or north of 20% overall, just for the full year. As Hal and I have talked, we believe we've got a great opportunity to capture, sustain that. So with a significant step-up in the revenue growth, we'll open up new stores at a similar pace year-over-year in the future. The percentage or size of the benefit from new stores will be less than it has been in the past. So we look at an opportunity of a 6% to 7% revenue growth, fueled by a target of 4% to 5% comp growth with the difference in there being consistent new store growth, so that's a bit of a difference. See where it was, 7% to 9% revenue growth, 6% to 7%, it actually is fueled by a higher comp sales growth, which is more profitable for us. It's where we really like to see that revenue growth come from. But because of the size of the business, the new stores are a smaller percentage. That's then -- if you add on to that a target of growing our operating margin to as much as 1% growth in a benefit on the bottom line from operating margin growth, you then add on the ability to continue to buy back shares at a consistent dollar pace, where the stock price is at, anticipating that dollar amount buys back less number of units. The buyback ends up filling in the gap to about an 8% to 10% earnings per share growth post-COVID coming out of this Life Out Here Strategy. If you then add on to that our commitment that we are still focused on a 30% payout at a higher base, we've acknowledged that we will have dividend growth that likely outpaces the earnings growth to achieve back to that 30%. It gives a really good compelling and certainly in comparison to our previous strategy, total shareholder return which, as you heard in that Life Out Here Strategy, is a core focus of us is maintain a good, consistent total shareholder return target.

That's great. Yes. So including the dividend, we do kind of get back into those low double-digit range. That's really helpful. And then we're butting up on time on keeping on schedule. Maybe one last question. Hal, obviously, the market, there's always concerns in these tough comps coming. You've been in retail long enough to know that. As you look out to 2021, what gets you most excited about the Tractor story? Is there anything you think is just -- is misunderstood about the story that you guys are executing on? And yes, what excites you most?

Yes. I'd start by saying we are really excited about our Life Out Here Strategy. We're excited about the initiatives that underpin the strategy. And we're confident that it's going to create compelling value for our shareholders. And we provided the guidance in our enhanced earnings call on that outlook to kind of demonstrate our bullishness and our confidence. As it relates to 2021, I think 2021 is -- has as much uncertainty as 2020. I said this a couple of times where -- who would have thought that Q3 would have been as challenging as Q2, but it certainly was. And we had -- we're still dealing with COVID the entire quarter, we had forest fires on the West Coast, we had countless hurricanes in the Gulf, we had a presidential election. So it was a -- and I think all that uncertainty is going to continue into next year. It's going to be different, but it's going to still be uncertain. That said, we're really confident that we can continue to grow our business. We can continue to capture share in the market. And we know our primary challenge is to lock in those new and reacquired customers that have been shopping us these last 6 months and then also really do a great job of executing on our initiatives. And those 2 focuses, combined with this larger incremental structural base that we're operating on, I think, set us up well for 2021.

That's great. Thanks so much for your time this morning. If you have any follow-up questions, anyone in the audience, feel free to reach out. But if not, I'll leave it there. Guys, thanks again.

Thanks, Daniel.

Thanks, everyone.