Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Well, good morning, everybody. Thank you for joining us this morning at our conference. For those that don't know me, I'm Bobby Griffin, I cover consumer hard lines, retail -- especially retail as well as convenience stores here at Raymond James. This morning, we're privileged to host a fireside chat with the senior management team of Tractor Supply. In attendance are CEO, Hal Lawton; and CFO, Kurt Barton. So first, guys, thank you for attending. Thank you for the support. Also, I would be remiss not to mention one of the best IR teams in the business is also in attendance, so Mary Winn and Marianne. So thank you also for the support for this conference. I must say it's great to see everybody in person again. So the format is going to be a fireside chat between myself and the team, and we'll dive right in.

So how you guys -- you guys have capped off an impressive year growth on top of another impressive year growth. And there's clearly some really good trends driving your business. So maybe let's unpack some of the tailwinds that are really benefiting Tractor Supply going into this calendar year.

Yes. Thanks, Bobby, and good afternoon, everybody. And to your point, our sales were up 52% the last 2 years, but we estimate our market was up 25%. In addition to the GDP growth that goes along with our market, kind of 4 big trends really driving our market. The first is around pet adoption. Millions and millions of pets have been adopted over the last 2 years. There's obviously a stock-up purchase that comes along with that initial purchase -- I mean, adoption, and then an ongoing annuity stream that's really fueled our business in the market. The second really is around rural revitalization. So we've seen over the last year, significant movement, particularly in the millennial generation, out of urban environments into ex-urban and rural environments, and that's benefited us. The third is the notion of self-reliance. And that's things like planting gardens and raising chickens and kind of the whole mentality of kind of living off the land. And the last is around home setting, and people investing in their homes and investing in their land. And those 4 mega trends are ones that I think we uniquely play at the center of and have really been driving our market over the last 2 years, like I said, to the tune of 25% growth. And again, by comparison, we were up 52%, so also a significant share gain on top of that in our results. But those are the big mega trends that I think are driving our business, driving our market, and we see them as substantially structural and ones that will continue to remain this year and beyond.

Awesome. So maybe let's dive into some of the -- there's a ton of initiatives going on right now at Tractor. So maybe if you look at the handful that are going on, 1 or 2 that excite you the most for calendar year 2022 and maybe even into 2023?

Yes so -- to the point of -- if our market was up 25%, and we were up 52%, there's a 27-point difference, right? And I'd kind of point to 2 big things for that, the first is kind of short term. We've been investing in customer service, in the supply chain and technology and in inventory to make sure that we were the preferred retailer for our customers during this time. And so -- and kind of its -- customer service in today's world. It's just really difficult, everyone knows given the labor market. Inventory, just having the inventory there. I think we've gained substantial share versus our competition from just being priced right with inventory and great customer service. And you gave the example of our investments there. We had 32,000 team members at the beginning of 2020. We now have 46,000 team members. So we've increased our team member population by 40%, in arguably the most difficult labor market this country has seen. And our inventory levels, we finished 16% above last year at the end of Q4. Again, one of the more difficult global supply chain markets ever seen. So investments there, I think, really are paying off in terms of just winning that customer shopping. And then the second is around our Life Out Here strategy. And so that's to your point, Bobby. We introduced our Life Out Here strategy in October of 2020. We're about 1.5 years into it now. There's kind of 5 big initiatives that we've been focused on over the last 1.5 years: Our Neighbor's Club program, which is a 24 million member program, highly scaled with significant technical capabilities underneath it, supporting it. Our FAST program, which is our merchandising kind of execution arm, it's a 1,700 person team solely focused on executing planograms and resets and seasonal sets in our stores, for the most part, fully funded by our vendors; our Fusion remodel program, which is inside the store, kind of a full remodel of the inside of our store focused on sweating that asset more and driving productivity, as well as making a more contemporary shopping experience; our fourth is around our Side Lot initiative, and this is really taking a concrete pad that we've historically had on the side of our stores and then agriculture equipment and kind of other types of products out there. And we're now better merchandising those products, putting them up on racking, et cetera, and they used to be on the floor and pallets and we're building a 4,000 square foot garden center, and we're entering the live goods space in a destination way; and then the fifth is around digital. We've been investing heavily in our ONETractor strategy for a number of years. This year, our -- last year, our digital business was nearly $1 billion in sales. To put that in comparison, our digital business is larger than any of our core farm and ranch customers -- I mean, competitors total sales. So those are kind of the 5 big initiatives our historical capital spend, kind of 2019 before have been in that kind of $250 million, $275 million range. And with our Life Out Here strategy announcement, we increased our capital spend between $600 million and $700 million. But at the same time, took our sales up, sales growth rates up, took our operating margin rates up, took our EPS top end up and also increased our dividend to a 40% payout, a 77% increase over last year.

Okay. Yes. And before we maybe dive into some of those, I mean, just to piggyback off the record 2 years of growth, there's been a ton of incremental revenue added to the business, Kurt. So is there a catch-up investment phase? Or do you feel the business has been investing kind of on a nice cadence going forward to support this new level of demand?

Yes, I think Hal's comments right there is a great segue into it. 1.5 years ago, when we launched the Life Out Here strategy, we recognized then those top 4 macro trends. And the Life Out Here strategy has been all about investing from a position of strength. We've made that statement, we've been bold about that, that we've seen a revenue stream. We've seen a market share gain, and we're going to take that opportunity, take the dividends from COVID or the shift in rural revitalization and invest that back in the business. We've been able to do that, to Hal's point, while growing our operating margins north of 10%, but it's really important for us to make those investments. Hal talked about the capital spend. It's investments in capital, it's investment in SG&A. And really just to summarize again, I mean 4 things from an investment standpoint: The Fusion and Side Lot investments in our business and Neighbor's Club; Secondly, the digital investments we're making to make shopping at Tractor Supply extremely convenient and just dominate on that; and then third, but very important, the supply chain, recognizing we've got to have the supply chain to be able to feed the demand into the business. And so we'll open up another distribution center this year. We've already getting started on one to open up in 2024 and then likely Pacific Northwest a couple of years later. And that's a much faster pace, but we've got to be able to build the business to support this demand. And then lastly, but very important, investing in our people, in the store experience. And we are committed to being number one in customer service, making sure that experience of the store is exciting. There's theater, but there's great customer service. And so to your point, is there a catch up? The last 1.5 years, we said we were going to make those investments in line with it. So our plan over the next 5 years, our long-term targets all include the investments we're making throughout this time.

Great. And let's maybe dive in a couple of those points. Let's maybe start with Project Fusion and kind of expand on what that does inside the store, what you're seeing is expanding space, new products, new layouts, just dive into that, and then we'll hit on a couple of the other points.

Yes, absolutely. How many people have been in a Tractor Supply? All right, so maybe half or so. So if you know that about us, we're a lifestyle retailer. And we've got a whole variety of categories where the assortment is all tailored about to Life Out Here is what we call it. And so we've got apparel as you walk into our store, and you saw Carhartt and muck boots in [ Columbia ] and Wrangler jeans and those sorts of things, work gloves and hats and T-shirts and stuff like that. then you kind of come around and you've got pet food. Then you've got animal feed, right? Chicken feed, cow feed, horse feed. We're top 5 in pet food. We're #1 in the country in animal bag feed. We've got agriculture equipment, so things like stock tanks and t-post and that sort of thing. And you've got truck tool and hardware, everything from power tools and hardware to truck boxes and trailers. And then you go all the way to garden wares, where it's fertilizers, but also zero-turn tractors, but all this is tailored to Life Out Here. And so the Fusion Remodel is basically how do we make sure we've got the highest productive assortment and layout in that store? And so what we did was we took kind of 75 to 100 little mini business cases, combined them all into one remodel program so we can minimize construction costs. And we're going kind of store by store. By 2026, we'll have all 2,000-plus of our stores, by that time there'll be many more stores, but they'll all have the Fusion remodel program in them. And what we're seeing is low to high -- low to mid-single-digit growth in our -- with our Fusion remodels when we're complete. And I'll give you examples of some of the things we're doing. We're shrinking our apparel area by 1 row, kind of call it, 8-ish feet, but then densifying it more and basically increasing both the sales and the numerator as well as reducing the square footage of the nominator, driving significant productivity in apparel. That allows us to add cash. That's an area we under penetrated in. So now we have more of an assortment. We put it right at the beginning, so it gets great visibility. We've seen substantial increase there. Another example is that we've been able to do that with -- because we took a service desk, so took 300 square feet. We moved that up to the cash register, and now we have laid out areas, because we have 26% more poundage of animal feed and pet food over the last 2 years running through our stores. 26% more poundage. And so we've got to have pallet positions to support all that demand. Then you come around power tools, that's an area that we've under-invested in the past. We now have a legitimate power tool corral as you go down into our stores. We brought in PORTER-CABLE to be our consumer, kind of DIY-oriented brand. It's exclusive to us. They pulled out of home improvement and supporting just us. We've expanded into Makita. They were in 1 of the 2 home improvement retailers exclusive. They're now with us as well. We've added Bosch and Dremel and we have a legitimate power tool destination as you go down. But I can kind of go on and on across the store where we're going kind of square foot by square foot and making sure we've got the optimal assortment for that store and the right program. And again, we're seeing kind of mid -- low to mid-single-digit comp lifts as we drive it. In addition to all those productivity enhancements, it's also contemporizing the store. So every one of our in-caps now have these nice light boxes, it could be changed out seasonally, bring more light to the store. We're upgrading the walls, we're upgrading the bathrooms, team room. Because our average stores are over 10 years old now, so we've got to go through a kind of freshing of our stores, but we want to do it in a way where it's creating real value for our shareholders. We're really pleased with it. We've got over 15% of our chain already done. And as I said, again, 100% of our chain will be completed by 2026.

And the other exciting part is there's another initiative going on that at times it goes in connection with Project Fusion. So you're kind of seeing a double action lift at time. So maybe let's touch on the Side Lot, which seems like a very big opportunity over the next multiple years as well.

Well said. So the history of Tractor Supply is founded in 1938. So we're an 84-year-old company. We historically began with like tractor parts and tractor supply and then we got into agriculture equipment. About 40 years ago, we got really heavily into animal feed. And that's how we became the #1 player in bag animal feed in the country. About 20 years ago, we continued to evolve our business model into pet food. And now we're a top 5 player in pet food. Now what we're doing is evolving our business model, again, to get into the live goods. And so we are building garden centers on the side of our stores, about 4,000 square feet in size. This has really found space. We've always had a concrete pad outside of our stores, as I was saying earlier. We were able to just better merchandise the product that we have, they're stock tanks, fence posts, t-posts, et cetera, and we're adding this 4,000 square foot garden center. And what we've said is in stores where we do both Fusion and Side Lot, we're having high single-digit growth rates post the completion at about the 12-month mark. And it's -- our customers tell us that the category they most participate in that we least address for them is live goods. And so it's just the next step in us kind of creating another demand-driven needs based, kind of -- we call it CUE, consumable, usable and edible-type category in our business that just drives further transactions and it's a great ticket starter for the rest of the purchase of our customer. The one final thing I'll mention is it will be very different than what you might see in kind of your traditional garden center or say, a home improvement store because those stores are typically focused on suburbia, which is all about color and beautification, whereas our customers is much more about functionality and need. So it's going to be much more about trees that you need to plant in your yard to create shade for your animals, shrubs that go around your property and down your fence line, fruit trees that you might need to be replacing for maybe a frost over the winter or vegetables. So it's vegetables, fruits, tree, shrubs, et cetera, things that are really the needs of our customers, and has really been an underserved part for them. If you go to a garden center or a home improvement store to buy those products, you kind of got to sort through all the suburbia stuff before you can get to those. So it will be a great -- we've got a proximity and location to our customers. We're going to have the great customer service, which we're always focused on, and then we'll have this new product offering, it's a big opportunity for us of growth.

Absolutely. And then we've touched -- Kurt, we've touched on some of the megatrends in favor. When you look at 2022, there's clearly some headwinds and some tailwinds. So maybe we unpack a little of what you think could be the headwinds towards the business and lapping big high-ticket demand, how you guys think about that, what you're seeing from the customers in that sense? And yes.

Yes. In our outlook for 2022 we've said we're targeting a 3% to 4.5% comp on top of the 2-year stack, 40% comps that we had in the 2 previous years. And when you unpack that, we've said, we expect that inflation will have a benefit to the top line. We -- our guidance included about 400 basis points of that. We've said that could actually be on the high side of that. If you then look at some of the other factors, we expect 1% to 2% comp transaction growth during this time as well. And that's just amazing coming off of the 2-year over 20% -- nearly 25% 2-year stack on comp transactions. And then I think the only other factor that plays into it, we recognize that a portion of our total sales growth, our comp growth of 60% last year, a few points of that was really driven by stimulus and big ticket. And so if we could see some of that big ticket having a little bit of pressure on the AUR, so we factored into that. But all of those factors play into a really strong comp sales growth for 2022. And as it relates to inflation, which has been even greater topic today than it was even a month or so ago, we're managing that. We're maniacally focused on it, whether it be from grains to steel to oil even. And Tractor Supply has had a strong history during inflationary or deflationary environments to be able to navigate that well. We're a needs-based business, demand driven. Roughly about 15% of our product, we attribute that, you could call discretionary type spend. Most of it is very needs-based. We're a grocery type store for the land and animal. And so the consumer comes in, they have a need. They don't change necessarily the vehicle, the animals and all that. And so we've been able to very carefully be able to take those inflationary pressures and pass that on, while still maintaining an everyday low price on that. And with the environment that it is today, we still feel that our merchant team can navigate that well and maintain our guidance range on sales and operating margin.

Very good. And I think it's a great transition into just the supply chain in general, just kind of where do you see the day where our in-stock levels, there still areas that are tight. And then clearly, there's some new geopolitical stuff going on in the world with Russia, Ukraine. Just do you see any ripple effects from that on potential areas that you supply in?

When we think about kind of macro headwinds, there's kind of 4 big ones that we talk about. We talk about the labor market, where we talk about supply chain, inflation. And when you think about -- and COVID -- and when you think about each of those 4 kind of -- for now, knock on wood, right, we're all here today without masks on. And COVID seems to be abating some. You look at the labor market, I think it's becoming a little bit more market by market now and kind of the overall national kind of pressures are starting to slow a bit. Supply chain is probably the same as it was in, say, November, with a few less ships off the coast, but nonetheless, still 60, 65 ships. And then I think inflation obviously has reared its head again. On supply chain, we've not let our foot off the gas pedal one time over the last 2 years. We've been consistent to say we're going to invest or a position of strength and that includes inventory. And I think part of the share capture we've had over the last years has been the confidence that our customers have had that we have the stock. Now there's no doubt when you walk our stores, you'd find a category here or there, that are little spotty, but the things that customers really shop us for, animal feed, pet food, garden, et cetera, we have -- we have been in stock the whole time. We're committed to staying in stock. And we've been doing things like we took our 8 existing DCs that we have that are 1 million square feet. And we've got 24/7 operations and all those. We've gone from 6 mixing centers, which are cross dock facilities that allow us to flow pallets of feed and food to the stores hyper efficiently, and we've gone to 12 of those last year. We'll add another 3 or 4 this year. We opened up 4 or 5 pop-up DCs last year to provide some additional capacity for us. As Kurt said, we're building 3 more DCs, but it will take some time for those to come online. So we added these pop-up DCs. So we've just been maniacally focused on staying in stock. I think our kind of line that we always use is pleased but not satisfied. We'd like to have some more inventory, but we finished Q4 16% above last year, and we'll continue to stay focused on running strong in inventory.

Maybe let's switch gears and hit on the Neighbor's Clubs program because that's really been an area of pretty impressive growth. And it seems like something Tractor's really stepped up over the last 2 or 3 years really building that out and then starting to leverage the data. So I guess first of all, let's touch on with that many members now, what are kind of the opportunities going forward with your vendors, your top vendors and even some of your smaller vendors to leverage that and to different ways to drive sales?

Yes, so a little bit of background, 24 million members under Neighbor's Club program. So very scaled loyalty program. Last year in March, we updated our loyalty program, so it's tiered rewards. So we had a Neighbors, we have -- the phase -- tiers is called Neighbors. Then you have Neighbors Preferred and Neighbors Preferred + so it's kind of, typical silver, gold, platinum type thing. The more you spend the more percent back you get, the more points you earn. If you use our private label credit card, then you immediately go to the top tier and earn 5 points back. To get a very scaled loyalty program, I'd have put at the likes of a Starbuck's or Costco in terms of its sophistication and also its scale within our business, represents about 70% of our overall sales, and has an 80-plus -- 80%-plus retention rate, customers once they join the program. Our top tier, if you go into our highest valued tier, it's well over 95% retention rate. We got a lot of opportunity to continue to make it better and better and harness the power of it. Everything from -- with all of our customer data sets up in the Azure platform, we've got all kinds of analytical tools on top of that, whether it's for personalization or whether it's for customer data, data insight to analytics. We're feeding all that into e-mail pop, mobile app notifications, text messaging, social media-type and digital ads, and kind of tailoring all that. But a lot of opportunity to continue to do that, with the vendors to your point. A lot of opportunities to partner with our vendors on, kind of, customer offerings based on either customers' preference for their brand or maybe if they've shown that a customer profile like theirs has it -- would normally prefer their brand, but they haven't yet taken it on, right? So it's an opportunity to kind of drive consideration. But it's a big opportunity for us.The thing that -- is impressive is even if you think of it, 70% of our sales, our Neighbor's Club program is consistently quarter-on-quarter on a like-for-like basis outperforming in total store by like 4 and 5 points. So it's still growing, it's still accelerating. It's driving engagement. We're seeing tremendous -- one of the reasons we released this tier to loyalty program was to start to be able to mechanically encourage customers to trade up in the tiers and it's exactly what the behavior is that we're seeing.

Yes. So it seems like there's a lot of internal opportunities in this mix or not opportunities for the vendors. Maybe on a longer-term basis, you see even a way to monetize it in a mini advertising business or something like that, that other retailers have started to push a little bit into.

Yes, that's certainly something we have on the white board.

Okay. And then maybe let's -- we can't get out here without a capital allocation question, especially sitting next to you. So maybe let's first hit on business continues to generate a lot of cash, great results, so priorities for cash. And then we even a little bit how M&A fits into that because there is a fragment kind of nature to some of your competitors as well.

Yes. Bobby, it's a great point. So for the group, Tractor Supply has just been a strong producer of cash flow. And certainly, in the lift in the business the last couple of years, our operating cash flow north of $1 billion. For 2022, it's $1.1 billion to $1.2 billion in operating cash flow. And when you take our $600 million in capital spend, or $625 million to $675 million as our range, the amount of free cash flow that produces gives us the ability to then as a second level of priority after investing in the business to then return to shareholders. And that gives us the ability, as we announced to be able to -- in the long term, be able to maintain roughly an estimate of pulling about 2% of shares out of the market in our share repurchase program. And then as we just announced in our enhanced earnings event the end factor, we really believe this operating cash flow with a strong, consistent already planned investment in the business, it gives us the ability to lift that dividend that was targeted originally at 30% payout, we can move that to a 40% payout. That's roughly -- depending on the stock price, that's north of 1.5 yield, 1.7, 1.8 yield on that. And it's exciting for us to be able to do that. We -- it's our confidence in the business to be able to raise the dividend, our announcement was a 77% increase in dividend. So that's our top 2 primary uses of cash. And then with $1 billion of cash on hand, it allows us to do that and be open to opportunistic acquisition. And we've got 1 acquisition in the works right now. That's a great opportunity where you've got a really good, similar type farm-and-ranch retailer that's in the Midwest, great locations, very similar to Tractor Supply, to be able to add in the markets that we really like, to be able to do that. But for us, things that are on our Life Out Here strategy, where either there's other retailers where Tractor Supply can be the exit strategy for that generation, or if there's other opportunities just to be able to meet the areas of our focus, whether it's land, animals, pets, all that, we look for acquisition opportunity, but it really be for things that are core to our strategy.

Okay. And then how you touched on it a little bit, maybe let's touch a little further on the ESG efforts because one of the pretty impressive stats was when I think you said 30,000 to 46,000, was that the number of employees over the last 2 years the business added?

Yes.

So -- and in a fairly tough labor market. So maybe touch on the benefit structure has changed a little bit, to keep retention and anything going on there from the company from an ESG standpoint.

Yes, absolutely. ESG is near and dear to our heart. It's something that we've been focused on for well over a decade now. We really do take the kind of notion of Life Out Here as it's integrated into our culture. It's who we are. We talk about we hire our customers, right? We're a representative of our communities. And we've always prided ourselves on being a steward of Life Out Here because that's really what our -- how our customers approach things. They live on their land, many of the -- much of their land is typically multigenerational in nature. The grandparents lived on it, and then the parents, then now the adults that are current, they're thinking about their kids living on it. So it's all about sustaining that land, reinvesting in the land and the home. We think about our businesses is the exact same way, and we want to contribute to our communities in the same way. So whether it's in the well-being of our team members, as you mentioned, Bobby, all of our team members have access to benefits, the same benefits as I do, right? So a part-time team member who works 12 hours a week, right, and our minimum is 10 hours a week. There's 10 hours a week to get benefits. So we have one of the lowest miles -- benchmarks kind of bars in all of retail. Everyone has access to the same benefits. On wage rates, we've increased our wage rates by over 20% over the last 2 years. We've also gone in and done a number of appreciation awards and other types of things to support our team members. Like as an example, 2 years ago in August of 2020 when everybody was having to do at-home school, we get donated 3,000 laptops to our team members so their kids or their grandkids could do school kind of virtually. So a lot of things on our team member well-being. Environmental, we have -- we've made new environmental commitments last year to have a 25% reduction in our greenhouse emissions by 2020, and a 40% reduction by 2030 and then carbon neutral by 2040. We've got a game plan for that and a capital investment against it. For example, our DC that we're building in Ohio will be zero carbon footprint. And then we also have a number of social goals as well out there, specifically focused on people of color, both improving the representation of our store team members but also in management as well as our spin with suppliers. So it's something we're highly committed to. We're investing in and we'll continue to, and it's just part of our culture.

Absolutely. We got about 2 minutes left, so maybe one final question. We do get some concern about higher interest rates, impact from housing. I believe remembering the stats correctly, the business performed actually pretty well during the last big housing crisis, maybe slightly modest negative comp but positive transactions. So maybe unpack kind of how you think about interest rates, potential impact, if they do move higher on the business. In my view, the business today probably even has a little bit more sticky revenue base than a decade ago. So just touch on any of that aspect in it.

Yes. So first off, I'd say last time in the 2007, 2008 bubble, like you said, we had 1 year of very modest negative comps, I think it was minus 1%, but still positive comp transactions. So given the need, as Kurt was describing earlier, given the needs-based orientation and then it's demand-driven, our business has demonstrated the ability to perform through all various economic cycles. We've had 30 straight years of positive revenue growth as an example. What I would say just on the housing market right now is just -- I think we're in a multiyear strong housing market. You've got a millennial generation that is now beginning to purchase homes. And it's a larger generation to the baby boomers. So there's not enough housing stock out there. And so I think mortgage rates are going to need to go up 3, 4, 5 points to curtail some of that demand, which I don't think we'll get there. And so I think you're going to see a very robust housing market for the next several years.

Absolutely. Well, we're right on time. So Hal and Kurt, appreciate the time, and let's move to the break out.