Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Good morning, everyone. I'm Michael Lasser, the hardline, broadline and food retail analyst from UBS. We could not be more excited to have the team from Tractor Supply with us today. It doesn't need any introduction, but just in case, I will give the team their just due. To my far left is Hal Lawton, Tractor Supply's CEO, who's been with the company since 2020. Prior to that, he spent some time with Macy's and Home Depot. To my immediate left is Kurt Barton, who's been Tractor Supply's CFO since 2017. And then we are also blessed to have Mary Winn Pilkington, the legendary Corporate Communications and Investor Relations Head of Tractor Supply; and Marianne Denenberg.

I wanted to start with Hal Lawton, who might have the honor and privilege of having the strongest follow-up to the best rookie season since LeBron James. Would you say that's -- it's probably true, right? It's pretty remarkable couple of years for Tractor Supply with volumes now up 50%, basically, on a per-store basis over the last 2 years. So as you reflect, Hal, how do you separate what Tractor Supply has done to drive that versus the fortunate circumstances of just being in the right place at the right time?

Yes. Thanks, Michael. Appreciate the intro, and good morning, everybody. It's great to see you. I'd kind of break it into 3 buckets. First off, our market, it's up about 25% over the last 2 years and kind of well above GDP growth rate, and there's kind of 4 main megatrends to that, and I'll mention that in a minute. But our sales, as Michael mentioned, up 52% over the last 2 years, so a significant share capture. And I'd point to 2 main things for that. One is the investments we made in short-term areas but then also the investments we've made in our Life Out Here strategy. On the megatrends driving the 25%, it's really 4 big things that we see as very structural in orientation, things like pet ownership, pet adoption, self-reliance, homesteading setting and then rural revitalization. So to hit each one of those real quickly, millions of pets have been adopted over the last couple of years. That's an annuity stream that's going to keep going on. You look at a couple of other pet public companies that are performing well also. But we're not only just at the intersection of pet, we're also at the intersection of something like homesteading. I firmly believe that we're in a bullish housing market for the next many years since you've got a millennial population that have been renting for the last 5 to 10 years that's now all wanting to buy homes, win enough housing stock. And so people are buying homes, renovating homes, splitting homes. That's going to continue to benefit us. Rural revitalization. 20% of America moved last year. That's -- the average is 10%, so you had a much higher move rate last year. The millennial population was a big percentage of that increase, and they're moving to ex urban and rural for 2 reasons: one, affordability of a home; but also they've been living in the urban and city environment for the last 5, 10 years, and they want space, and they want land. I'm not saying cities are dying. You've got a whole another Gen Z that's coming through, graduating college who are going to go into the cities and urban environments as historically generations have. But the millennial population that have been kind of putting off some typical generational norms for an extra 2 or 3 years than past generations is now kind of in one fail swoop kind of adopting those. And the last thing I'd say is self-reliance. We're now really year 3 into very different behaviors than we all had pre-COVID. We were just remarking at break how any thoughts that people had of substantial travel outside of the country to Europe and other places, all that's changing now, right? People are going to be spending again this summer more time outside and traveling inside of the United States. And so this self-reliance mentality is just such a big driver of our business as well. We see all 4 of these things as very structurally sound. We think we're uniquely positioned to sit at the epicenter of all 4 of these, and there's very few other retailers who actually have kind of all 4 of these megatrends applicable to them. Again, that's driving about 25% of our growth. And then if you look at, well, how do you get that other 27%? Well, first off, investing in staffing and in inventory and in price and some basic digital competencies over the last 2 years. We have grown our team member base from 32,000 to 46,000 over the last 2 years, a 40% increase right in the tightest labor market this country has probably ever seen. And what that's allowed us to do is, as we've scaled our business, is to have that customer service that we're known for in our stores. Sending on inventory. We've never taken our foot off the gas pedal there. We finished the year up 16% over last year with excellent in-stock rates. If you're in our stores now, you'd see them fresh and full, ready for spring. And the same thing even goes on pricing and on digital. We've made some investments of things like buy online, pick up in store; a rollout of our mobile app; a number of these sorts of things that's created a competitive advantage for us in the market. And then the third lever, as I mentioned, is our Life Out Here strategy. We increased our -- we announced an increase in our capital investment in October of 2020 from what had historically been a run rate of around $275 million to now between -- to $600 million and $700 million and so a substantial increase. At the same time, we also took up our long-term targets. But as -- and that capital is going against store remodels, the Fusion and Side Lot projects. It went against a number of technology investments we made. It's going against supply chain investments as we build out 3 new DCs, and it's also gone against things like our FAST team and our Neighbor's Club programs that have been -- driven significant performance improvement in our business. So we've been very fortunate to sit in an epicenter of a number of really strong macro megatrends that are kind of structurally sound but then also to kind of reinforce the competitive advantages that we have in the market. We participate in a really large $180 billion market that's highly fragmented where we really have more scale and wherewithal than any other competitor. One of the facts always tossed out is our digital business, which is nearly $1 billion, is actually bigger than any of our -- it's actually bigger than the total business of any of our direct competitors. And that just kind of gives you a sense of the scale and the advantage that we have.

I feel bad for those smaller mom-and-pop players in the marketplace that have to compete with Tractor Supply. Kurt, I want to bring you into the conversation. The world's changed a little bit since you provided your guidance about a month ago remarkably. So we're now sitting in an environment where gas prices -- or oil prices are as high as they've been in recent memory. You do have stores that are levered to the energy complex in certain regions of the country. We -- and other grains, which are key inputs in pet food, which is a decent-sized portion of your business, are sitting at recent highs. How does -- what is impacting the world today? Influence some of the -- and can you influence some of the planning assumptions that you made behind your guidance? Can you put it in perspective for us?

Yes, sure, Michael. And even after the last 2 years, it's probably fair to say would you have guessed that that's a valid question a month or 2 into the new year?

People always question whether I have valid questions or not, but that's...

And so it's a fair question. And when you think back of 2020, the unprecedented but fluid nature of even the last couple of years: 2020, the unprecedented impact from a pandemic; and then 2021, everybody navigating through supply chain and inflation. Most companies go into 2022 thinking, "All right. We still got to navigate that." And sure enough, to your point, early on in the year, you've got global events that are impacting that, so it's a fair question. And in regards to that question, for 2022, we -- our assumptions, our guide was a comp sales of 3.5% to 5% comp for the year, and...

3% to 4.5%.

3%, sorry. Thank you. 3% to 4.5%. Yes, yes. 3% to 4.5%.

I saw Hal mildly -- differently, so I thought I would jump in, yes.

Thank you for that correction there. And then what plays into that is we are targeting and believe we can drive both ticket and comp in the year, positive comp transactions coming off of a 2-year stack 40% comp in the business. And from the ticket standpoint, our guidance includes a benefit from -- we said roughly about 400 basis points of benefit from inflation with some pressure of cycling on the ticket stimulus. So those are some of the key algorithms and the key variables into our comp sales. And during our call a month ago, there was questions about the inflation. And I think it was appropriate that, at that time, when asked, is there a risk of the high or the low side of it, and we said if there's a risk to higher load, it's more to the high side of it. We've been pretty hawkish on inflation over this period of time, calling it out and planning for it. And at this point, it seems all indicators would be that it would be the higher side or the upside of that number. The other thing to point to with Tractor Supply is in an environment like this with continued inflation, being a needs-based, demand-driven business where there's limited or a lower percentage of discretionary spend. Over the years, when we've been in these environments, Tractor Supply has managed it very well. The traffic count continues, and we can manage through these as we had in 2021, so we feel confident to be able to manage through what might be additional inflationary pressures. And then lastly, to your point, there are aspects of our business. It helps kind of balance out some of the pressure's inflation, but there are benefits to it, that, to your point, we do serve in certain states, the energy sector and some of the tradesmen and the contractors. And the farming communities do see additional revenue flow through the inflation as well. So again, it positions us to be able to be balanced in regards to the pressures of inflation and the benefits from it. And again, another good spot for Tractor Supply.

There's no doubt. Hal, I want to bring you in on this question as well. You have the benefit of operating in a few different categories throughout your career, whether it's apparel or home improvement. Is there a point where certain categories see too much inflation? And as part of that, how do you manage this in a way that, inevitably, this is going to be cyclical, so there could be deflation on the other side of this? And your predecessor once mentioned to me that when the price of a bag of birdseed drops in half, you don't sell twice as many bags of birdseed. So how do you manage it what potentially be on the other side as well? Does that enter your mindset as you're operating through this environment?

Yes. So I'd say 3 things. First off, I think a good bit of the inflation that we're seeing in our -- across the country is structural in nature. I think you'll see some soybeans and some wheat and some corn will moderate. I think albeit it will remain at higher levels than it has historically. I think we're in a multiyear secular trend higher on oil as well. But I think wage rates, container cost, import cost, some of those underlying variables, I think we're at a new norm on those. So I think there's a little bit of give and take but more structural in nature than perhaps other inflationary cycles. The second thing I'd say is we're not going to be the canary in the coal mine for our customers on inflation. We are the grocery store for our customers' land and home, and they're going to cut back on trips first. They're going to cut back on going out to restaurants, other discretionary items, to your point, like whether it's a payroll or higher ticket items. And they're going to make -- their animals still have to be fed. Their pets still have to be fed. Fences that break still have to be fixed. Riding lawnmowers that break still have to be fixed or purchased. So I think you're going to -- we will -- to date, we've seen little to no elasticity at all in terms of customer behavior, with the exception of birdseed which we talk about is the most discretionary item we sell. You literally toss it out on the back porch, and the birds fly in. And so other than that, but the third thing I'd say is just we are -- it's just worth reinforcing, and we talked about it in just 5 or 10 minutes ago. The competitive advantage we have in the market relative to our core competition, it's worth really reinforcing that. Let's take like a bag of Purina animal food. And when it leaves their manufacturing facility, it makes its way to kind of a mom and pop or -- so our largest competitor is kind of 120, 130 stores. You get down into some 60 and 70 stores. But there's 10,000 farm and ranch stores out there ripe for market share gain, and they're all much more descaled than we are. So when it leaves the Purina manufacturing facility, the vast majority of them go to market through distributors. So it's going to -- they're going to take a price increase immediately. The animal fee price is monthly. They're going to take that price increase on day 1. It's going to go into the distributor. 10 or 15, 20 points are going to be piled on top of that where you got wage increases and such, COVID cost. Then it's going to make its way finally into that retailer and at a much higher price than what Purina price to that. With us, being the -- we're the largest seller of animal feed in the country. So we can negotiate Purina, hey, maybe half of that goes through this month. Hey, maybe give us 10 or 15 days relief. Hey, look, what -- you all know how those manufacturer and top retailer negotiations go. Then once that happens, it heads straight to any store that's over $8 million, which we have 300 or 400 of those. It goes straight to that store, straight full truckload, full pallets, offloaded straight onto the floor. You remove all of that distribution costs and all that second truck of cost. At a minimum, for our stores that are under $800 million, it goes to a cross-dock facility where maybe they bring in either another Purina truck of chicken feed or cow feed or animal food from Mars, we're literally cross-docking full pallets straight on the trucks, heading it straight to the store. So just the efficiency that's in our supply chain and in our total cost on our core products, like 50% of our products when you think about animal feed and pet food and other bag feed in queue is just so much greater than our -- the small mom and pops we participated. I was in Long Island last week, and one of our core competitors there. We were literally going animal feed by animal feed, and we were $5 better than them on price, on everything. And we're not -- we're holding our margins right now, right? We're not -- we aren't out there saying we're going to invest in price. We're passing through much of the cost. We're holding our price, holding -- I mean, we're holding our margins, raising prices. And yet still, we're really price competitive versus our competition.

We got a question that kind of jumps off on this. Are you seeing any bifurcation in demand or behavior in high-end consumers versus low-end consumers?

We don't have a lot of low-end consumers. We're kind of that middle to upper-middle class, and they've got a couple of billion dollars of pent-up savings, and you're starting to see income -- you're starting to see the savings rate come down, right? People starting to tap into that savings. And so I think the United States economy has got 12, 18 months to be able to navigate that pent-up savings, and I think our consumers are faring very well right now. And we do monthly surveys of them, and they are starting to see some qualitative responses that they're going to cut back on some discretionary purchases. But when we dig into that, it's as much inflation as it is things like gas prices. They just go and like, "I'm not going to go to a restaurant, pay $20 for a hamburger." And so they're just cutting back on it more just out of the mentality of what some of those more discretionary purchase costs.

Kurt, this one is probably for you. What are the biggest risks to the comp growth this year? And as part of this, one of the key debates within hardline, broadline retail is how these categories have done so well? Big-ticket, durable purchases that could be subject to demand being pulled forward, how did you factor that into your comp guidance for this year? And what would be the risk? Or where would be the risk that categories like gun safes or riding lawnmowers will be pulled forward?

Yes. So -- yes, on comps, the way we've looked at it, first, the business has been amazingly consistent. When you look at the last 2 years from week to week, to month to month, quarter to quarter, even the last couple of quarters that the 2-year stack running almost exactly at that 40% comp rate. From consumables to the hardline side of it, the items that were viewed as non-discretionary and discretionary, it's been relatively consistent. When we called out in 2021 some benefit from stimulus, you saw a couple of those points in late Q1 or in Q2 where we saw some benefit from stimulus, and we'll lap that in the first half of the year. And that's what we played into our guidance. We recognize that there was some additional, and that's baked into that 3% to 4.5%. But beyond that, as we see it, the megatrends that Hal mentioned in regards to rural revitalization, self-reliance, pet, homesteading, that business and that growth, those new customers, and the unprecedented highest retention rate of new customers on that 19 million new customers is really the fuel for this. And so we're very disciplined and focused. It's a really good question of that. But with our business, it's really a good, consistent growth in new customers and market share gain.

So you factored in some drag from the stimulus. The consistency of the performance of a lot of these categories has provided confidence that there's not going to be as much pull forward. If there were, where would you -- where do you think you would see it? Would it be riding lawnmowers, gun safes, other -- log splitters?

We've always had some timing differences. So if you follow Tractor Supply, we've often said, sometimes between seasons, you can see a pull forward in between season on there. And that could always be the case, timing of that. But some of those categories you mentioned on seasonal goods, you could see some pull forward in there. But again, our business has been really consistent.

I just -- I'd add to this. Like, we're maniacally paranoid about all things in general, as most retailers are. But like on the megatrends, we've got like a monthly trend tracker where we're looking at mobility data, we're looking at housing data, are people still moving out to the rural America. It was like, okay, last year and July and August, as COVID started to abate a bit, there was a thought that, that might stop. But if you look at the December housing data, there's as many millennials moving in December as there was January, earlier in the year. Same thing goes with like kind of the self-reliance mentality. So in 2020, we sold 11 million birds, right? So I don't know if folks know that. But in Tractor Supply, we sell live birds, kind of livestock in its orientation, and most of them are chickens or ducks. And so last year, we were like, "All right. Did everybody just buy a bunch of chickens and ducks in 2020 because kind of they were stuck at their home and they were outdoors and such in their backyards?" Well, now we sold another 11 million live birds last year. And the birds are a couple of bucks a piece, but the average ticket, either in that ticket or maybe when they come back for the second purchase, is $300, $400 because you're buying a coop, and you're buying the chicken feed, and you're buying your flock, all your snacks that go along with it. And then this year, we're a couple of weeks into the Chick Days but off to another great start. And to Kurt's point, these behaviors have really just changed, and we're constantly watching them, whether it's across all the megatrends and also just across elasticity of inflation, and feel really good about the business.

If you haven't checked out Chick Days at Tractor Supply, I highly recommend it. Each and every one, you should go check it out.

They come in little boxes, like a Happy Meal box.

Let's stay away from that, Hal. One of the hallmarks of your early tenure at Tractor Supply is the assertiveness and aggressiveness with which you're rolling out initiatives to improve the productivity of the box, namely Project Fusion, Project Side Lot. Can you give us a sense for how these initiatives are progressing? Presumably, from the early days of piloting these initiatives to where they are today, you've even made more improvements. And how do you expect them to unfold from here?

Yes. So we now have 2,000 stores. We recently announced that -- increased our total store target from 2,500 to 2,700. But nonetheless, at a 2,000 store base of which the average store is over 10 years old, we know we need to squeeze the productivity of our assets more and more, right, and get that productivity dollars per square foot up and up and up and get it where those best-in-class retailers are. And we've got a really great format, 15,500 square feet. It's large enough. You can scale and drive sales through it but not so large you feel like you've got a whole bunch of extra space. It's also small enough. You can really staff it well and provide that great customer service. We've got this great format. We've got a great lifestyle business model, and we want to just go after driving as much productivity through it as we can. So we have kind of 2 ways that we're doing that, to Michael's point, on reinvesting in our existing stores. The first is our Fusion remodel program, so that's inside the 4 walls. And then the second one is our Side Lot project, which goes outside, where we have a concrete pad typically that's fenced in. And I'll hit each one of those briefly. So on our Fusion remodel, that really is a summation of about 75 to 100 little business plans that all sum up to the remodel. As an example, we took an entire row away from apparel. We pulled the aisle in, but we densified apparel. And if you walk in now, you go, "Holy cow, look at this, the experience. And look at this, the setup that we have." We elevated the brands. We've got great brands at Carhartt and Blue Trading and Columbia and Wrangler and Muck Boots area. We really elevated the experience, densified it, expanded our women's assortment. Apparel has been one of our best-performing categories over the last 2 years. The second thing is we didn't use that space to increase our capacity for CAT. It's an area we've under-indexed. And we've talked about now, CAT's one of our best-performing categories coming out of the Fusion remodel. Same thing if you go on the other side of the store, power tools. So we've historically had kind of an okay power tools experience. We've upgraded our power tool corral. We've -- we're now exclusive with PORTER-CABLE. They pulled out of home improvement. They are a focused DIY kind of brand. We've added Makita, which has only been one of the big boxes but not the other. We now have a Makita. We've also added Bosch and Dremel, in addition to having DEWALT. So we now have a legitimate power tool kind of execution. Additionally, in the back, we had a 300 square foot service desk that really wasn't adding a lot of sales value. We pulled that forward, integrated it with our registers upfront, freed up that 300 square feet now to do pallets for animal feed. We're driving 26% more animal feed through our stores than we did prior to COVID. We've got to have places for those pallet positions to drive velocity and have the inventory in stock for our customers. So those are just a handful of those kind of little mini business models that kind of all add up. And what we've said is we're getting kind of mid-single-digit comps at the 12-month mark once we implement the initiative, and kind of the store gets back through the disruption. In addition to this, some of the other side benefits are we're up-leveling the look and feel of the store. If you walk into one of our Fusion stores, we finished last year at 300. We'll have a 15-ish percent. We'll have 30% of our store base done by the end of this year, but it's more contemporary rural farm and ranch store. You'll see lightboxes. You'll see skylights, a much more contemporary look and feel. But they were also able to do things like refinish the floors, paint the walls, redo the bathroom and get some of those things that you need to do when you're a 10-year-old store. And the great thing is we're doing all that and getting a 5% mid-single-digit comp lift, and we're getting a great return out of it. And then -- but our goal is by 2026 to have all 100% of our stores with the Fusion remodel, and that's all reflected in our capital outlook and also our margin outlook. And then you've got the Side Lot initiative. Historically, we've had a fenced-in concrete pad, about the same size as the inside of our store, and it's been dominated by agriculture equipment. So think like 3-point equipment that you drag behind a tractor to till your garden or such, or you think about stock tanks or fencing or T-posts, corrals and gates, those are all the things we've had out there. And typically, they've been stored on pallets, kind of laying on the concrete floor. So now what we've done is we've actually brought racking in. We've got that stuff kind of much better merchandise to kind of -- equate it to cleaning up your closet. And it's freed up 4,000 or 5,000 square feet that we've added a garden center. We exited last year with 150 garden centers. We're looking to be at 300 by the end of this year. We've said 60% to 65% of our stores will have a garden center at -- by the end of 2026. If you look at our total addressable market, we added $40 billion to our total addressable market, dominantly based on our -- moving from a convenience play to a destination play in live goods. And it's a category that our customers tell us that they most participate in that we least address. And it's a very different need that our customers have than what you would get -- experience at a home improvement. If you got a home improvement, typically, it's going to be dominated by annuals and perennials because they're targeting suburbia, right? And it's all about color and beautification of your yard for spring or fall. For our customers, while there's some of that, it's much less, and it's about utility. It's about vegetables for your garden outside. It's about fruit trees alongside your garden. It's about trees out in your land to create shade for your animals or maybe trees up and down your driveway, or it's about shrubs around your house or down along your fence line. So we'll have it very differentiated. It will not be kind of a me-too live good strategy, very differentiated. And we've got the competitive advantage of proximity Typically, our customers, we're the closest store to them. They got to drive maybe another 5 miles to Walmart, maybe another 10 or 15 to a Lowe's and 15 or 20 to get to a Home Depot, so we've got convenience. We're already getting a lot of their purchases. This will be another category we add on to just like pet food and animal food, and we'll make sure we've got the right assortment, so 2 very exciting initiatives. What we have said also on the return for the garden centers, when you do Fusion and Side Lot together because we always do them together, if we're going to do a Side Lot, that you get a high single-digit comp lift at the 12-month mark for that. Anyway, so 2 very exciting initiatives that are really focused on driving space productivity and maximizing the sales dollars that we can drive through each of our boxes.

And now you're marrying the power of your physical assets with the power of your intellectual assets, in part, by growing your loyalty program, which is affectionately called the Neighbor's Club. And now I believe there's 24 million members. I'll direct this one to Kurt. What have been the observation around the newer members to Neighbor's Club? How are the spending patterns of those new members compare to legacy members? And what have you been able to do to unlock the power of this data versus what you've been doing in the past?

Yes, sure. The Neighbor's Club has been one of the exciting initiatives that we've had. I mean, it is definitely giving our customer a reason to shop even further with Tractor Supply. So we've grown significantly, like 40% in 2 years in Neighbor's Club members. Of the 19 million new members, 1/3 of those have joined the Neighbor's Club. And in regards to how they look, it's very much like the new customers that we've seen where we've had a higher percentage of our new Neighbor's Club members much like our customers being millennials, new homeowners. We've had a higher mix of female versus male. So pre-pandemic, we had a slightly higher mix of our core customer being male versus female, and it's flipping on the new customer, really causing us to be a bit more balanced, almost at 50-50 in our customers today between male and female. And so those are some of the -- what does the customer look like? Those are some of the difference. Where are they spending? How do they enter into Tractor Supply and with Neighbor's Club? Entry points like pet or chickens, live birds, lawn and garden, those are some of the areas that we've seen entered. But then with Neighbor's Club, certainly giving the value for the reward and giving incentives to move up into the tiers of Neighbor's Club. We've seen our customers experience the theater in Tractor Supply and moving across, what we say, the other 4 -- the corners of the store. Our Neighbor's Club members spend, on average, 3x a non-Neighbor's Club member, so you could certainly see the benefit and the incentive of that. And that trend is held over the 2 years. Whereas new Neighbor's Club members come in, we see them mature, evolve and very consistent with that. And at this point, with -- growing from 14 million or 15 million Neighbor's Club members 2 years ago to now 24 million, the power of that is really what our marketing team is using on our investments and our digital advertising. We know much more today about this new customer or what the customer potential is. It's helped us with our research on growing from 2,500 to 2,700 stores because of understanding that customer. It's helped us understand our total addressable market. It is $180 billion versus the $110 billion. And there's a lot we'll do and are doing with the marketing program to market these new customers, but those are some of the exciting things about Neighbor's Club members. Anything to add?

Yes. I would just say on the comp -- capability side, let's talk about the technology side for a minute. Those are -- I love the interaction of digital and retail at scale and -- we've just, again, you go back to like thinking about our core competition and just scale and the competitive advantage that we have here. So we've got 24 million members. Our customer data is up in the cloud, the Microsoft Azure platform. We're able to layer on all sorts of analytical competencies on top of that, take advantage of kind of that cloud-based platform, and it enables us to do analytics on our customers, the feedback in the merchandising and planograms and assortment. It also drives day-to-day decision-making as we're seeing customer behavior. And then, as Kurt mentioned, it also goes into our personalization engines that then manifest themselves, whether it's in mobile notifications, whether it's in text messages, e-mails, also all of our digital marketing. We're starting to be able to get really sophisticated to look at near-term behaviors and what someone's shopping in the moment and when to market there versus longer-term behaviors and intent over time. And then all that then translates into our ability to then drive them up because it's a tiered rewards loyalty program. So we have a Neighbor's level, Neighbor's Preferred level and a Neighbor's Preferred Plus level. The more -- as you move up, the more you spend, the more points you earn as a percent. If you use our private label credit card, you get 5 points back -- 5% back in points. And what we've seen over the last year as we've rolled this out is customers migrating themselves up, and we're using the personalization engine to encourage that. We're calling out where you are in your spend to encourage you to clip to that next level at POS or inside of our checkout online. We're showing you your points to drive redemption. But it's a very systemic, very well-built-out program. And again, if you think about from a competitive advantage perspective, nothing that any of our core competition would ever be able to replicate, and it just drives kind of customers to take a left versus to take a right.

It's not hard to see your excitement about some of these emerging developments at Tractor Supply. And you brought this digital-first mentality, omnichannel mentality. The e-commerce penetration for Tractor Supply has gone from 1% to 7% over the last few years. Where does that go over the next few years? And if your e-commerce penetration goes into the teens, how is that going to impact the margin of the business?

Yes. So we've talked about the target of $2 billion e-commerce business by 2026 over the next 5 years. And to your point, it's at 7% now, nearly $1 billion, so we've got consistent growth that we're planning on for the next 5 years. One of the great things about our e-commerce business is that the vast majority of it is picked up in store. So 75% of our e-commerce business is picked up in store. 65% is pick in-store pickup. The other 10% we ship in, and then they pick it up. So it's far and away one of the most attractive online purchases profiles out there. Kind of from my past days, recall when it's all direct ship and you get that it's a lower margin because you're doing it all via parcel, and so you've got to blend down. And the mix implication for us, that doesn't exist. One of the things that you'd say is, okay, with that growth, does it shift more to direct-to-customer home over time? And interestingly, in the midst of the pandemic, so think back to like May or June of 2020, and everybody was locked in their homes, and everything was getting shipped to your house, our buy online, pick up in store penetration actually went up by a couple of points during that time. And it just demonstrates the convenience of our stores and also the fact that people like coming to our stores. And in many ways, I think visiting our stores in the midst of all that was a little bit of a reprieve for customers. And so even as we've grown, to your point, we've basically tripled the size of our online business in the last 2 years. Our buy online, pick up in store as a percent has held steady.

Okay. I'm going to give you one more, and then I'm going to turn to Kurt on the margins. This is from the audience. Are you seeing people buy more than usual given inflation expectations are going up? We haven't been in a true inflationary environment for a long time. Does behavior change in that consumers buy more now because there is an expectation that prices will rise more tomorrow?

I don't think we've seen inflation-driven stock up. I think, on occasion, you'll see kind of supply chain mentality driving a stock-up. In a couple of categories, I don't know if folks have cats, but if you have a cat, and you're trying to get cat wet food, it's almost -- it's hit or miss across the country, not just in our stores, but everywhere. And so you'll see that. You'll see, "Oh, I actually can't get a mixed variety assortment here. I'm going to grab 3 boxes when normally I would grab one." But that's really one of the few categories that we've seen any sort of stock-up behavior. Mostly, again, we're kind of this grocery store for our customers' home and land and animals, and they just are used to coming in weekly and just like you would shop a grocery store.

And have you seen the supply chain improve? And when the real expectation on when it's going to be whatever normal is now?

Yes. I'd say supply chain has -- it's kind of plateaued at where it was back in October and November. There was 100 ships off the coast well into early January, now I think it's around 60. So that's come down, but it's still 60, and our ports are still overwhelmed. You have a COVID case pop up in China at a plant or in a port, and they shut it down for 5 or 10 days. I think our manufacturers are still trying to navigate the labor market to ensure they get production out the door. That said, I think we've navigated it much better than the vast, vast majority of retailers out there and certainly against our core competition. We exited Q4 with better in-stock rates the year before, 16% above last year. Been in 5 or 6 different states over the last week, visiting stores, and we're ready for spring. We've got trailers. We've got riding lawnmowers. We're stocked full of feed and food and all the other necessities for spring.

So when you go in for Chick Days, don't be afraid to buy a riding lawnmower as well.

Yes.

Yes.

Especially if you have a little bit of lawn. Kurt, I want to turn this one to you. You're guiding to slight margin compression this year before. Long term, you'll see moderate margin expansion annually. What are the puts and takes that are going to drive margins down slightly this year? And then how do you see margin expansion playing out over the longer run?

Sure. First, let me just -- our guide for this year is 10.1% to 10.3% on the operating margin. In 2020, we did an adjusted operating margin of 10.1% and then last year at 10.3%. So those are kind of the guideposts on that. A bit of history, though. In pre-pandemic, in 2018, 2019, right below a 9% operating margin, and we were targeting to move into that 9% plus in operating margin. And in 2020, I mean, we just leaped over the 9s and had a significant operating margin improvement. And largest percentage of that was on the gross margin side. As we said, there's additional costs, such as COVID, investments we're making into the business, Hal talked about that, and really have landed in a great spot there, north of 10% operating margin. And when you think about 2022 and even really 2023, a lot of the same things. As we've mentioned, we can navigate the gross margin side well in this environment. And we see ourselves holding on the gross margin with our scale, our ability in our area of the industry to be able to have the lowest cost to serve that we believe on the gross margin side, we continue to hold on that. On the SG&A, some of the puts and takes, from a favorable side of it, we'll be -- we anticipate seeing less COVID-related costs as we're cycling off of this pandemic. We look at lower incentive comp as we had outpaced those in the prior years and then certainly leverage on the additional comp sales and the scale. That also, though, is helping us offset the investments we're making in the business. We have said we are going to invest from a position of strength. The next 5 years are very purposeful to invest for the Life Out Here strategy and Fusion, Side Lot, supply chain. So all of those in the SG&A really help us offset the investments, the increased cost of doing business today with the tightest labor market. And so we have a lot of confidence that the puts and takes in both gross margin and SG&A really put us around that flattish operating margin for 2022, probably something in 2023, similar to that. And then the opportunity beyond that is really be able to increase scale and drive efficiencies and see operating margin improvement in our long-term target.

We're running up against our time limit. But Hal, I want to turn it back to you. As I mentioned, you're in your second year and making LeBron James proud, and it's probably been a fascinating experience during your tenure so far. What's been different than what you expected during your time here? And how does that inform what you make the priorities for Tractor Supply moving forward? And can you put that in the context of where you see some of the biggest challenges ahead for the company?

The #1 strength that we have as a company is our culture. We have a -- company was founded in 1938. We have a set of mission and values that were built, kind of were written down well over 45 years ago. We've had 5 CEOs in 50 years, so there's been just really thoughtful investment by each CEO in the culture. There's never been one time kind of a shift away from that. I spent some time in Home Depot, and I won't get into too much detail, but some of those who are -- have known Home Depot, well, there's like a period actually where they kind of veered away from the culture, and I think you lose a lot when that happens. And with us, we've never veered away from that. We have such a strong culture, and it's driven in servant leadership. It's driven through things like empowerment. Our motto is work hard, have fun and make money. And I really do -- it's just -- when you -- it's hard to put into a financial model, but there's no doubt it drives significant bottom line. But the only way you really can feel it is when you walk into one of our stores. And when you walk into our stores, you're going to get greeted by the cashier. You're going to get helped in the aisles, right? We're going to come to -- we're going to support you in any way. And a couple of -- I'll give you a story of it, just kind of, I think, sets us apart. I was -- I get an e-mail from a customer the other day, and their horse had been bitten -- attacked in the neck overnight. And they called a couple of vets. They weren't able to get a vet, to get in contact with a vet. And they had our store manager's cellphone number, which is pretty common for a lot of our primary customers in the store. A lot of our store managers grew up in the community. They went to high school or what have you with the customers. They typically walk in, they're like, "Hey, Beverly, or Hey, Jed. How's it going? How are the dogs, the cats, the kids?" Our store manager hops up out of bed at like 12:00, 1:00 in the morning, races to the store, gets the wound kit out, a variety of other things necessary for the horse, blanket, et cetera. The customer shows up, hands it to them, says, "Hey, you've got a lot on your hands right now. A couple of days when things calm down, circle back." Customer comes back, credit card, wherever, whenever. And -- but it's that sort of customer service, right, that's really what makes us legendary, what concretes us with our customer, in our customers' purchase behaviors and really, what I think differentiates us from really lots of other retailers out there. And I'd say when I first joined, I heard a lot about the culture. As I was joining made a lot -- it come up in every Board interview I did, every management person I met. And I would say just blown away by even how much better and just more advanced and strong the culture is than even 2 years ago when I was joining.

And how does that fit in with some of the challenges and the risks that you see coming down the road that you're mindful of?

Yes. I mean, I think businesses -- I think culture eats strategy. I think we've got a great strategy, but I think we've got a great culture, too, and you put those 2 together with some commonality around metrics and performance systems, which is what we've been implementing over the last 2 years. Our store managers get restricted stock. This year, we added 25% of management's bonuses along our strategic initiatives, not just net income. So we've got -- we added performance share. So when you take your metrics, you take your goals, and you take your performance -- and your performance, your compensation and align that with your culture and your strategy, I think that's when it all comes together, and that's really what we've been focused on the last couple of years.

Well, we look forward to seeing your continued success. Please join me in thanking Hal and Kurt for a wonderful conversation this morning.