Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Thanks, and good morning, everyone. So I'm Peter Benedict, senior retail/consumer products and services analyst here at Baird, and really pleased to kick off day 2 here with Tractor Supply. For those of you who don't know, Tractor Supply is a leading farm and ranch rural lifestyle retailer here in the U.S., operate a little more than 2,000 stores really from coast to coast. I've been covering Tractor, it's scary, for maybe 20 years now, almost. But they always have something going on, but I have to say I don't think there's ever been a time where there's been more impactful initiatives underway at the company. So really an exciting time to be talking about Tractor Supply. Joining us from the company, we have CEO, Hal Lawton; CFO, Kurt Barton; along with Tractor's IR leader, Mary Winn Pilkington, and Marianne Denenberg. We thank you guys for coming back to the conference. I'm going to turn it over to Mary Winn very quickly. She's going to -- no, she's not going to read anything. So I guess we're good there. Just take note of the safe harbor statements that are in the deck. Yes. Perfect. Thanks, Mary Winn. So in case you missed it, after the close yesterday, Tractor Supply did issue an update on their 2Q [indiscernible] on a calendar quarter, so the quarter ends in a few weeks. It was positive. The numbers are a little bit better than where Street expectations were. So I think we appreciate them doing that refreshing and allows us to have a frank conversation here because given all the news that continues to roll across the table. But anyway, thanks so much. Hal, maybe I'll turn it over you for a couple of comments, and then we'll just jump right in.

Yes, to your point, we did preannounce yesterday, our Q2 with all the narrative that was [indiscernible] retail and kind of the rhetoric and the fact that we're on a calendar quarter, it's been some time since we've had kind of an update out in the market and been able to provide some clarity on topics that are top of mind for everyone, whether it's inflation, supply chain, inventory levels, op margin rates. And to your point, we wanted to have a transparent candid discussion on today's -- today here. And so we did the preannouncement yesterday. And as you said, it was positive news, 5% comps, 8% net revenue growth, EPS in the $3.48 or greater range, which implies kind of flattish operating margins for the quarter year-over-year. And from our perspective, what were -- there's a lot of challenges that are out there, proud of how the team is navigating it, how we're executing. We think we've got an exciting strategy, as you mentioned, Peter. And we think we're going to have some very solid results in Q2. And there's is lot of rhetoric out there in retail. We want to make sure that we're clear on what Tractor Supply story is and how we're differentiated as a business and to a large extent, insulated from a lot of the pressures that other retailers you're seeing right now.

Yes. No. Fantastic. Well, thanks for that. Listen, we're asking each of our companies 3 macro questions just to kick things off, and then we'll get into some more company specific. So [ maybe ] a quick response to these questions. You actually alluded to them earlier. First is just on inflation, how you would characterize the overall pace of inflation that Tractor Supply is seeing? Is it accelerating, decelerating or kind of holding steady?

Yes. I think inflation is persistent right now would be the words I would use. It's hard to tell if we're at a peak, but I certainly expect for the foreseeable future well into next year that, as a country, we'll be operating in mid- to high single-digit inflation rates, and that's what we'll be seeing through our business from a cost perspective. As we've discussed several times, our business is a demand-driven, needs-based that allows -- affords us a little bit of a pricing power in the market. Also being the largest player in the market, we have a little more pricing power. We've been able to pass the majority of that through or find efficiencies elsewhere in our business. But I do think inflation is here for quite some time.

Yes. That make sense. How about supply chain? How would you characterize the current kind of flow of goods to Tractor Supply? Is it getting better? Is it getting worse? About the same?

Proud of how the team is navigating that. I think we finished Q1 a little over 20% of inventory over last year where we expect that we'll finish Q2 under that same range. On a 2-year stack, that's well below what our overall comps are. I mean you take into account inflation and look at units, we're basically flat to last year. So the team is navigating the supply chain challenges very well. I would again say it's persistent, a bit of a description that Kurt talked about in one of our internal [indiscernible] kind of that whack-a-mole game. It's like the West Coast port that it's China, there's another port in China, maybe then it's finding freight in the United States, then it's the cost of freight in the U.S. It's just there's some sort of nuance that's always popping up, but -- and I think that will continue for the foreseeable future as well and well into next year.

That makes sense. And then lastly, just on consumer behavior, maybe the most notable change, if any, that you're seeing your consumer make here over the last few months?

I would say our consumer behavior has, at the highest level, maintained pretty steady. Since the beginning of the pandemic, we've talked about 4 key themes, self-reliance, pet adoption, rural revitalization and home setting. And we've seen kind of those lifestyle trends, those behavioral shifts continue even into this year. We've seen heavy pickup of millennial in our business. That's continuing. More [ female ] purchasing into our business, shoppers into our business. With [ that ] continuing, maybe a slight shift away from discretionary. Very little of our business is discretionary, but maybe a slight shift away from that. But we've not seen anything like downturn -- substitutions or down selecting our product or anything of that nature.

Great. Super helpful. Okay. And for those of you here, if you want to get involved in the conversation, [email protected]. If you send that e-mail, I'll pick it up here on the iPad and then try to work into the conversation. Let's go big picture here before diving into some of the initiatives you guys have. Earlier this year, you increased the TAM for the business, I think, by 60% or so. It's $180 billion. Help us understand how you build up to that number? And what do you think the growth rates look like over the next several years?

Yes. So in October of 2020, we released our first estimate of our TAM, our total addressable market, and we stated it was $110 billion, and that was based on 2019 data. Over the last 3 -- 2.5 years, our market has seen substantial growth, our core market. And we estimate it went from $110 billion to $140 billion. So that's about a 25% growth. And that market is kind of Rural Life Out Here kind of Lifestyle. So apparel, pet, animal feed, truck tool and hardware, garden and agriculture equipment. So that takes us to $140 billion. We then add in the second tranche, another $40 billion on to take us to $180 billion, and that's really reflective of our Life Out Here strategy that we're executing against, notably the addition of Garden Centers to our business model. As we announced yesterday, we now have over 200 Garden Centers opened. We are -- by 2026, our goal is to have around 2/3 of our stores with Garden Centers. That's a large, large multi-multi-multibillion dollar business. Combine that with some of the additional things we're doing in pet, and we added an additional $40 billion to our TAM, and that took us to $180 billion. On revenue -- rolling revenues, call it, 13.5. That still gives us substantial upside for growth even as the market share leader. One other thing I'll mention is between 2020 and 2021, those 2 years, we grew 52%. If you think about the TAM going from 110 to 140, that's about a 25% increase. So we -- our growth rate over the last years was double that of the market as we took significant share in the market.

Perfect. Any comments on population growth and one of the things that we always get asked about is [ why are ] people now moving back into rural America? Or do you guys have any data on that or a view on that?

Yes. We -- it's a set of metrics that we look at very closely, ranging from just kind of Google mobility data to home purchase data, looking at home purchase data by kind of age segment, and certainly looking at it, urban versus suburban versus exurban versus rural, looking at what are the top 50 growth markets in the U.S. The net-net is if you take all that -- those data sets into account, there is a migration occurring out into rural America. And there's a variety of reasons for that. It's being driven by the millennial segment, and they're looking for affordable housing. They're looking for a change in their lifestyle. They're really looking to adapt to more normal generational behaviors that you would if you're in 30, 31, 32 household formations, homeownership, [ pet ] ownership, eventually starting a family, and the most affordable place for them to do it is ex-urban and rural [ lifestylers ], and we're benefiting from that. We've seen a big surge in millennial customer in our business.

Terrific. Recession is a popular topic these days. I remember back in '07, '08, when -- I mean the Tractor Supply was like the first retailer to kind of call out the consumer acting a little differently. [ It was ] the old repair, replace, I think, dynamic around like riding mowers and those types of things. It doesn't sound like you're seeing that yet, but maybe talk about how Tractor Supply has performed historically during tough periods in the economy and your strategies to kind of manage that if it clearly is going to be tough, but what your strategies are there?

Peter, I'll take that. As Hal mentioned, being a needs-based business has really shown resilience over different economic times. So when you think back to '01, '02, '07, '08, '09, the track record for Tractor Supply and this resilient business just stands strong, 30 years of positive transaction counts. 29 of 30 years of positive comps. And to your point, the onetime that there wasn't a positive comp was a negative 1% comp in 2009. And in retail, in 2009, a negative one stood really strong. To your question, in '07, '08, there were some signals. I think the financial crisis hit really broad across all states, across all demographics, [ and of those ], and we did see some shift in consumer behavior. I think there are some differences today of what you heard from Hal and what we're saying our business is that the consumer at this point still shows healthy behavior. The rural economy is strong. To your point about migration, I mean, we're seeing strong migration out of some of the bigger cities or the states with big cities, and you're seeing that migration to the south, there's a southeast where we have a really strong presence. And so all of those factors are -- continue to get solid tailwinds. And at this point, it is a very critical day-to-day maniacal effort that we work through as Hal mentioned on the supply chain and inventory side. But in this business, selling consumables, supporting a lifestyle versus just discretionary businesses really proves out over economic ebbs and flows to continue to be a consistent business. And that's one of the strengths of Tractor Supply.

And Kurt, just in the event that the market gets unexpectedly weak, talk about maybe the flexibility you have in the P&L and your expense structure to kind of maintain margins? Or what would be your approach at that point?

Yes. I think it's an excellent point that's unique to Tractor Supply right now. When you think about the 5-year long-term outlook. And as what we've pointed out as to the puts and takes on the cost structure, the -- one of the biggest pressure points in our financial algorithm is our investments we're making in the business. I mean we're -- we have unapologetically said, we see such great opportunity, and we are so excited about these strategic initiatives that that's where the investment is being placed. And so there's a lot of that pressure that is in our control. And we can dial back or dial up where we need to. If there were to be a situation that we felt we ought to pivot, we feel that we've got the ability to make those adjustments flexible. We are committed to growing our market share. We believe we can do that while maintaining and growing our operating margin. But much of what plays into that are things in our control. And so we've shown over the years the ability to flex up and down and to be able to adjust. We've got a really, really strong profit improvement, lean type culture in our business. It's always been a great asset for us, and we'll lever all of those aspects.

Yes. And I think you guys deserve credit for leaning into investment during the pandemic. I mean your sales per store doubled and your operating margins went up like 100-something basis points. I mean, obviously, we know companies who had 1,000 basis points increases in operating profit. So you guys -- you took advantage of the opportunity you're investing. So that's a good segue into some of the business optimization initiatives that you guys have. There's too many to talk about. But I think about them in 3 ways. There's like the in-play initiatives that have been happening. You've got some of the scaling initiatives, the newer ones that are coming and then more kind of on the horizon opportunities. So as best we can, like to get through a handful of these. In terms of in-play initiatives, I think, in my opinion, the Neighbor's Club loyalty program has to get addressed here. I mean it is a tremendous program for you guys that's still just kind of coming along. Talk a little bit about Neighbor's Club loyalty, what it has done for you and what's the opportunity?

Yes. All right. So for those not familiar with Neighbor's Club program, it's our loyalty program. We've got nearly 26 million members now in the program. It's a program that's been -- we've had for a number of years, but we replatformed it in March of last year and made it a tier-based kind of points reward system. And so basically kind of the more you spend, right, kind of the higher tier you go into and the more you get back. And then if you use our private label credit card, you get 5 points back. It's been an absolute home run for us in terms of driving the behavior that we want out of the consumer, rewarding their purchases. And we've got -- it now represents over 70% of our total sales comes through our Neighbor's Club membership. The retention rates of those in the program are well above 80%. Our top 2 tiers are well above 90%. It continues to grow and kind of drive the business exactly as we had designed it to, very, very pleased with the program, and we continue to make improvements to it. Just in fact, yesterday, we announced that this week, we'll be updating our app, as an example, with a big call out for kind of My Pet that allows our customers to aggregate all their pet information, their Rx, their [ vet ] mobile clinic visits as well as their kind of dog food information and other types of things. They can set that up for subscription. So just another feature to benefit kind of tying into the Neighbor's Club program.

Yes. No, terrific. How about maybe mobile and digital, maybe a minute on that, what you've done because you're in a rural market. So your stores are in locations that are different from most retailers.

Yes, absolutely pre-pandemic, e-commerce was about 3.5% of our sales with about 75% of that being picked up in a store. Post kind of now, it's running kind of 7.5%, so it's more than doubled in penetration -- pickup in store still represents 75%. Over the last 3 years, we've replatformed our website to a kind of API-driven kind of cloud-based open-source software architecture that allows us to deploy code much faster and kind of bring our website up to more contemporary standards. Last year, and the 2 summers ago, we released our mobile app, and we now have 3 million downloads of our mobile app. But the thing that I'm most proud of is the end-to-end technology deployment that we've done in the business, tying in consumer technology and our team member technology to deliver a best-in-class experience. And I'll give kind of Buy Online Pickup in Store experience just briefly that if you were to go into our mobile app and place an order for Buy Online Pickup in Store at the conclusion of the mobile app -- at the conclusion of purchase, you can say, I'd like to have it [indiscernible] car, right, curbside pickup. You can put in your -- obviously, your name and address and all that, but you also put in the make and model of your car and if you have any special instructions. Orders process through our order management system. Every one of our team members wears an audio headset, Theatro audio headset. As soon as the orders placed, down to that store gets routed the order, and it will say Buy Online Pickup in Store ready to be picked and it will keep saying that in the ear of the team members until a team member acknowledges the task. When that team member acknowledges the task by audio, we know exactly what team have been assigned that task. They all carry handheld technology, brand new Honeywells that we just rolled out. I think it's like 25,000 of them. They then go pick the order. As soon as the orders confirmed pick in the handheld, it's then -- the customer gets an e-mail saying it's ready. As the customer is approaching, it pops into the team members ear again. It says how [indiscernible] approaching the store ready for pickup out front. He's driving an F-150, silver, please put it in the truck bed. And all that comes through the earpiece, the handheld technology and obviously, our consumer facing, but it's all threaded together for a best-in-class experience. Our average pickup time is under 5 minutes. And our average pick time is under 30 minutes for Buy Online Pickup in Store now. So it's a great end-to-end experience with high execution. And I think when our customers start to see that, then they start to adopt the technology more.

Yes. That's great. I think the associate's biggest question on that is always which F-150.

Yes, exactly...

Two other quick ones before we get in the Fusion and Side Lot. One, brand awareness. We don't talk a lot about brand awareness with retailers, talk about it with our consumer products companies. But Tractor Supply actually had a brand awareness opportunity and you guys kind of went after it aggressively at the beginning of COVID. So maybe talk about that.

Yes. So Tractor Supply's brand awareness in October or November 2019 from our brand [ tracker ] was 34% unaided brand awareness. It's now 55%. So we've seen a 21-point increase over the last 2 years. And to Peter's point, that was due to a very significant shift in how we approach the marketing in May of 2020. We stopped doing print ads. And we did one print ad last year, and we'll likely do one this year on Black Friday, but other than that, no print ads. And we took all that spend, call it, $40 million, $50 million in spend. We put approximately half of it into TV and video and then the other half, more into digital, [ PLA ], social and paid search. That the digital spend has provided great ROS. And then to your point, the TV and video has provided a significant increase in our brand awareness. And I think it's just driven more and more of those customers into our stores as they're moving out into rural America.

Yes. For sure. Okay. I'm going to jump into Fusion and Side Lot. We only got 9 minutes here. So Project Fusion, Tractor Supply's first wide -- broad-scale remodeling program in history of the company, really. Where are you on that? And then Side Lot Transformation. Just give us an update there, please?

So Project Fusion is our inside the store remodel program. Three big things it does. One, and most is space productivity optimization. We shift space around between certain categories. We're bringing -- we're expanding certain ones, shrinking others, bringing in new brands through pretty big kind of set of activities there. That is driving mid-single-digit comp lift in the store when we execute that. The second thing we also do is up leveling of the customer experience, bring it to more contemporary kind of farm and ranch retail look and feel. And then the third thing is because our average stores are over 10 years old, we're able to go in and do the floors, the bathrooms and all that at the same time. So it's a -- when we finish, it's almost like a brand new store, it is a brand-new store. The second one is the Garden Centers you're mentioning. Sorry, and on Fusion, our goal is to have 28%, 30% of our stores done by the end of this year with Fusion and all of our stores done with Fusion by the end of 2026. And then on Garden Center Side Lot, for those not familiar with Tractor Supply's format, we've got -- we have a 15,000 square foot concrete pad to the side -- typically to the side of our stores that's fenced in. That's been historically used for the storage of a kind of inventory management, if you will, of agriculture products, 3-point equipments, sometimes [indiscernible] out there, that sort of stuff. But most of [indiscernible], those sorts of things for the most part that's always been on just lay down the concrete on top pallets. What we've done is we've gone in [indiscernible] in, we've taken that stuff and made it much -- we've not lost any of that inventory, but we just kind of merchandised it better and got it up out of the floor kind of like organizing your closet. And that's freed up about 4,000 square feet for us to then be able to go build Garden Centers. And our goal is to have 2/3 of our stores with Garden Centers by 2026. We just announced yesterday, we now have over 200 stores with Garden Centers. When you take Fusion and you take the Garden Center and you put them together, we're seeing high single-digit lifts in the stores at the 12-month mark post implementation. And so to your point, when we do the combination, which will be about 2/3 of our stores out there, we're seeing excellent lift. It's a multiyear program. It should provide a sustained outsized performance for us over the next few years.

Super exciting program. And given your background at Home Depot, you have a little experience with Garden Centers. So look forward to more on that. Let's shift over some of the horizon opportunities, supply chain. As I mentioned earlier, sales per store [indiscernible] doubled. Opportunities to reengineer the [indiscernible] stores down the road, how do guys envision supply chain evolving?

Kurt, do you want to talk about that?

Yes, I'm glad to. I think the important thing is that, as you mentioned, we've had over -- significant growth over 2 years. I mean 50% growth in the business. And in those 2 years, while we're in process of building distribution centers, our supply chain network has not grown. And so that's why we have launched over this 5-year period of time, a plan to really grow the supply chain. And so we're opening up a new distribution center to be operational by the end of this year, then another one in the Southeast and then working towards plans in the Northwest. So the ability to serve and be the best at moving big, bulky, bagged food and be the fastest and most efficient to our customer is key to our strategy, which is why one of our key strategic initiatives is what we call delivering demand on our [indiscernible]. And so Colin Yankee and the team is putting efforts for the supply chain to grow distribution centers. We'll continue to grow our mixing centers across stock that gives the ability to be extremely efficient and fast in palletized bagged feed and other bulk items to our stores. And that's part of our investment in the business. And right now, the supply chain is muscling through this. It may be a good way of saying. And it's not the most efficient process right now with the distribution growth and the investment that we will be more efficient on units per hour, the labor, everything and even in the transportation side. In this environment, transportation, if you can reduce the stem miles, that's really a benefit. So the work and the investments, Peter, we're doing right now and we'll do over the next few years is all considered in our financial plan of maintaining growing operating margin but gives us that ability to be much more efficient even beyond the next few years. And that's really what it's going to take to be -- continue to gain market share and be the leader in this area.

And that's a good segue. You recently introduced kind of a long-term financial algorithm kind of updated everything, targets basically 10% to 12% total return for shareholders. Maybe walk us through the building blocks of that.

Yes. I think the key for the long-term outlook is -- our goal is to grow total sales 6% to 7%, modest operating margin growth over time. So if you add from 10 or 15 basis points of operating margin growth, add 1 point there to the earnings, we have got the consistent solid commitment to our share buyback at 2%, 2.5% growth. So if you take the 6% to 7%, you add 1 point for your operating margin growth, 2%, 2.5% for share repurchases. And as we announced earlier this year with a 77% growth in our dividend rate yield of about 1.5%. It really gives you a really solid low double-digit total shareholder return over that long term. That's our commitment, doing all of that while we're making significant investments for the long term. And it's exciting to be in that position with tremendous cash flow, great momentum in the business, make the investments, but be able to commit to a solid total share of return in the long -- in the low double-digit area.

Terrific. I guess, Hal, maybe you can close this out here. I remember last July or [indiscernible] months ago or so, we -- you guys hosted folks down in Nashville for basically the first in-person event at least we went to in COVID. But one of the things you talked about there was providing legendary customer service. That was kind of your message. So maybe talk to us about how you plan to do that at Tractor Supply.

Yes. So if you haven't visited Tractor Supply, I would encourage you to do so. It is a much higher level of customer service experience than you would get in probably a normal retail environment. We proud ourselves on kind of delivering legendary customer service. And I'll mention that in a few fronts. So when we started 2020, we had 32,000 team members. We're now over 47,000 team members. So as our sales have surged over 50%, we've been committed to staffing up. We've also increased our average hourly wage by over $3 over the last 2 years. So we've invested in our team members. We've also invested in technology to make them more efficient, as I mentioned earlier, the headsets and the handhelds and those sorts of things. But it's all focused on investing in our team members, taking care of our team members, and we very much believe we take care of our team members, they'll take care of our customers and everything else will take care of itself. And I think that's why we've gained so much share over the last 2 years. It's why we're confident in our strategy as we move forward. Our customer service scores right now are at all-time highs. Our attrition rates and retention rates are better than they were 3, 4 years ago, even pre-pandemic. And the team is in a great spot. We're delivering fantastic customer service, capturing market share and we'll deliver a record-breaking Q2, all-time high in sales, all-time high in earnings. One of the things that you don't mind up, I just -- I know there's a lot of news out there in retail right now. And I do think that there's going to be some divide going on, and particularly the businesses that are heavy replenishment, much more domestic in their orientation are going to be able to navigate kind of the inventory levels and navigate operating margins much better than those that are heavy import base, those that have long lead times and are buying overseas. And we're very much the former. And so that's why you don't hear from us today a lot of concerns around inventory, around operating margin, also given the trends we have around consumer, why you're not hearing a lot from us about consumer pullback, transaction reductions and those sorts of things, like our business model is very unique, but our team members are certainly at the core of it.

Terrific. Well, I think we can all agree it's probably good to be Tractor Supply. So thank you. We're grateful for you guys showing up today. Hal and Kurt will be available in a breakout session if folks want to continue the continue the conversation. But join me in thanking Tractor Supply.

Thanks, Peter.