Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Well, good morning. Thank you all for joining us. So my name is Brian Nagel. I'm the senior equity research analyst here at Oppenheimer, covering consumer growth and e-commerce. So this is our 23rd Annual Oppenheimer Consumer Growth and E-Commerce Conference and we're once again holding the event virtually. So we very much appreciate everyone's attendance. So I'm very pleased to have with us our -- I guess, my first presenting company of the day, Tractor Supply and the company's senior leadership team. So I'm just going to turn the call over quickly to Mary Winn, Senior Vice President of Investor Relations, to introduce her team, and then we'll jump into the fireside chat. Mary Winn?

Thank you so much, Brian, and good morning, everyone. It's now my pleasure to have Hal Lawton, our CEO; and Kurt Barton, our CFO, on the call today. And we have all we enjoy talking about Tractor Supply and Life Out Here lifestyle. So Hal, I'll turn it over to you.

Great. Good morning, everyone. It's a pleasure to be here. For those who just quick guess [ little bit ] on Tractor Supply at 2,200 stores, 49 states, approximately $15 billion in revenues this year, our guidance, so a little above. And we serve out -- the Life Out Here, as Mary Winn said. So most of our stores are an hour and further outside of major metropolitan areas and really all built to support that, that rural country suburban, farm ranch lifestyle from pet food and animal feed to apparel and tools and hardware and garden that. Pleasure to be with everybody today and look forward to the discussion.

Great. And we also have like Kurt Barton, as CFO, too. So this will be structured as an informal fireside chat. I'll be asking questions and then Tractor Supply team will be answering those questions. To the extent there are questions from the audience, I shoot them through the chat, and I'll be happy to work them into our conversation. So gentlemen, look, I think at least I'm going to start just the conversation. One of the questions I get a lot from our clients, and that is going to sound pretty basic to those who know Tractor Supply, but more for the benefit of those who are maybe less familiar to the story. And Hal, you've mentioned this a bit in your opening there, but who is your customer? Who does Tractor Supply serve? And we want to understand how this -- how you serve well a very differentiated consumer? And then to what extent has that consumer base expanded here either through the pandemic or over in length of time?

Yes. Great place to start. I'd add, we serve Life Out Here, as I mentioned earlier. And our business has been around for 85 years. And we've spent those 85 years year after year, carefully curating 1 piece at a time the right business model to serve Life Out Here. That starts with an 18,000 square foot selling space store. So not so large like a big box where you kind of lose productivity, not so small, let's say, like the equivalent of like 3,000 or 4,000 square foot as hardware where you're going to unable to really scale. So the right kind of 15,000 to 20,000 square foot selling square foot box, provides convenience in and out, easy parking, but big enough where you can scale your productivity, then the assortment inside of carefully over time, curated the space allocated to that assortment, the type of assortment, the categories, but all really to serve Life Out Here. So if you live in kind of country suburbia, rural America, you're a farmer, if you're a rancher or like we are, in many ways, your grocery store, we're your one-stop shop. Over 85% of our customers have pets and animals. So we have -- in animals, we have over 20% market share in animal feed in America. And so far and away, the largest animal feed seller likely in the United -- the world from a [ bad feed ] perspective. And so poultry to chicken and equine and horse and cattle and just livestock feed in general, pet food, we're talking big 40-, 50-pound bags, not 5-pound bags, 10-pound bags because these -- our average customer has more than 2 pets, multiple animals, right? When they're coming into our stores, they're stocking up on these large bags. And then we -- that's the kind of main traffic drivers. And then you've got apparel, which is mostly a workwear-type thing. So think Ariat boots, muck boots, work boots, work gloves, denim jeans, Carhartt, Columbia, things you need for Life Out Here, whether you're working out in your field, your pasture, on your farm or going to the local Applebee's for dinner on a Friday night. Then we also sell a ton of truck tool and hardware. Majority of our sales there in things like trailers and truck boxes. Certainly, we sell power tools and hardware that are used for thing -- activities like fencing and welding, just about all of our customers have a welder somewhere in their home. And then certainly, garden, riding lawn mowers because all of our customers have large lawns. And so we're the, if not one of the largest riding lawn mowers sellers in the United States, but also things like fertilizer and grass seed and certainly, those sorts of things that people need for multiple acres of land. But all carefully curated. And the origins of our business really came up out of the farm and ranch industry sector. And what we've done is really expand the concept to a broader set of consumers that had historically been the kind of more narrow farm and ranch. We don't have a large national competitor that we compete with head to head. It's really more local market based. It might be a local co-op or it could be a farm mom-and-pop or a regional or a local player. We certainly, at a national level, compete against category-specific retailers depending on the category, pet specialty and pad or grocery or maybe mass and pet and apparel, certainly, a whole variety of players. But no one at a national level competes kind of head-to-head with us on format as it relates to the format. And then to your point, Brian is we started serving a more narrow and niche on farm and ranch. We've expanded our footprint, the categories we serve, the types of products. We've upgraded our store experience, particularly through our Fusion remodels and we've invited a whole another set of customers out who want to experience Life Out Here particularly the millennial generation. And to that end, we've had significant customer growth over the last 4 years that's really expanded the base of Tractor Supply and been a large part of what's driven our -- on a 4-year basis in Q1 '19 to Q1 '23, 80% revenue growth.

Well, that's a great opening. Hal, I think it's a great flavor for your unique business. There's 1 topic I want to address before we really jump into the heart of everything that went on Tractor Supply. I know it's on the minds of investors, and it's unfortunately the weather. Last week, we heard from Tractor Supply when you report your first quarter results back in April. And look, those of us who stayed your business for a long time, we know that you are susceptible, so to say, to weather variations through is particularly as a season chain. So that was a topic then. So I guess the question I want to ask is, how are you thinking about the weather now? When I look outside how the window does see more spring-like and how the Tractor Supply is basically performing against this weather backdrop?

Yes. I'll start out by kind of breaking our business into 3 buckets for the sake of the group on today's call and provide a little perspective there, then get into maybe a more near-term perspective. So one way to think about our business is in 3 buckets of kind of merchandising categories are consumable, usable and edible products. And we aggregate products from across the business and lump them into this group. But think about them as almost like the grocery store products in our stores, animal feed, pet food, things like propane, wood pellets. These are things that are consumable. Our customers need them on a day in, day out basis. That is well over the majority of our business and is a very stable business. And it's one we've grown over the last 5 to 10 years in an outsized way to lessen our reliance on weather-related products. And that business has been outperforming our total comp sales by 3 and 4x for the last probably 5, 6 quarters now and continues to do so. We're gaining share in pet food. We're gaining share in animal feed. Those are very consistent products. People have to feed their pets and animals. And if we've learned anything in past downturns, they typically feed their pets and animals and take care of their kids before they do anything else. The second piece of our business, which is only of around 15% is discretionary. So it's a small piece of our business. Things like gun safes, riding lawn mowers, trailers, these are bigger ticket items. There is a repair -- there is a replaced component to it, but there's also a discretionary component to it. Those have been running kind of negative low double digits for the last 4 quarters, counting the 1 we're in, we'd already indicated that, that was our expectation here for Q2. And the big swing in our business is always the seasonal. It's less than half of our business. It varies anywhere from 30% to 40% depending on the quarter that we're in. And like if you look at last year, Q2 and Q3 were okay. And so we were kind of at the lower is middle end of our comp range. Q4 was outstanding, and we ended up with over an 8% comp because we had really strong weather in Q4 last year. Q2 was -- I mean, Q1 of this year was difficult weather. And so we're kind of on the low side of our comp expectations, in fact, a little bit lower than that. So just the swing on our comp from quarter-to-quarter is really the seasonal business with the Q business driving very sustained footsteps and comp transactions into our stores. And so there's a few weeks left here in the quarter, so I'm hesitant to say too much. But what I'd say is that if you look at the weather patterns, it was fine -- good in April. The first couple of weeks in May, so the last couple of weeks of May, good. We had a Canadian forest fire that blanketed half of east of the Mississippi last week that kept some people from going outside. It was this back half of this week is looking very nice. So we'll see how it plays out. But the thing is that I think is the great thing about our business is we're demand-driven, we're needs-based. The vast majority of our business is consumable, usable product. It's what's driving to sustain footsteps into our stores. It's what's driving our growth as a company and it's a very consistent, reliable component of our business. And it's why we continue to have positive comps when a lot of retail has gone negative, we've had positive comp continue to -- we're having positive comp transactions even in the context of where we are now, which most retailers are not having. So even in spite of the ebbs and flows of seasonality, this is a very attractive business, I would assert.

Very helpful, Hal. So let's jump, you mentioned in one of your comments about Fusion is we talked a lot about some of the internal initiatives that are happening within the existing capacity of Tractor Supply, so Fusion be one, what you're doing in your side lots and Kurt, I'd love to get you in the conversation as well. But so maybe just update the audience on these internal efforts, kind of where we are and the benefits we're starting to see. The other thing I know, Kurt, you and I have had this conversation, but as you think about the near-term, intermediate-term comp algorithm, how much of the comps of Tractor Supply are coming from these internal initiatives as they're enhancing the productivity of your stores?

Yes. Good morning, everybody, and thanks, Brian, for the question. We've said that Fusion and our Side Lot Garden Centers are a key part of our opportunity to continue to grow our market share in this large $180 billion TAM. And it's the 1 area in live goods and Garden Centers that our customers told us that I engage in this hobby, it's a need or a part of our lifestyle that you modestly serve or underserved me. And so it's from the beginning of launching it and our Life Out Here strategy, it was a key aspect of it. And today, we're roughly at 30% of our chain today has the Fusion reset remodel, and we're on a 5-, 6-year path of converting the entire chain. Our goal of converting and renovating the Side Lot to have Garden Centers, feed rooms, drive-through and just turning that previous storage space for large ag equipment into a true shopping experience, we believe we've got the opportunity for roughly 2/3 of our chain to have that. The biggest inhibitor for 100% is that if you've shopped our stores, we've got some great legacy stores that either don't have an attached Side Lot, don't have the space to be able to put that in, but it's a tremendous opportunity to be able to put that additional selling space and meet an area of our customers' needs. And so we're moving in that pace. We're roughly 15% of the chain with Garden Centers and Side Lot. We'll be reaching over 20% by the end of the year on that. And again, on our path, we've said and seen through the results of 2022 and first half of 2023, the [ smart ] continue to prove the early indications that a Fusion-only store against an existing control group sees in the first 12 months, a mid-single-digit incremental lever. If it's a combined combo store of both Fusion and Side Lot, high single-digit growth on incremental comp sales over its control group. The Fusion stores, in particular, would have most of their lift, say, in the first 12, 24 months for Garden Centers as you -- it draws in new customers. It allows customers to come in and then see the other 4 corners of the store. Early indications, our belief, our model is that those combo stores have a maturity curve on their growth cycle. Yes, it's high single digits in the first year of the store, but there's still an outpaced growth as customers mature in the other categories for Tractor Supply. So our models, our belief is there's at least like a 3-year maturation curve on incremental sales. And what that basically does if you -- we look at it as a 10-year investment and a 10-year return on invested capital, and the growth that we got on the investments we've got in both Fusion and the Garden Centers, are really giving us a return on investment consistent with the chain return on invested capital and a very productive at or above what investment you get in the first few years of a new store. So you can see our excitement of take this additional capital and gain incremental sales while opening new stores and making the existing stores more productive.

That's great. Kurt, if I can just follow up. So just from a consumer's perspective, when a store goes Fusion or when the Fusion update is, what do I see? What are the changes in that store?

Yes. For us, on Fusion, it's principally inside the store when you refer to Fusion. But the customer is going to see a significant change, especially like right when you walk in the store, the legacy store had cash registers, your old style cash registers right there. You're going to have a team member there, but you're going to have a lot of the help desk in the service and a lot of the offerings in the back of the store. We converted free up a help desk space. And now we have pallet drops of high-volume product that we're selling there and converted the front into that hub space where it's basically a very convenient checkout, but also all of the help desk right there in the front of the store, engaging your customer. You're going to have wider aisles. You're going to have brighter signage in indicating all the areas of lawn and garden, et cetera. So for our new customer that wants that better, more open, bright shopping experience, they're getting that with the new Fusion. We've seen that we are moving pet and animal feed at paces that the existing stores weren't able to handle efficiently. So now it's created pallet drop spaces. So we can internally move and handle product more efficiently, and it's more efficient customer experience. Lastly, it gives us more space for the growing pet industry. We've definitely made a statement that we are here in outdoor power equipment and power tools. So it's given us now a whole extended tool corral with Makita and many other brands besides DEWALT and others that we've had. We're certainly making sure that the growing consumer, those that are even more of a professional and want the Makita that Tractor Supply is everything from basic to best in regards to power tools. It's hundreds of different changes across the different categories that we believe takes existing and new customers and give them a more efficient and better shopping experience.

That's great. So I recently visited -- I guess it was earlier this year, I was with Tractor Supply team now in your headquarters, we walked your store. So I took note of the tool craft. I mean, the power tools what's always amazing is how good job you do, whatever merchandising tailoring specifically to the customer you're going after. So I guess how -- what else are we seeing from a merchandising perspective? Are there other -- as you continue to understand your consumer better, and you made the comment coming out of pandemic, now you have a bigger consumer base. What are your key merchandising changes that are allowing you to capture more share of wallet from this core consumer?

Yes. It's -- I'd say for merchants, it's an exciting time because the last 3 years, you've really just been navigating macroeconomic environment between supply chain disruption and cost inflation. And now that we're getting back to a steady state on those as a merchant, it's a great time because you can really start line reviews back up, innovation, bringing in new products, new brands and really start to get back to like the core and the fund is on merchandising. And the team is doing a great job on that. If you look in the last, call it, 12 months in our apparel area, we've really broadened our assortment with brands like Columbia, starting to bring them in and expanded in pet. We brought in a new brand called Victor for us. That's become a significant brand in animal. In horse feed we brought in a couple of years ago, Triple Crown. And really now we carry every horse brand out there. And we're the only player that has all the top 5 equine feeds out there. And power tools, to your point, over the last couple of years, we'll be able to bring in Makita. We've been able to bring in Bosch and Dremel, tailoring the products we carry for them to Life Out Here, doing things like cutting things cutting metal and steel and welding and working on fences and stuff. We've been bringing in a battery-powered product both in power tools more and more but also in outdoor power. One of the ones we're really excited about is a great partner of ours is Bad Boy Mowers. They're one of the top riding lawn mower brands out there. We worked with them over the last 12 months, introduced a battery power lineup, outdoor power with them. We're carrying that exclusively this year. It's doing fantastic. So just a lot of fun -- a lot of great stuff coming in innovation across the business. Another 1 that I'm very excited about is poultry is folks may not be aware, we are -- we sell live birds for about 6 months out of the year, dominantly chickens, but also ducks and turkeys and pheasants and other things, but dominantly chickens. We sell them for like $3 a piece, $4 a piece. We sell $11 million of them in a year. So on a revenue just attributable to chickens, it's a small dollar amount and immaterial, but it's everything that we sell around the project that becomes a large driver of our sales and we brought in a lot of new organic chicken feeds this year and those things, even in spite of them being more expensive than mid and opening price point product. It's our highest performing area of growth in chicken feed right now. It's an organic chicken feed, and that's a brand-new product that we work with Purina on this year. So really excited about all the new innovation that's coming into our stores and also just the opportunity to continue to ramp that up now that we've gotten back to a more normalized supply chain and kind of vendor relationships.

Great. I do want to shift because another key real, I think, in my mind, a real key attribute, if you will, the Tractor Supply investment stories, the continued successful new store growth, new store expansion. So maybe we can talk about just the growth plans. I mean, kind of what -- where are your opening stores, the duration of the openings? And then I think it was just recently, you opened -- you launched a new distribution center. So the question I have there is, how do you think about the Tractor Supply operating model? To what extent or how many stores in the operating model basically support over time?

Yes. I'll start on the store growth and then hit the DCs second. And then just talk about the collective infrastructure, the advantage I think that gives us. First, on the store front, we participate in a $180 billion total addressable market. . And again, using round numbers at $15 billion, right, that's putting us at like an 8% -- 7%, 8% market share. So a lot of opportunity for us to continue to grow even in spite of the growth we've had over the last 30, 35 years and the pronounced growth we've had over the last 4. And we dominantly go after that opportunity with new stores as well as obviously driving productivity in our existing stores. Our current long-term store target is 2,800. We have approximately 2,200 right now counting the Orscheln stores that were in the process of converting. So we've got about 600 left to go. We have historically built 70 to 80 a year. So we've got a good 8- to 10-year run rate ahead of us on new store builds. Our new stores continue to be very productive. The last several cohorts of new stores have exceeded the business plans that we approved before stores built. We're very pleased with the performance, the returns they're profitable in the first year. Strong return prospects. And we're very pleased with the opportunity that's ahead of us on the new stores. The second piece is around our distribution centers. Historically, we've opened a new DC for every, call it, 200 to 300 stores. And as you did the math, our historic average store volume would have been around $4.5 million. So about every $1 billion of sales, we would add a new distribution center. Well, we grew nearly $7 billion, $8 billion in sales over the last handful of years with no distribution centers. And so the team had to do a lot of things to drive capacity through our business and increase our capacity. We went 24/7 in all of our facilities and opened up the capacity there. We, like many other companies, had to go out and use 3PLs to do pop-up DCs and create some extra space near our core distribution centers we had. We opened up mixing centers, and we now have 15 mixing centers, which are cross dock facilities. And we just opened up our ninth DC. We made the decision to build that DC in July of 2020. So right in the midst of the pandemic when we saw our sales accelerating, but it takes 18 months to get 1 open and so we opened up the first 1 here in January, and we've got another 1 in the pipeline that will open up in the first quarter -- in the first quarter, beginning of the second quarter of next year. And so good to bringing back -- getting back to a more normalized distribution network allows us to take the cost out of the 3PLs where we're inefficient and also to lower our freight cost because we're placing the DCs that are closer to the stores they serve, and we're able to bring down our freight -- our mileage. But more broadly, if I step back, we are the largest player in the vast majority of the markets that we participate, particularly in animal feed, and we're the largest retailer for our customers -- I mean, for our vendors, particularly in the categories of animal feed. Last year, we moved over 8 billion pounds of food and feed. We have a supply chain built for our business that's built for our business at scale. It's co-located with our core manufacturers on the pet and animal side to minimize freight costs, and it's an ecosystem that is absolutely the lowest cost to serve in the business. And that creates a lot of competitive advantages for us and ones that we'll leverage as we continue to move forward and just grow our business and continue to be the leader in our market.

That's great. And I want to talk just a bit about it, and Hal, you mentioned obviously the supply chain. I think what we're seeing now across consumer, across retail is easing supply chain disruptions, shipping overseas shipping costs have moderated significantly from the pandemic highs. If I look at Tractor Supply, you, as a company we're very, very skilled at a -- strategically passalong inflation to consumers kind of picking your spots, if you will. As we head into what was likely to be a less inflationary more disinflationary environment, how does that change? How does that change the thinking of Tractor Supply? And I guess the question I'm asking is if inflation has been a driver of sales growth without inflation to sales growth moderate, do you expect to see improved unit demand, any benefits on the margin side?

Yes. I get 4 points on this, Brian, real quickly. The first is, if you look back over the last 4 years, the collective body of work we've had with outsized growth, right, in kind of the 80% revenue growth over the last 4 years, Q1 '19 to Q1 '23, about half of that has been driven by transactions and about half of that has been driven by average ticket. So 1 thing I would call out different than a lot of retailers over the last 4 years that really benefited mostly from an average ticket growth whether it's because of discretionary spend or just inflation. Even though we benefited from inflation, it's been -- we also had a really good story on transactions over the collective 4 years. To your point, on inflation over the last 18 months, seen significant amount of inflation. And the team has done a nice job navigating the market to be able to maintain margins and navigate price with our customers at the same time and still be kind of the price setter in the market. The third thing is as we do well in periods of volatility. We don't see deflation on the near-term horizon. But if it were to occur, we would be very comfortable navigating in it. When you're the largest player in your market, and you set price on the vast majority of the categories that matter to our customer, we're able to -- and also we're the largest retailer with our vendor partners. We're able to navigate costs with them, navigate wind pricing will moderate. And then typically, in periods of volatility, we're able to grow gross margin and typically grow gross margin dollars as well along the way just because we've got the scale on the cost side and the ability to navigate the retail side. So just like we navigated it well on the way up, it appeared of disinflation or deflation, we would be able to navigate it the other way very well. Long term, we expect our business to continue to be a nice blend of comp transactions and average ticket. And when we think about our long-term comp targets, that's what's implied. It's a nice blend. We've historically grown 50% of our growth ticket, 50% of our growth comp transactions. That's even in the collective body to work over the last 4 years, how it's been, and that's what we expect moving forward. When we gave an update on our Q2 performance, we mentioned we were at mid-single-digit comps 4 weeks into the quarter and low single-digit comps on comp transactions. And so just use that as a proxy or indicative of how we expect to come back into a more balanced growth as we move forward.

Very helpful. And I know our time is running down here. So maybe the final topic I wanted to address is Tractor Supply has been a great generator of cash. You strategically use that cash or excess cash to return that cash to shareholders. So I guess, just update us there. I mean, is the kind of the cash flow prospects of the company and your philosophy towards the redistribution of excess capital?

Yes, Brian, you're right. I mean we definitely had a history of strong, consistent operating cash flow and our outlook long-range plans show that to be consistent and continue to grow. So we'll produce roughly $1.5 billion of operating cash flow targeted for 2023. It's -- we expect that to grow in line or even at or greater pace than the overall growth of the business. And so that allows us to do is continue to execute on our growth strategy. So open new stores, continue the path on the existing store remodels, new distribution centers. And as you've seen from our long-range plans and targets, some years heavier than others, but roughly $650 million, $750 million in capital into the business, 80% of that towards growth drivers of the company. And if you think about the whole allocation of capital, on $1.5 billion if you're taking the $750 million in capital investment into the business, that leaves still half of that and more to return back to shareholders. I can't talk about cash allocation without even our capital and we just secured and fixed all of our debt, any remaining variable is fixed with the recent bond offering. So we've got a strong balance sheet. We target a 2:0 leverage ratio. So we can -- as the company grows, we continue to grow into the capital structure. So it really leaves us about $1 billion of cash that we allocate toward return to capital, continues to target removing net roughly 2% of shares from the market and our share repurchases and to continue a consistent strong dividend of 40% payout means we'll grow dividend. We'll target it to grow in line with earnings and continue to have strong payout and dividend yield as well. So we find it is a unique, but a really good balance between a heavy investment for growth, giving us ability to grab more of that $180 billion TAM, but then take that excess cash and also give that to our shareholders to continue what we believe is a really strong total shareholder return.

I gave a notification that our time has run to an end. So I truly appreciate Tractor Supply being with us. Kurt, Hal, Mary Winn, thank you very much for your participation. We look forward to connecting again soon.

Thanks, Brian, and thanks, everyone.

Thank you.

Thank you.

See you.