Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us for the fireside chat with Tractor Supply this morning. For those of you who don't know, Tractor Supply is a DIY rural lifestyle retailer in the U.S. with more than 50,000 team members and serves all the needs of those enjoying life out here. It operates 2,200 stores, generating revenue of $14 billion a year. We today have Hal Lawton, President and Chief Executive Officer of Tractor Supply. Hal has served as President and CEO since January 2020, and is a member of the company's Board of Directors. We also have with us Kurt Barton, Executive Vice President and Chief Financial Officer and Treasurer of Tractor Supply. Kurt has served in this role since early 2019 and is also a member of the company's executive committee. Thank you so much for joining us today.

Thanks, Kate for having us.

Thank you so much for joining us today. We appreciate it. Unlike some of the other companies we're speaking with today, you guys are -- we haven't heard from you in a little while. You reported earlier in the cycle. So we wondered if we could maybe start out talking with your view on health of the consumer, just your updated view about how you're feeling about the consumer. Maybe you could walk us through what you've seen throughout the year up until now, how you're expecting the back half to play out?

Yes. Absolutely. Thanks, Kate, and good morning, everybody. Our view on the consumer is that they are stable, they have been very resilient, and that the economy is overall in good shape. That's the -- as always, there's a bunch of nuances. And start with at the highest level you think about GDP, call it, 2.5-ish, perhaps even 3%. So you've got strong economic activity in the United States. For us as a retailer where the nuance is, is when it clicks down 1 level below that, start with consumer expenditures, which are obviously the bulk of our GDP here in the United States, and those continue to run it, let's call it, 3-ish percent as well, right, and perhaps even slightly above overall GDP. But then when you click into that and you look, that's really where it starts get a nuance for retailers because you've got services up 7% really year-to-date and you've got goods up, call it, 1% to 1.5% year-to-date. So you've got this big divergence inside of consumer expenditures right now. Obviously, on the services side, it's things like entertainment and travel but it's a lot of rent, insurance, those sorts of things that are also driving up that. If you look at pre-COVID, we were -- it was about 69% services. We're roughly 100 basis points off of that. So at this point, you would think that divergence would start to moderate and start to narrow back. But for us in retail right now, I think that's some of the narrative in retail is the consumer's strong and the economy is solid. Obviously, there's some nuance on inflation and unemployment underneath but it's really more of a services goods. I think that's a consistent theme probably here across all of retail. But from our view, given our earnings 2.5 months ago, 2 months ago, it really hasn't changed much since then. The consumer keeps navigating through it. Net wealth levels are at all-time highs for a large portion of the population. And from our consumer, we don't have a lot of the lower-end consumer, and so some of the documented difficulties in that segment really haven't affected us.

So it's the share of wallet, which I know many retailers have talked about, whether it be maybe at the lower end consumables versus discretionary and certainly at the higher end, more discretionary versus services. There also was, I think, the pivot to services came as a result of just how many goods people did buy during the pandemic. Did you have a view on how much digestion has taken place, I guess, now that we're almost 5 years post-pandemic and when you could expect to see maybe some of that stabilization in the share of wallet?

Yes. So as it relates to share of wallet, let's say, goods to services, we've been on that kind of outspoken, it's unclear when that's going to stabilize and come back, kind of narrow that gap. But one would think if you follow normal trends, maybe another year, if you just get how much of that gap versus pre-COVID good services made up over the last 18 months. And then as it relates to kind of definition of pull forward on goods, that has not been -- I think there's certainly elements of -- particularly in the retail segment, that there's elements of that. But for us, that's really not been as much of a factor or a consideration. We commented this year that big ticket has been very strong as an example, which is categories like riding lawn mowers, UTVs, altering vehicles, those sorts of things. And I think that's indicative of strength of the consumer on the higher end, when people want to buy something, their ability to do so, and also would point to the fact -- and the units that we're selling on both of those categories, for example, are well above 2019 levels. So it would be indicative of if there was any pull forward in those types of categories, that it's certainly passed itself by now. The rest of our business really doesn't have that kind of consideration. It was animal driven, it's pet driven or discretionary or seasonal oriented.

Speaking of that C.U.E categories are about half your business, over half your business. And I know there had been at least last year at this time, a lot of concern about deflation. So I wondered if you can maybe talk us through what you are seeing from a pricing standpoint, how you are focusing on conveying value and promoting the C.U.E. categories, and what the elasticity response has been as a result of that?

Yes. I'll start out with the C.U.E. As Kate's mentioning, stands for consumable, usable and edible products. So in many ways, we're much like the grocery store for our customers, animals and pets. We have between 20% and 25%, somewhere in that, which market share of bagged animal feed in the United States. So far and away the largest player in that space, and we're top 5 in pet. And so there's a lot of consumables happening in our business. But also, we sell a lot of things like lubricants for our customers' tractors and vehicles. And then certainly in the seasonal side, like during the summertime, fertilizer and grass seed are big categories for us, things like propane all year round. And then in the winter time, things like wood pellets for secondary heat for our customers. And all those products have an underlying element of commodity exposure. And in 2022 and the back half of '21, we saw some significant inflation due to commodities but also wage rate increases and supply chain increases. The majority of those goods have stabilized at this point, aren't seeing dramatic inflation. Those that aren't seeing further inflation, those that -- the majority of those saw deflation during '23, so things that were steel related or fertilizer related, et cetera. Pet food has really been stable on pricing, and it's really animal feed that's been the majority of our deflation this year. We started the price reductions in those businesses last year at the very end of the third quarter, beginning of the fourth quarter. So we're about to cycle those. Other than that, really don't see much inflation, further deflation risk in our business. We're obviously watching our corn pricing, and that has a major influence on animal feed. But we don't see any further deflation on the horizon, and we're starting to lap last year's inflation right around the corner.

Great. And then if I could maybe just ask another thing that we've been hearing from retailers recently, actually, more than recently, is just how much newness is driving the consumer decision. But also you're hearing a lot about consumers leaning into occasions or holidays. And I know you do have business around all of that. So I wondered if you could maybe talk to any newness that we can expect to see in Tractor Supply in the back half and how you're thinking and what you've seen from some of the holiday spend this year?

Yes. Maybe I'll make 3 points on that. First off, in the first half of the year, to your point, we called that out on our earnings call as well that things that are new, where you're seeing innovation, new brands, new product introduced to the market this year, those have all sold incredibly well. We commented earlier on the strength we've had in riding lawn mowers this year. We had several new items in the lineup this year. Similarly on grills. We've had really strong performance in grills this year. We had -- we brought Weber into our lineup this year on grill in addition to innovated on several of our key items. And so anywhere we've sprinkled newness into the business, it's done incredibly well. As we're looking towards the back half of the year, second thing I'd say is we're seeing similar trends. So as we start getting into the fall season, where we're bringing newness in. We're seeing that sell really well across the business. And like an interesting fun note is like Halloween this year for us has been very, very strong. We're not obviously a large player on like say, the costume side or even the candy side, but more on the home decoration side. And that has been a really strong business for us. It's been encouraging to see that off to a good start. And then as it relates to holiday, I think this is going to be a very interesting holiday for retail for a number of reasons. First off, as we all know, we've got the national election on November 5, the federal elections. I think you're going to see most consumers wait to purchase their holiday goods until after the election. And that's compounded by the fact that this year, there's 5 less shopping days in the holiday selling season. It's the latest Thanksgiving that you can have. And obviously, Christmas is always on the 25th. So there's 5 less shopping days than last year. So if you start the season late because of the federal election and you've got a narrow shopping season, it's going to put a lot of pressure on the month of December. And so I think the consumer is in a good spot. Hopefully, we have good weather during that time so everybody can get out and shop. And hopefully, other conditions are right, but it is going to be a very tight Q4.

Great. If I could maybe move over to a question on competition, which I don't feel like you guys get asked too much about because what you're offering is so differentiated and specific. But we wondered if you could maybe talk about how the competitive environment has changed since the pandemic? And would you say there are more points of distribution in which you overlap categories today or less?

I'd say it's roughly the same as it relates to a point of distribution. If we were to step back and talk about our market and the competition a little bit. So we estimate our total addressable market to be $180 billion in size. Our revenues this year will be approximately $15 billion, putting us just at an 8% share of our market. That has grown about the market but also our share of the market as we've been a significant share gainer over the last decades. If you look at how we think about our competition in that kind of breaking into 2 big buckets. About 40% of the market is core farm and ranch competitors, vis-a-vis, regional chains or co-ops, and there's about 8,000 co-ops across the country. So between our stores, there's another 2,250, call it, those 8,000 co-ops, maybe about another 1,000 or so retail, I mean, regional and local chains. There's, call it, 11,000, 12,000 competitors on the farm and ranch had some points of distribution, to your point. And then the other 60% of our market is really, we compete against a whole range of competitors. So on the apparel side, where we carry brands like Carhartt and Colombia and Wrangler, plus our own private brands, we'll compete against the tens of thousands of apparel and footwear locations in the country. In pet food, significant competition there as well. Animal feed, it's more against the core farm and ranch. But then you get into our tools and hardware business. You're competing against home improvement there or mass merchandise and then certainly seasonal very similar. So it's a big market, one that we compete against a whole wide variety of competitors. But if you step back, one of the things that I think is a unique compelling investment opportunity as it relates to Tractor Supply is that in the farm and ranch channel, we're far and away the largest player with our 2,250 plus stores. No one has the national scale that we do. No one has the competitive advantages that we do on supply chain, on digital, on marketing, et cetera. And it puts us at a really compelling competitive advantage relative to the majority of our competitors.

Kurt, I wonder if I could throw some questions your way. Sorry, just to get to it now. But we wanted to talk to you a little bit about productivity. And just obviously, since 2020, I feel like there's been a lot of chase of demand, chasing the supply chain. Now you have a macro environment that's a little bit more challenging with higher interest. But if 2025 were to be a normal year and you could operate the way you'd want to operate, how would you think about your current investments? What would you speed up if you could? And what would that lead to in terms of productivity and margin enhancement?

Yes, sure. Kate, if I could, let me first add one comment to the last topic that Hal talked about. And we've said for years, but I don't think we've said it recently enough on your question on competition. One of the unique things of Tractor Supply is that you can find everything within the Tractor Supply and other retailers, and most of it even online. But what's unique is you can't find everything within a Tractor Supply at any other one retailer. And we bring all of that together for that one unique lifestyle. So yes, there's competition. There's even scenarios of others trying to get into some of what Tractor Supply does well. But you really can't reproduce or there's not a great reproduction of everything you can to supply the lifestyle of Tractor Supply in another retailer. And we think that's pretty neat, and we believe our customers do as well. On productivity, I'd step back and say, if you look at the last 5 years, 2023, 2022, a tremendous amount of growth, 45% 3-year stack comp sales. And in that period of time, there was a lot of inflation but there's a lot of inefficiency in that process. If you think about how much we grew during that timeframe, we muscled through that in regards to how do you move that much product through the same pipeline. And we had to utilize 3PLs. We had to be at the highest level of volume going through our distribution center. So there was a lot of great success during that timeframe. But we're coming off of a lot of the inefficiencies. And I think that's one of the reasons in the last 2 years that Tractor Supply -- even though the demand has softened coming out of there, that Tractor Supply kind of maintain operating margins during a very heavy investment time period, is that while we're investing, we've been able to reinvest in our supply chain, reinvest in our people in our stores and be able to drive much more productivity. So extremely pleased on the returns that we've been getting on these investments that sometimes don't get as much exposure as all the sales driving initiatives. And we still have some more efficiencies to go in that. And we just opened up our 10th distribution center. That has, for the next 12 months, a process of realigning supply chain and transportation lanes and productivity within our distribution centers. And so as to your question is, if there's a bit more normalization in there, where would we invest? I don't think that, that really changes our plan at this point. We will -- we've said we're going to invest in new stores at a greater extent, where we had 70 in 2023 new stores, 80 this year targeted, targeting 90 next year. Our new stores are coming out of the box stronger than ever. We'll continue to invest in our supply chain and all the technology and automation. And we believe in the Life Out Here strategy that we launched a few years ago, and believe that even during the time of deflation on the top line pressure, and even a softening on the discretionary, that there's some long-term growth and ability for us to widen the moat and even distance ourselves from competition. We've got a model that need space, and we believe that our investments that we're making that are at the highest levels will drive greater productivity for the long term and give us additional market share. So our expectations for 2025, to Hal's point, we see that we're -- we believe we're nearing as a U.S. economy some potential movement back to normalization. And we're investing right now to be able to continue to take advantage during that time.

You mentioned new stores in your answer. And I wondered if you could maybe walk us through how the store economics are looking for some of the newer stores you've opened? And do they include the Project Fusion layout as well as the Garden Center? And how should we think about growth of these newer stores and what they look like in return?

Yes. As I mentioned, we're continuing to -- we're increasing the number of new stores we're opening that has everything to do with the ability that we said in previous announcements, a goal, a target, identify 3,000 locations within the U.S. But our new stores continue to be a hallmark of Tractor Supply in regards to the best investments we can make. I'll give some of the data points. Pre-pandemic, so 5 years ago, a new store was coming out of the box about $3 million per store. While we've had 45% comp store sales growth during that timeframe, our new stores are coming out of the box at like $4.5 million. So they've pretty much kept up the pace in the growth of the business well. And we've had about 60% to 70% new store productivity, and they have about a 5-year maturation period. All of that has pretty much stayed relatively consistent. So our new stores continue to have the top line growth that we've seen overall in our market. They continue to be cash flow positive in year 1, basically breakeven returning on the investment within 3 years. And so we've made the investments in new stores that like Fusion, Garden Centers, all of the new stores who have Fusion, most of the new stores who have Garden Centers. And a new store, if it's not going to have a Garden Center, it may be because we've taken advantage of a retrofit location that does not have maybe the side lock capacity to have that. But a vast majority will have Garden Centers as well. And that also plays into the overall long-term or 5-year growth opportunity for those stores. I couldn't be more thrilled about the investments, which is why we're increasing it to 90 next year.

And then just how do you think about cannibalization? You mentioned that it's 3,000 stores are accelerating the growth. What role does cannibalization play in this? How are you measuring it? What's your view going forward as you open more?

Yes. We've always had in most of our existing markets some level of cannibalization on our existing stores. We view it that cannibalization that we're creating with a new store is typically a pretty healthy cannibalization. We are seeing stores in markets where we evaluate the holistic market that may have potential for 10-plus stores as having much greater value when we look at it. And we've got to add more stores in to be able to take advantage of that and you have stores that were running pre-pandemic $6 million or $7 million. Now they're $9 million, $10 million, $11 million. That's a lot for that box. And so we may have stores that we open up and they may cannibalize by $1 million, but be coming out of the box, $4 million, $5 million and adding incremental $3 million or $4 million of sales right out of box. And that other store had definitely a relief of some of the volume pressure. But the interesting thing is that just like anything else, when you release some of that volume pressure, they begin to comp as well positively from that point as well. So we have about roughly -- probably about 2/3 of our stores that will open up are in an existing market that will have some level of cannibalization. We evaluate that. We feel it's the right and a healthy investment. But about 1/3 of them are going into markets where there's no real cannibalization of the existing store. And maybe last thing to add, new store maturation continues to drive comp sales. And it's part of our algorithm on a 5-year maturation that it's part of the comp sales driver. We always look at that net of cannibalization. It continues to be a net positive to pretty consistent with what we've seen in the past, a net positive to our overall comp growth year after year.

Okay. Hal, I wanted to ask you something that we haven't heard too much about from Tractor Supply yet. But we were curious, we've heard from other retailers having success at monetizing on their omnichannel with media subscriptions, marketplace. Do you see this as an opportunity for Tractor Supply as well?

It's a great question. I'll start maybe a bit on Neighbor's Club, just to talk about the foundation we have around our customers and how that could play into retail media. So for those that aren't familiar, we have our loyalty program, it's called Neighbor's Club. And we have over 34 million, 35 million members of our Neighbor's Club program, represents nearly 80 -- the sales in that program represent nearly 80% of our sales. It's a thriving part and a key component of Tractor Supply as a value proposition with our customers. We've continued to make enhancements to our Neighbor's Club almost on a yearly basis just to make sure we're staying out there as a best-in-class membership program. And I would put our -- I mean, a loyalty program. And I would put our loyalty program up against anyone else out there in retail or food service in the United States. If you look at as an example of that, we converted -- when we launched it, it was just a basic loyalty program. In 2020, we added -- made it a tiered-based, rewards-based loyalty program. Earlier this year, we tweaked the kind of tier levels a little bit to allow people to earn higher percentages earlier. And we also changed the way you can redeem to get to $1 and $2 and $5 increments of redemption, not just a minimum of $10. So this is a program that we keep reinvigorating and keep incrementing on to make it even more value-added for our customers. And most recently, we just added a component called Hometown Heroes. One of the things most folks may not be aware of, but -- so we had 0% of our stores in urban America, 8% of our stores in suburban America, and 92% of our stores are either ex-urban or rural America, 20% -- rural America represents 20% of America's population, that's 50% of our military. And one of the things we launched, as I was mentioning earlier, right in conjunction with July 4, is Hometown Heroes. And so if you're a veteran, active military, first responder police, fire, EMS, you -- and you're a member of our loyalty program Neighbor's Club, you can be part of the Hometown Heroes piece of that, and you earn our top-tiered status in our loyalty program. Plus, we provide percent off on July 4, Veterans Day and also First Responders Day. In addition, we have a quarterly coupon and such. So this is a vibrant, vibrant membership loyalty program that we continue to increment on and make better and better. And to your point, it serves as a great data set, it provides an immense amount of data and customer understanding, and depths of customer detail that would allow us to be able to then monetize on top of that in a way where our advertisers would see the real value to add, right, because they can get really targeted. To date, we do -- so we do offer ads on our website now. It's modest millions of dollars. But in the millions in terms of net income, its contribution, and we do see opportunities for that down the road. More broadly, I would say, we also see other opportunities to continue to build on our membership program and add more value-added features there, some of which that could be also monetized.

Great. Just one last question before we go into our lightning round. Just around inventory growth. Just with the backdrop being what it is, with the holiday being shortened and the prospect of rising ocean freight and maybe tariffs, how are you thinking about managing your inventory in the face of some of those challenges?

I'll take. We have been investing this year for what's really driving the business. And so you've seen even in our Q2 announcement, inventory is up year-over-year 10%. I'd point out really 3 things that was a key driver of that, and it's really going to be about the consistent 3 things for the remainder of this year. One, we talked about the success of our big tickets and the newness, and the innovation there. Our vendor partners have done an excellent job bringing innovation, and our customers are responding. We've made investments in that. Secondly, consumables, the C.U.E. categories. While there's deflation in there that's putting pressure on the AUR, the units continue to grow. We're taking market share in there. Last year, there was actually spots where we wanted and needed more inventory. So we're in the best inventory position that we've ever been in our consumable part of the business, and we believe that's key to our business. I'll just pause there and just say, as Hal mentioned, it's a bit of the grocery store for the land and the animal. It's what drives traffic in, it's what gets customers in to see the newness in the other categories. And the third thing, as I mentioned, we opened up our new distribution center. And it really takes about 6 to 9 months to normalize inventory after you've had to load in inventory for new distribution center. Those 3 categories make up the overall growth of inventory. And so we feel very comfortable and plan for that. And then in regards to any potential near-term, like geopolitical or tariffs, all that, it doesn't really change our inventory purchasing as much. For the last 5 years, we've done a lot since the first round of tariffs to really mitigate the risk and move inventory out of a primary country such as China into other Asian countries, Mexico, et cetera. And ultimately, we're probably more insulated by that exposure than most retailers where only about 12% of our product is purchased, direct-sourced overseas. So we're a bit insulated with a heavy domestic purchase company. But we've also mitigated that over the last few years and really feel like while we managed well the previous round of that, if this were to come, it's a scenario that we're planning for, and we feel like we can manage it well.

Okay. And just the last couple of minutes, we have 5 questions that we're asking every company. I'm actually not quite sure we'll get to all of them but we'll try. Expectations for the environment in the second half of '24 versus the first half? Do you think things will be seen better or worse with the consumer?

The forecast we've given is Q3 would be much the same as the first half and then Q4 has a higher range of outcomes, a wider range of outcomes, some of which could be very positive. And depending on some of the circumstances that I mentioned earlier, some of which could put some pressure, so wider range in the fourth quarter.

And then on the second question on the topic of margins, and this is more of a '25 question. How are you thinking about cost pressures around materials, labor, freight, seeing better or worse than '25?

Yes, that one's got some broad scenarios out there. I would -- as we've indicated, Hal mentioned earlier, we believe as pricing has stabilized, our base case assumes beyond 2024, there's either steady or even potential for slight increase in the materials because we're -- in our environment, we're running net deflation on cost. We expect that to either be flat or growing. I talked on tariffs earlier on that labor coming off with some of the highest years in 2021 through 2023, 2025 is probably a bit more like historical norms.

And then I'll skip over to the fifth question. You guys are EDLP but curious about how you're viewing the promotional environment in the back half, either when you look at your own promotions year-over-year or what you expect from the industry year-over-year?

Yes. As you said, we're an EDLP retailer. One of the ways we enable that is about doing print ads. We'll do 1 print ad this year for Black Friday. But otherwise, all of our marketing is digital or CRM or above the line kind of TV, radio type stuff. Because of that, it doesn't really drive the need to do promotions, right, whereas print ads have a tendency to do that. You can focus on items and categories and real marketing. That said, certainly, everybody is scratching and clawing for business right now. And so you'll see things like bonus buys. You'll see pack-ins. You'll see some brands doing promotion, and we'll participate in that. Certainly, on holidays, I think you're seeing everybody kind of load up and tried to take advantage of the holiday and drive traffic in. And I do think it's going to be a competitive holiday season. As I said earlier, with the 3.5 weeks, 5 days less than last year for holiday and the fact that I expect holiday shopping will start later because of the election, I think you're going to see a fast and furious holiday season. The good news is we are not a huge holiday player. I mean the vast majority of our business is pet food and animal feed, and things like wood pellets to keep people's homes warm, that's where we play more. But I do think we do obviously have some holiday elements where there's decorations and giftable type stuff, and I think you'll see that go fast and furious this year.

Okay. Well, thank you so much for joining us. I appreciate the time. Thank you.

Thanks, Kate, for taking the time this morning. Thanks, everybody.