Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Okay. Good morning. Thank you for joining us. It's our pleasure to introduce Tractor Supply Company. Today, we have with us Hal Lawton, President and Chief Executive Officer of Tractor Supply. Hal has served as President and CEO since January 2020. We have with us too, Kurt Barton, Executive Vice President and Chief Financial Officer and Treasurer of Tractor Supply. Kurt has been in the role since February 2019. And we'll start there, and thanks for joining us, both of you, today. Thank you.

Yes, thanks for having us, Kate.

I think if we can just start maybe talking about the health of the consumer, you guys see a really broad swath of the consumer. And so we'd love to hear your view on what you're seeing and hearing and what you expect for the second half this year.

Yes. From our view, the consumer is healthy and resilient, remarkably resilient. You think about the challenges the consumer has been through over the last 5, 6 years, and they've just been remarkably resilient through it. They've evolved, iterated, adjusted based on the conditions, but GDP continues to be strong. Consumer spending continues to be strong. And that's what we see in our business. We saw a nice sequential improvement through the second quarter, last quarter. Talked about how the third quarter was off to a good start. We had positive comp transactions in the first half, positive comp transactions in both quarters, strong new customer growth, total customer growth. They're engaging in our C.U.E. business. We had very good big ticket purchases as well, better than expected in the second quarter. So just the consumer remains strong and very resilient.

Great. Could you maybe differentiate a little bit in terms of the categories in which you're seeing us right? You talked a little bit about big ticket, which has been a nice headline for you guys in the C.U.E. categories. The discretionary areas for everyone has been maybe a little bit more muted. And so we wonder if you could talk through each category, how you see, again, that possibly strengthening what the consumer preference is there?

Yes. For us, I think it's very situational based on consumer need and in the moment. So for instance, -- if I break our bucket -- our categories just generically into 3 buckets for the sake of this discussion, we always talk about our C.U.E. business, consumable, usable and edible businesses. So those are things like dog food, horse feed, poultry feed, but also categories like fertilizer and grass seed, lubricants for tractors. So it's really things that our consumers consume, use or eat, right? And -- but they're needs-based demand-driven. Those businesses continue to be very strong for us, nice mid-single-digit comps. They're the transaction drivers in our stores. We aren't seeing trade down at all in those categories. We're seeing just normal everyday behavior in those categories, and we continue to gain share in those categories. The second I'd say is kind of the kind of seasonally related bigger ticket businesses or just seasonally related businesses. And for us, it's as goes the weather many times, those businesses go. So it was kind of a cooler-ish and wetter April and May, then summer came in June and July, and we saw our business pick up. And it was not only did we see things like just your normal lawn and garden businesses performing well, but we also saw big ticket like riding lawn mowers performing well. And those were very strong for us. And we think we gained some significant share in the space, but also just our consumers had a demand and a need for that. And yards were growing fast. People are having to mow their yards a couple of times a week through the end of May, June and July, and it was kind of an extended season, and we saw strength in big ticket there. And then the third category would be just more your core discretionary, not as much seasonally related, let's say, something like a gun safe or -- another category would be like recreational vehicles, a little seasonality. Those 2 categories were really big for us last year. So we are lapping on top of some growth from last year, but they were a little more muted. But I think that's one of the attractive things about Tractor Supply is our portfolio of categories. And if you look over the last 6 years with the comps that we've had, it's always been the case that our C.U.E. has been really stable, and then we kind of have other dynamics going on, the other 40%, 50%, 60% of the portfolio, but we're able to kind of navigate it because of that.

So maybe while we're talking about the health of the consumer, I think, we have to talk about tariffs and just what kind of impact that might have. And on the last earnings call, you mentioned seeing tariff impacts in the second half and beyond. I think that has to do with how fast you turn and, again, the categories that you're selling. Have you taken any pricing so far in the categories? And what elasticity response have you seen?

Yes. First, I'll say on tariffs. First of all, I'd say there was some unreasonable expectations or maybe not quite grounded in kind of how balance sheets and inventory turns and the fact there were some thoughts that like tariffs might start coming through in both cost and in pricing in the first half of this year, even the beginning of the -- in towards the first half. But the facts are this is the way that all comes through on the balance sheet. A lot of -- every retailer has a different way they do accounting, retail accounting, cost accounting, et cetera. We're cost accounting, but those all have different ways of things flowing in. Also, all of us obviously worked with our vendors to try to navigate different dates. So I think you're starting to see as you head into the second half of this year, more kind of tariff costs flowing through people's P&Ls, and you'll start to see more pricing action associated with that where appropriate. For us, we talked about the portfolio a couple of times today already. We do take a portfolio strategy. We're committed to kind of our overall operating margin rates, but the profitability by SKU may vary depending on how the market conditions and also whatever costing is happening there and whatever retails we think are doable. We have taken a little bit of price, but very much kind of in the context of the market as well. I think you'll see a little bit more through the balance of the year. I think it will -- if you do the math, you're talking modest percentage points or 2 of price increases across the market, nothing in the high to mid-single digits or anything like that in the market. And I think you'll see that play out into the first half of '26 as well as a lot of these costs are really coming through, as you said, in the second half of this year and will continue into next year as long as -- as well as the pricing associated with that. On elasticities, we haven't really seen much elasticity in the market right now. Again, we haven't had what I'd call very material price increases, maybe things somewhere in the -- on a handful of SKUs, somewhere in the 5% to 10% range, some others in the low single-digit range. And we haven't seen elasticity impact on those price moves at all really.

So then that kind of leads us to just given your size and scale and just strong merchandising prowess, how do you see the tariff landscape playing out competitively? Meaning are you monitoring price gaps? Are you taking a look or taking advantage maybe of any opportunity there to take market share, like you mentioned before?

Yes. I think we're running the business the way we always do, just in the context of some incremental costs coming through. We have a very sophisticated cost management system, margin management system, pricing intelligence system and price scraping system. We also have monitoring of elasticity by SKU as well based on pricing actions we take. So very sophisticated. And I think this is -- as you deal with tariffs and you have these kind of large amounts of uncertainty coming through, I think this is where scale will matter and sophistication will matter. And retailers who have more of that we'll be able to better navigate their P&L, better navigate their inventory and also, to your point, Kate, take advantage of the market conditions where you might see someone -- you might see some pricing opportunity to take share in the market as well. And that's certainly how we always think about it on our key categories is making sure we're the market leader on pricing and setting ourselves up to take share.

If we could maybe just switch to margins and maybe more of like a shorter-term conversation. You reported your quarterly results a little bit earlier than a lot of other retail, just based on your December year-end calendar. But your expectation for gross margin expansion in the second half is maybe a little bit lower than the first half. Could you maybe walk through some of those drivers? And what do you think is maybe the most sustainable gross margin range for Tractor Supply longer term?

Yes, Kate, I'll start with a backdrop. The first half of the year, much in line with our expectations, we expanded gross margin by roughly 30 basis points. That was in a bit of a headwind more than we expected on strong consumable product sales, as Hal mentioned. So those items tend to have a little -- bit more of a mix pressure on us, but still a really strong 30 basis point improvement in gross margin expansion. We said even in the beginning when we came into this year that we expected gross margin to be -- to grow, but not at the same level in the second half of the year. It's principally 3 things, and those 3 things generally apply much like we thought at the beginning of the year. None of them really that significant, but -- we began seeing incremental supply chain benefit last year in the third quarter when we opened up a new distribution center. It's really one of the biggest unlocks. When we have a new distribution center, we can get reduced miles, better rates, new lanes, et cetera. We'll lap that in Q3. We also expected to see a bit more pressure on the C.U.E. consumable items that we're selling because we do see that as a key driver. And there's certainly the strength of the traffic of our business is coming in consumables, and that puts a bit of pressure. And then recognizing on the topic of tariffs that we expect some pressure in the back half of the year. So the combination of those 3 things, none of them really that meaningful movement puts us still at gross margin expansion in our expectation, but below the 30 basis point improvement that we saw in the first half of the year. It's likely more to be in that 5, 10, 15 basis point improvement in the back half of the year.

Okay. I think -- and this is just my opinion, but you guys had a December Analyst Day where you focused on new investments and longer-term strategies. And I don't know, I do feel like maybe the tariff discussion has become front and center now, and you're not hearing as much about the longer-term strategy as maybe we would have heard back when you delivered it in December. So I thought we could take this time to maybe go back and revisit it because you're doing a lot of things. The Allivet acquisition and integration, the Final Mile delivery, the direct sales and the localization. So I wondered if you could maybe just walk through each initiative for us and how you're prioritizing resource allocation for these initiatives.

Yes. Thanks for giving us an opportunity to talk about the Life Out Here strategy and our kind of second wave of it. In October of 2020, we introduced the first version of our Life Out Here strategy, and there was a number of initiatives that we launched at that time, including our Fusion remodel program, our Garden Center build-out, our revised Neighbor's Club program, but also some other programs like our FAST team. As we are now in year 5 of those, each of those initiatives have a couple of years left of kind of tailwinds that they will be generating for us in the business. And as those start to subside, what we wanted to do is have a second set of initiatives, kind of the horizons for growth that would layer right on top of those and continue to drive Tractor Supply's growth out into the back half of this decade. And so to your point, we launched a number of new initiatives beginning of this year, namely our -- we did an acquisition of Allivet, which was a pet and animal pharmacy company, and we've integrated that into the business and connected that into our Neighbor's Club program. That's one big strategy we have. Over -- nearly 80% of our customers have dogs, over 50% of our customers have more than 1 dog. They have a tendency to be much heavier than the average dog in the country, so it fits very well also with our 41 million Neighbor's Club members. So we've got a lot of synergy to be able to put together on that acquisition and that initiative. The other one, to your point, is direct sales. This is very much kind of a B2B play for us. If you think about hardlines retail sectors, say, auto or home improvement, where there's been a kind of B2B angle they've been able to pursue, very similar for us. There's a number of kind of larger farms, equine facilities, kennels, dog breeders, et cetera, that have large annual purchase needs that we can have a direct sales team go out and call on and grab that share and grab that incremental business. We think both of those first 2 opportunities are $1 billion in revenue opportunity for us in the future. And then the third thing is our final mile initiative. And that's really basically rolling out the ability to get items delivered to an end consumer's home in a owned way through Tractor Supply vehicles. We're building that in a hub-and-spoke like way where every 3 or 4 stores, there will be a truck and a trailer that will be associated with that territory, and we'll be able to deliver not only the direct sales orders that I mentioned that will be in the range of $4,000 to, call it, $20,000, $30,000 in size, to even orders that are placed online as well as orders of big bulky things that are placed in our stores. So we see that as a fundamental extension of our strategy and kind of next wave of logical customer service that we'll provide. And then the last one, as you mentioned, was localization. This is really the kind of wave 2 of our Fusion remodel program. For the first 4 or 5 years of that program, it was really one cookie cutter like approach across the country. Now that we've implemented a number of systems related to planograms and store clustering, we're able to overlay that and tailor about 15% of the square footage during a Fusion remodel program to be specific to the needs of that area. So if it's more outdoor recreation, we'll lean in there. If it's more equine, we'll lean more there. If it say is more of a hardware store, we'll lean more in there from a category and space allocation perspective. So 4 big strategies that we're pursuing. The first 2 are more expense-based -- sorry, Allivet was an acquisition, but the next 2 were more expense-based. And then obviously, the last one, a little more capital-based. But big initiatives for us, again, all about layering on the initiatives that we launched in 2020 to create multiple horizons for growth for us really through the back half of the decade.

And then just my follow-up question to that. Obviously, Allivet was an acquisition, but how you view maybe inorganic versus organic when it comes to these 4 initiatives?

Yes, I'd start by saying our -- from a capital allocation perspective, our #1 focus is always investing in the core business. And we have a very proven flywheel, and we want to make sure we don't underinvest in that flywheel as we move forward. After investing in the business, we're very much committed to a dividend for our shareholders at about a 40% payout. And then after that, we have share buybacks. We typically buy somewhere in the 1% to 2% of shares outstanding a year. And then from an acquisition perspective, those are typically more opportunistic for us. We've done a couple of acquisitions since I've been in the role over the last 5.5, 6 years, and we've had kind of about the same. Like once every 3 or 4 years, you might see us dip our toe into the water on acquisitions for a modest type acquisition to the extent it's aligned with our strategy. Another example of that was Orscheln Farm & Home, of course, when we acquired them a few years ago.

So maybe that's a good transition to your real estate strategy because you do plan to open 100 new stores. I think also you acquired some of the Big Lots locations, which I'm not quite sure we've seen you do before. So maybe, again, you can compartmentalize the -- just the organic growth versus real estate acquisition between Orscheln and then maybe the Big Lots stores, too.

Yes. I'll start by saying the hallmark of Tractor Supply is comp store growth plus new store growth. And that's been a hallmark of us for 30-plus years. This is a company that's had 1 year of negative comps in the last 30-plus years. That was in 2009, and it was a minus 1% comp. And this is a company that successfully built between 70 to 100 new stores a year for really the last 20, 30 years as well. So it's a hallmark for us. On the new store front, we are very sophisticated in how we approach new stores, both in terms of the real estate location, the financial modeling that goes around it, what we actually build in that location and then ramping our new stores up to their full maturity curve. Our new stores in the last year, as an example, as we're ramping up to 100 new stores, back from about 70 or 80 during the COVID years. Our new stores are performing incredibly well right now, exceeding our forecast, new store maturity curve, getting off to an excellent start, ROICs and paybacks all working out very well. And that's what gives us the confidence to build the 90-plus stores this year and 100 stores next year. To your point, we did also acquire 18 Big Lots locations. Those locations, we think of them nothing -- really no differently than we would have retrofit. So about half of the stores that we open a year are new, built-to-suit from scratch. The other half are retrofit where we'll go in and take a piece of real estate that's already been developed and retrofit it and make it fit to a Tractor Supply model. The Big Lot stores, that's how we think about them, is really a retrofit. And we did the math on will we be better buying this lease-out in the open market after they've gone through the bankruptcy process? Or would we be better off taking them through the bankruptcy process. And we went through both of those views. Obviously, each situation was a little bit independent, but we ended up settling on 18 of them that we thought made financial sense. And they're very easy boxes for us to retrofit. The way they're built in terms of basically a square-ish rectangle, we can set them up just excellent. They work really well for retrofit for Tractor Supply.

And most of those stores will be converted and opened to Tractor Supply stores before the end of this year. So there may be some that flow into 2026. But to Hal's point, it's easy. And it's retrofit stores at the right locations when they're in those markets that we've already identified as part of our target of 3,200, we love to look at those second use locations. And again, part of our portfolio of driving like low-cost, efficient, profitable new stores.

And how do we think about cannibalization for these stores? Again, you've been very successful and consistent at growing a good number of doors every year, 3,200 is the goal. But I would imagine just as things get a little bit more dense, there might be more propensity for cannibalization. So how do you manage that?