Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

All right. Good morning, everybody. Thanks for coming. My name is Seth Sigman. I am the U.S. hardline, broadline food retail analyst here at Barclays. My pleasure to have the management team of Tractor Supply with us today, Hal Lawton, President and CEO; Kurt Barton, EVP, CFO and Treasurer. We also have Mary Winn Pilkington, SVP, IR and Public Relations, in the audience somewhere. I don't know -- there she is. Perfect. Interesting time for Tractor Supply, a lot we want to cover today. I guess, first for you, Hal, to kick it off, high level, Tractor Supply has discussed a number of external drivers influencing the business over the last few quarters. We'll also talk a lot about the company-specific opportunities. But if we could just level set here, maybe frame down the top-down view of the business right now. What are some of the key factors, key end market dynamics that you're seeing? And what are you most and least optimistic about as we sort of look out?

Yes. Good morning, everyone, and thanks for joining us today, and thanks, Seth, for the question, and thanks for having us here. As Seth mentioned, kind of, if we start at the high level, Tractor Supply participates in a large market. We estimate our market to be $225 billion in size. We're the largest player in our market at around 7% to 8% market share. If you just kind of look at it over multi-decades, it's a very attractive market. So it's fragmented, significant opportunity for scale and aggregation, profitable from a tractor perspective there. And it's one where we think from a competitive perspective, we're uniquely positioned to continue to grow and expand and take share. That said, over the last, call it, 6 months to a year, our market has been stressed. And that's kind of the implied in Seth's question, and we've been talking a bit -- a good bit about that. We do see kind of some light at the end of the rainbow here, and we're excited about as we start to lap some of these pressures kind of getting back on top of them. But I'll talk about those pressures and what we've been seeing for the last 6 to 12 months. Our end market is $225 billion. So as I said, our total addressable market. And there's kind of 3 major end markets that I'd like to talk about today that are kind of stressed. About 40% of our TAM, our total addressable market, is kind of our core farm and ranch segment. So think about these as kind of your core hobby farmer, your core backyard enthusiast folks that are raising animals, raising pets, 3 to 5 acres of land in this kind of core farm and ranch segment with fuel prices being [indiscernible] with the ag economy being where it is, that part of our set market has been stressed for really the better part of 6 to 9 months started in Q4 of last year. If you look at Placer data, YipitData, look at that whole competitive set, it's really been a flat to negative market for the last 9 months. And that's about 40% of our market segment. The second set of our market segment is pet. We're a large player in pet, around the fifth largest player in the pet industry. And that industry, kind of, well documented for the last couple of years has struggled on the dog population side. And you've seen pullback in consumables as a consequence of that. You've also not had a lot of new dogs entering the market. So you've had a pullback on hardlines and other early dog kind of categories. And so as a consequence of that category collectively inclusive of services has been flat to modestly positive. And then if you look at our third end market, about 20%, that's kind of home maintenance, home improvement, property repair. That one is, as you all have been following really from the home improvement sector side, has been kind of a flat market now for 4 or 5 years. And we are seeing that kind of moderated as well. So when you take farm and ranch kind of flat to negative 1-ish, you take pet kind of flat to maybe positive 1-ish and you take home improvement kind of flattish as well. Those are kind of 80% of our $225 billion total addressable market, all kind of stressed. Now as we look ahead, we see ourselves starting to lap on top of the farm and ranch pressure beginning in Q4. There's a lot of pundits around pet, but there does seem to be some stabilization occurring in that business. So we feel good about our end markets kind of evolving over the next 6 to 12 months. And of course, we're taking a number of actions to respond to the moment as well as to set ourselves up more strategically as we enter 2027 as well, which we can talk about, Seth.

Yes. Perfect. We'll unpack some of that. I guess the other big change this year, maybe for you, Kurt, tariff refunds, a pretty big deal across retail. You haven't actually disclosed the number necessarily, but I guess, how are you thinking about reinvesting those dollars? Some of that started to flow in Q2, I believe, also expected to hit in Q3. I guess, how do you think about deploying those dollars?

Yes. With the backdrop that -- a couple of things on the backdrop. One, I mean, there's -- it's understandable that tariff refunds is a broad transitory issue for all of retail. And you're hearing more about that through all the earnings calls, et cetera. Tractor Supply is much smaller in regards to our direct import exposure. So when tariffs began to be -- those costs began to become part of the cost structure in 2025, we've said we are about 10% or 12% of our sales is tariff related. So I think with those 2 backdrop items, the way we're managing and the way we view tariff refunds for 2026 is that this is broad. It's somewhat unique to 2026. I mean every year, it seems like of late, there's new uniqueness and tariff refunds are a bit unique. As we said on our second quarter earnings call, we viewed in this environment at this time, the best strategic move is to reinvest our tariff refunds to drive and create value for our customer. And we did that and are doing that in 2 ways. First and the most significant reinvestment of the tariff refunds are to offset historical record high fuel costs, diesel costs even today hitting some of the historical highs. But the combination of fuel costs being higher and then the overall transportation business, principally domestic, but both domestic and import are certainly showing with new regulations, et cetera, there's inflation in transportation costs. So the biggest inflation environment right now for our consumer is the overall supply chain cost driving inflation. We're utilizing that to offset that rather than trying in an environment that the consumers are a bit stressed to be able to try to push through cost increases or price increases, we're reinvesting it to be able to offset that. And then to a lesser extent, secondly, we think it's a great opportunity, and we've invested on a few key core traffic-driving items where our tariff refunds may be coming in specific to certain merchandise categories. We're reinvesting that in the top most visible traffic-driving consumable items that bring the customer into Tractor Supply. It's a great opportunity for us to be -- and we use this as our unbeatable pricing on those to make sure the visibility is that Tractor Supply is driving value in an inflationary stressed environment. And so that's how we're reinvesting it. I think the other thing that's important is we said the timing of tariff is going to be a little bit choppy. A majority of it we estimate occurred in the second quarter, but there's still some tariff refunds in the second half of the year. And so we saw an outsized benefit in Q2, but we're managing and reinvesting this for the full year. Ultimately, our guidance says with high commodity cost inflation, transportation cost increases, those typically put a lot of pressure on gross margin. Our guide for the year puts gross margin not too far off of our original plan, albeit we get there differently. And we'll be managing throughout the year, which we've said for the second half of the year, the gross margin performance will not be consistent with Q2, but kind of view it as on a full year basis.

Okay. That's helpful. A few things that I want to follow up on there. On the transportation cost side, you called out a 50 to 75 basis point impact in the second quarter which is a big number. Anything else you can tell us about what drove that increase and how you're planning for those costs through the rest of the year? And anything that you could help us with into next year?

Transportation is a bit higher portion of our cost of goods sold than most retailers. Certainly, as you understand, we move a lot of heavy bag commodity feed, big bulkier items, et cetera. So most of retail, general merchandise transportation costs may be mid-single-digit percent of sales. In softlines, it might be low single digit. Well, we're more of a high single digit. So when fuel costs increase as they have, like almost an entire dollar per gallon and as we move more of the needs-based item in an environment where consumers are focused more on the consumable needs and less on the discretionary, the combination of those 2 does actually put an impact of 50 to 75 basis points. And last thing I'd say on transportation, it's not unique. We've seen these cycles. And it's almost every 2, 3 years, transportation may go through different cycles. We are using this unique environment to offset it, but it's not unique to us that how we manage that going forward, whether that be through cost or productivity, cost reductions from our vendors, productivity improvement, all of that, it's very much in our playbook to find different ways to offset the transportation cost increases if these types of pressures were to persist beyond 2026.

Okay. And then you mentioned pricing earlier, maybe for you, Hal. Can you talk about the recent price investments that you've made? How comfortable are you with the price gaps today versus your farm and ranch competitors? And just any other context on pricing historically like why the change now? Did you sort of pull back on that price aggression historically? Why do you need to ramp that up now?

Yes. Thanks, Seth. As Kurt mentioned, like a lot of retailers, we've been the benefactor of tariff refunds this year. We did not disclose it in our second quarter call, as you mentioned, Seth, mostly just from the sake that we were kind of first in line on earnings. And from a competitive perspective, didn't want to share too much information. But the math on our tariff refunds was north of $100 million, but south of, say, $150 million, somewhere in that range. And obviously, some of that will depend on the dollars that actually get refunded. So there's a range there. And to Kurt's point, we invested about 2/3 of that back into covering freight and incremental fuel costs, and Kurt just went through the details of that. And then the second kind of -- the remaining 1/3 we invested into price. And I think you're seeing -- that was really -- first off, Tractor Supply always stands for low price on consumable goods, everyday low price. We price -- benchmark ourselves against our competition on our top 100 KVI SKUs, our top 1,000 KVI SKUs and then, of course, across the entirety of the store. And we typically are somewhere between 1 and 3 percentage points lower than our competition on those sorts of basket of goods. As we all know, right now, there is a significant pressure on the consumer. And so the way you see retailers responding is leaning into their consumable and transaction driving businesses. Those of us that are fortunate enough to have consumable and transaction-driving businesses, not all of us do. We're fortunate that 40% to 45% of our business is consumables. And we are leaning into the price points on those to drive those transactions and drive that traffic. Right now, there's not a lot of kind of real growth occurring in retail. Most of the growth is just nominal growth based on average ticket. And so there's tremendous fight in retail for transactions right now. So that's why we lean into it, call it, $35 million, $40 million of our tariff dollars are going into this price investment. As Kurt mentioned, it's a smallish subset of SKUs, call it, 50-ish SKUs but they are the most widely prevalent SKUs in our baskets and our customers' transactions. They're the ones that our customers note when they're pricing out their projects. And we've seen almost a 200-point price increase -- 200 basis point price increase in customer price perception since we launched our Unbeatable campaign. So our customers are noticing. We're seeing the transactions. We're seeing the response to the price investments, and we're very pleased. To give you an example of the types of SKUs these are on, things like shavings. So if you're -- if you have a horse, chicken, anything -- any sort of animal outdoors and also sometimes indoors with cats. Shavings are a huge portion of your purchases in almost 15% of our baskets. So we've made price investments on those, but also some of the key consumables by category, whether it's chicken feed, dog food, equine feed, things like sweet feed, which is a universal product or even on the liquid side, things like lubricants, which are a huge transaction driver this time of year or even things like deer corn this time of year as well, but really leaning into those consumables, making those price investments, and we're very pleased with the response we're seeing from our customers.

Given that unique benefit of having the tariff refunds this year to fund some of that, how do you think about the sustainability of these price investments into next year?

Yes. Great question, Seth. First off, I'd say, if I step back really in retail for the last 6 or 7 years, we've been playing kind of these like annual challenges, right? So I think when we started this year, it was a very different setup than what we're experiencing now 8 months into the year. And I'm pleased with how we're responding to the moment. And I've also reflected ck over the last 6 or 7 years, and each of the years have had a challenge, and I'm pleased with how I'm pleased at how we responded to those as well. So certainly, we know there's a challenge ahead of us in 2027. First thing, we're working really closely with our vendors right now on our support funds and our relationships with them to be able to offset that going into next year. We just had our vendor partnership meeting last week. We've got a new set of vendor support funds we're in the process of negotiating. We've made great progress on that. That in and of itself should help us offset the price investment we're making. And so then we're really just talking about the freight offset. And I feel more comfortable navigating the freight offset. It's something we've done historically very well. But also if freight stays elevated at this level for a year plus in time, I think the entire market will have to reconcile with that.

Yes. And so wrapping that all together, maybe for you, Kurt, what's the right way to think about the starting point for gross margin as you look into next year? Because obviously, there's a few cross currents here. You have tariff refunds rolling off. You have the price position that's going to remain elevated. You do have those vendor offsets, but you also have cost pressures that persist. So if we wrap that all together, what's the starting point?

Yes. A couple of key framework points to make. One, we continue to target and have been consistent with as we grow to maintain or even slightly improve our gross margin rate year-over-year. And that's been our target, and we've been relatively consistent with that. This particular year, as I mentioned, even with a lot of these cost pressures, we'll be generally in line with that, flat, maybe slightly down year-over-year for the year on gross margin. And so from an annual perspective, I think that's a decent -- 2026 is a decent jumping point to look at that. There's a lot still to know. And certainly, we'll be giving more guidance on 2027 in 3 to 6 months. But when you think about it, I wouldn't look at Q4 or Q3 as the primary jumping point, but really look at 2026, to my point earlier, the choppiness of tariff refunds, how we're managing that. Hal mentioned that we had our vendor partnership conference just last week. And so with the expectation that this isn't going to be a light jumps on or off in regards to the end of 2026, either cost pressures dissipating or persisting, we really view that we've got to manage through this. So we're already making plans on how we manage with the different levers that we have on how we can maintain our gross margin. So the way we look at it right now, 2026 for the full year is a relatively good basis from that point. And I think that's the position we'll work from as to how do we take that and be able to manage the balance of both comp sales, ticket and transactions, but also our margin rate for 2027. And I'd look at it more from the full year of 2026 than, say, third or fourth quarter.

Yes. Okay. That makes sense. And I guess a related follow-up on pricing is inflation. So we have seen a pickup in some of the commodities recently. Inflation, I think, in first half of the year was around 1%. How are you thinking about it from here?

I'll take that. We said on our last earnings call that while at the beginning of the year, we could see inflation having anywhere from a 1- to 2-point benefit to ticket that with a lot of the pricing adjustments we've made and how we're managing that, we saw that being more towards the lower end of that. So more like a 1% benefit. It's really been trending that it's likely to fall into that category. Now we do recognize that the points we've made on transportation inflation, commodity, corn in particular, has certainly had a jump in its pricing of late. It's still relatively early, but if the current price is above $5.00 were to persist, we'll work to manage as best we can to not have to raise prices. But eventually, you have to look at the market, you look at how we have to adjust for that. And so I'd say still see us at the low end of that range, but a persistent inflation level could push that modestly up for the year. And then we'll certainly see what position we're in for 2027.

Okay. Great. And then for Hal, I want to switch to the pet category specifically. Obviously, you faced some challenges. As you noted earlier, there's a lot of work happening in the store. Maybe just update us on the trends that you're seeing, the progress through some of the initiatives.