EV/EBIT = 19.03x
ROE = 44.97%
FCF Yield = 5.39%
Dividend Yield = 1.03%
Debt/Equity = 182%
Tractor Supply (TSCO) is a niche retailer that has been operating since 1938. Their niche focus is on the “rural lifestyle.” This means that they sell products mainly to recreational farmers, ranchers, and residents of small towns. They operate 1,940 locations across the United States.
Of the 1,940 locations, 212 are located in Texas. Other top states include North Carolina (99 locations), Pennsylvania (97 locations), and Tennessee (96 locations). They lease most of their individual store locations and own 11 massive distribution centers spread throughout the country.
The main product categories include 1. Livestock & pet supplies (47% of revenue), 2. Hardware, Tools & Truck (22%), 3. Seasonal, gift, and toy products (19%), 4. clothing & footwear (8%), and 5. agriculture (4%).
TSCO is an exceptional company with a long history of solid performance. Since 2000, the stock has advanced 27% CAGR, turning $10,000 into $1.5 million. Since 2010, it has advanced at an astounding 25% pace.
The business has advanced at a rapid pace. Since 2000, revenue has increased from $759 million to $9.9 billion. Operating profits grew from $34 million to $1 billion.
TSCO regularly buys back stock, which helps fuel growth in per-share FCF and EPS. EPS has advanced at a 19% CAGR.
Moat & Growth Prospects
Tractor Supply has a moat derived from its focus on rural customers in rural areas. It is the primary supplier for the needs of these customers.
Tractor Supply’s main competitors are stores like Home Depot, Lowe’s, and PetSmart. Tractor Supply can compete with these large retailers by focusing on a niche: rural customers.
They strategically place their stores far away from these big-box retailers and close to their actual rural customers. In small rural towns, Tractor Supply is the best location to acquire their products. Additionally, TSCO offers niche products that can’t be found at these larger stores.
For example, if a farmer needs to buy feed for livestock, a trip to Tractor Supply is an easy one-stop-shop. They can get everything that they need close to where they are doing the work.
At this point, it seems unlikely that a competitor will emerge on the scene and disrupt Tractor Supply’s niche focus on these customers.
Tractor Supply’s niche focus and geographic focus also gives it pricing power. This is reflected in its gross margins, which have averaged 34% for the last 10 years. The strong margins also support strong returns on capital. ROE has averaged 29% for the last 10 years and ROIC has averaged 29%.
I think that TSCO can maintain these margins & returns on capital. It doesn’t seem plausible that another firm will spend the resources necessary to disrupt Tractor Supply’s unique niche. They would have to build new stores in dispersed rural areas and then try to win over Tractor Supply’s customers. It doesn’t seem like such a massive investment would be worth it. The final payoff of disrupting TSCO’s business is also an unknown. For that reason, I don’t think that anyone will attempt it.
It also seems likely to me that per-share earnings and FCF will continue to grow. Revenues & operating profits have both advanced at a roughly 10% pace over the last decade. Meanwhile, Tractor Supply has been able to pile its excess free cash flow into buybacks, helping EPS grow at a 19% pace.
In terms of an additional source of growth, it also seems likely that there will be a move to rural areas in the coming decade. COVID has made employers much more comfortable with work from home arrangements than they were in the past. As a result, I suspect that many people will move to rural locations to improve their quality of life and reduce their cost of living.
In the 1950s and 1960s, there was a migration of Americans to the suburbs. People wanted to get out of cities but still had to live close by for work. Now, that is no longer a constraint. Location is meaningless. Why not live where the cost of living & crime rates are low? I don’t think that cities are going to die, but I do think that more people are going to opt to leave and this turns rural America into a growth area.
With that said, TSCO doesn’t need migration to happen to continue growing. However, I think it is likely and can help TSCO’s growth prospects.
Tractor Supply has a high debt/equity ratio (182%), but the free cash flow that it generates can easily support that debt load. Interest coverage is massive at 35x. The Altman Z-Score is overwhelmingly strong at 5.2. The Beneish M-Score is -2.7, so there are no signs of earnings manipulation. The average ROIC over the last 10 years has been 29% and the cost of capital is estimated at 6.22%, so the firm is not a net destroyer of capital.
TSCO cannibalizes its shares, which is excellent. In the last year, the total share count is down 3% and it is down 27% since 2007. The dividend yield is 1%, but they have been able to massively increase dividends over the years. Since 2010, dividends per share have grown from 14 cents to $1.36. An investor today is earning some shareholder yield, but they could likely have a much higher yield-on-cost if held for another 5 or 10 years.
On an EV/EBIT basis, the stock currently trades at 19x. This isn’t absurdly expensive for a business of this quality, especially in today’s frothy markets. However, in the last 10 years, it has traded in a range of 10x-25x, so it is near the upper end of that range. During the 2000s, the stock was significantly cheaper. Post-GFC it was down to 8x. Back in 2001, this stock could have been picked up as an absolute steal: 5x EV/EBIT.
Price/sales is currently 1.87, which is very high for this stock. The last time it hit 2x was in 2015. From 2015 through 2018, the stock did nothing while this valuation multiple mean reverted. From 2016-2017, there was a 43% drawdown. Average price/sales over the decade have been 1.47, trading in a range between 1x and 2x sales. The fact that this is on the upper end of that range may mean that some multiple contraction is on the way.
The current FCF yield is 5.39%, which seems reasonable to me for a business of this quality. Even if per-share FCF growth (19% over the last decade) is cut in half over the next decade, per share FCF can grow at a potentially 10% pace.
I think that TSCO trades at a fair price. With all of the valuation metrics taken into consideration, I don’t think this is insanely overvalued. I just don’t think it’s a wonderful price.
- Can the stock deliver a 10% CAGR over the next decade?
I don’t like to count on extremely high growth rates to continue into the future as a source of my return. TSCO has been able to grow EPS and FCF/share at a 20% rate for a long period of time. However, that is an extremely high growth rate and it is unknown how long this company can continue to grow at that torrid pace.
I would prefer to conservatively assume that top-line growth in the business will slow down, so I’ll cut it in half and assume per-share earnings and FCF could potentially grow at a 10% pace at this lower growth rate.
Multiple appreciation can’t be counted on from these levels, so that can’t be a strong source of returns.
If compression takes place (say, from 2x sales to 1x), then the stock could deliver less than a 10% return even while the underlying business grows at a 10% rate.
Additionally, if growth slows, then the multiple is more likely to compress.
While the stock can potentially deliver a 10%+ return, that requires that it maintains its current growth rate and the multiple can’t compress. Those are assumptions that I am not comfortable making.
- Has the business delivered consistent results over a long period of time?
TSCO has consistently been able to grow revenues, earnings, and cash flows over the last 20 years. It has also been able to maintain strong gross margins and returns on capital over a long period of time. The company has a strong long-term track record.
- Does return on equity consistently exceed 10% without the use of heavy leverage?
The average return on equity has been 29% over the last 10 years. This is aided by leverage, but it is primarily driven by the pricing power of the business. ROIC has averaged 29% over the last 10 years, as well.
- Is management sketchy?
Management is transparent and honest. The CEO, Hal Lawton, is an excellent choice with a strong track record at eBay, Home Depot, and Macy’s. Management has been consistently honest and transparent. Management’s track record of strong growth and high returns on capital also shows that they are competent. They pass my easy hurdle of “not being sketchy” and go far beyond that. They strike me as excellent managers of the company and stewards of shareholder interests.
- Is the company financially healthy?
Debt/equity is high, but the company is still in a position of strong financial strength. The Altman Z-Score is 5.2 and the interest coverage is 35.
- Has the company consistently generated returns for shareholders? Is the industry in secular decline?
Tractor Supply has generated excellent returns for shareholders. It has delivered a 27% CAGR since 2000. This is not a “buggy whip” company that is in secular decline. They have a strong relationship with their customers & a geographic/cultural niche. I don’t think this is easily disrupted by a competitor or technological change.
- Has the company survived previous recessions?
The company remained profitable through the GFC. Operating profit declined for one year (2008) when it declined from $160 million to $136 million. It didn’t report a loss and weathered this storm well. By 2009, the company posted a then-record $192 million in operating profit. They have not posted an annual EPS loss in the last 20 years.
- Does the company have a moat?
Tractor Supply has a moat. The moat is derived from its niche. It builds its stores close to its rural customers and supplies them with niche products. This gives them an edge with these customers over more generalized retailers like Home Depot, Lowe’s, or Petsmart. It seems unlikely to me that a competitor will invade TSCO’s turf and try to disrupt it.
- Is the stock cheap on an absolute and relative basis?
From a free cash yield and shareholder yield basis, the company is fairly valued. Most of its multiples are in the higher range of the stock’s history. The price isn’t absurd, and it seems reasonable if one expects the high rate of growth to continue into the future. However, I don’t like to count on a 20% EPS growth rate to continue. I would not describe this as “cheap,” or a wonderful price. I would rather remain patient for the company to trade at a more attractive price.
- If I was forced to hold the stock for 10 years, would I be comfortable?
I would not be terrified to hold the stock for 10 years. They have a strong moat and I think they are unlikely to be disrupted. However, I think that multiple compression is likely from these levels and the stock could suffer a significant drawdown if the economy entered a difficult period. Based on the valuation, I wouldn’t be comfortable holding this 10 years without the ability to sell.
Conclusion: I am passing on this stock for valuation alone. It doesn’t strike me as a wonderful price. However, it’s on my crash wishlist of wonderful companies if Mr. Market ever decides to offer it up at a bargain price. It trades in a reasonable enough area right now where I think it would become extremely attractive if the larger market took a dive.
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