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Tractor Supply Company (NASDAQ:TSCO) has been able to differentiate itself among homegoods retailers in a way that appears to set the company up for longer-term success. Additionally, the recent acquisition of Orscheln Farm expands the business further into important rural communities. After a 100%+ move over the last 12 months, the stock still appears to be trading close to its intrinsic value with the potential to provide 8%-10% returns over the next few years.
Tractor Supply Company is a United States-based rural lifestyle retailer. The company primarily caters to the home, land, livestock, and pet owners throughout the country that have above average income, but below average cost of living expenses. The primary sales product categories for the company are below:
Tractor Supply’s long-term growth strategy is to drive customer loyalty through personal and localized experiences while continuing to expand the store count methodically. Over the last 5 years, Tractor Supply has seen a compounded annual sales growth rate of roughly 11.3%. Plans are to open an additional 80 Tractor Supply Stores and 10 Petsense in 2021, adding roughly 4% to the total selling square footage and bringing the total store count to 2,195.
Tractor Supply operates in the incredibly competitive retail industry, but has done an excellent job of differentiating themselves by finding an unfilled niche in the marketplace. While offering many of the same products as Home Depot or Lowes, Tractor Supply has been able to expand their offerings in ways that rural customers resonate with and have a need for.
Looking forward, there is plenty of untapped market potential for Tractor Supply to grow into. As mentioned above, their primary sales categories are livestock and pet (47% of sales), but their store footprint is limited in the largest agricultural producing states.
From a livestock production perspective Texas, Oklahoma, Missouri, Nebraska, South Dakota, and Kansas make up the 6 largest livestock producing states, representing roughly 45% of the total cattle, but those states currently only account for 18% of the current Tractor Supply store footprint.
This lack of representation in the major cattle production states, combined with the close proximity of the states, should allow for continued sales growth well into the future while maintaining reasonable marketing expenses. Additionally, the acquisition of Orscheln Farm for $297 million is a fantastic strategic purchase as it helps add fuel to the fire of the midwest expansion.
In the short term, Tractor Supply has also benefited from the COVID-19 induced sales boom in home goods retailers. The COVID-19 boom saw Tractor Supply increase their FY2020 net sales by 21% to $10.6 billion while also increasing their gross margin by 104bps to 35.4%. Unlike some other retailers, however, Tractor Supply is expected to hold onto those long-term sales increases as consumers continue to spend more time at home.
From both a short term, and a long-term perspective Tractor supply appears to have plenty of runway for continued growth.
Considering that Tractor Supply is a relatively mature realtor in a mature industry, a Discounted Cash Flows, or DCF, model is appropriate for evaluating the intrinsic value of the stock.
To calculate the WACC, I looked at the effective tax rate of 22.6%, the $28.8 million spent in interest expense, the $3.541 billion in debt and equivalents, a treasury yield of 1.73%, a 5 year beta of 1.01, and the US equity risk premium of 4.72%. As a result, the estimated WACC for Tractor Supply is 5.61%.
I then estimated the perpetual growth rate of the business based on the maturity of the industry and the expectation for forward growth. For the purposes of this exercise, I estimate the perpetual growth rate of Tractor Supply to be a very conservative 1.5%.
From there, I used historic revenue, net income, FCF, and forward consensus earnings to determine the intrinsic value of the stock. I estimate that the intrinsic value of the stock is roughly $186/share. While this does mean that there is roughly $10/share in potential upside, that is without a risk premium. After adding a 5% – 10% risk premium it would be reasonable to assume that the stock is relatively close to its intrinsic value.
Tractor Supply is definitely not without risks. Being that Tractor Supply is a realtor in a mature market, there is very little moat for the business to build or maintain. With that, Tractor Supply is highly dependent on its brand and reputation for customer loyalty. If something adverse were to happen to either the brand or the reputation sales could be impacted as a result.
Additionally, due to the lack of an economic moat, if Tractor Supply continues to perform well it could draw new entrants into the market. The retail market is highly saturated at this point and there are very large players such as Home Depot and Lowes and are always looking for ways to expand. Since the product offerings are already somewhat similar, it would not be difficult for other existing stores to add more of the livestock and pet supplies that Tractor Supply carries.
Overall, Tractor Supply appears to be priced relatively close to its fair value and is poised for continued success. Management has a clearly defined plan for ongoing growth and has been executing that plan successfully.
With a current dividend yield of 1.18%, the expectation for share repurchases, and cash flow growth of 5%-6% over the next few years, Tractor Supply appears to be poised for long-term success.