EUR 850.00 For Business Accounts Only

Morningstar | Cooperative Weather and Solid Merchandising Support Tractor Supply’s Profit; Shares Fairly Valued

Despite increased logistics, rising compensation, and new distribution center cost inefficiencies, narrow-moat Tractor Supply posted solid third-quarter 2018 results that included same-store sales growth of 5% and a revenue increase of 9%, well ahead of our 1.8% and 5% forecasts, respectively, helped by normal weather and strong merchandising. Given the persistent demand strength through the year, management again raised its 2018 guidance, with sales of $7.84 billion-$7.87 billion (versus $7.77 billion-$7.80 billion prior and our $7.8 billion outlook) and earnings per share of $4.23-$4.27 (ahead of our $4.12 estimate). We plan to increase our $84 fair value estimate by about $4 after incorporating recent results, and view shares as fairly valued, trading at nearly 20 times our 2019 EPS estimate, versus midteens EPS growth in our forecast over the next five years.

While it appears Tractor Supply is set to post its best annual comps since 2013, we don’t think the company’s long-term opportunity set has changed and plan to maintain our long-term outlook, which calls for average sales growth 6% and operating margins of 10%. Any upside stemming from efforts surrounding the OneTractor initiative are bound by investments to continue to build out both the business infrastructure (supply chain) and IT efforts (point of sale, kiosks), which keep capital and operating expenses inflated and profitability from expanding beyond a low-double-digit pace. The Neighbor’s Club loyalty program (now 9.7 million members) remains a catalyst for sales expansion, as historically, these customers shop 3 to 4 times more often than nonmembers and should help bolster the brand intangible asset, which underlies our narrow moat rating.

There was a plethora of positive data points offered, including comp transaction values that rose 3.6%, comp transaction count that increased 1.4%, and 25 consecutive quarters of double-digit increases in the e-commerce business. Additionally, we think Tractor Supply is finally beginning to optimize its e-commerce and brick-and-mortar dynamic, with 70% of the company’s online orders fulfilled at the store level, which has been noted to lead to a 20% attachment rate, and is likely to help leverage occupancy costs. The only notable offsets on the negative side were on freight expense increases (something that is being felt across numerous retailers) and labor wages. We generally view other inflated technology investments in the business as necessary in order to remain competitive and relevant to consumers, protecting the brand.