EUR 850.00 For Business Accounts Only

Morningstar | Tractor Supply Marks Solid Close to Winter With Healthy Comp Print; Shares Modestly Overvalued

Narrow-moat Tractor Supply put up strong first-quarter profit, driven by 5% same-store sales growth, an above 8% total sales increase, and 26 basis points of gross margin expansion (to 33.8%). In our opinion, efforts stemming from the ONE Tractor initiatives and the Neighbors Club loyalty program (now 11 million members strong) have allowed Tractor’s merchandising prowess to improve, locally deploying inventory to locations it will turn the fastest. As the company continues to slice the rich data it’s collecting from its loyalty members (who shop 3 times more often than non-members and contribute more than 50% of sales), we expect Tractor will continue to get closer to its customer, leading to both gross and operating margin expansion as improved product deployment helps to take pricing gains, fortifying its economic moat. This thesis underlies the operating margin improvement we have embedded in our model, which calls for 20 basis points of expansion on average and leads to a nearly 11% terminal operating margin at the end of our forecast.

However, reaffirmed sales guidance of $8.31 billion to $8.46 billion supported by 2%-4% same-store sales, leading to $4.60-$4.75 in earnings per share implies a modest slowdown over the remainder of 2019. Specifically, it implies mid-single-digit sales growth and around 3% same-store sales over the remainder of the year, metrics we find commendable at a mature retailer late in the cycle. However, given that our prior outlook called for $8.37 billion in sales, 3% same-store sales, and $4.64 in EPS, we don’t plan any material change to our $93 fair value estimate. That said, with shares up more than 70% over the last year, we view shares as overvalued trading at 23 times the midpoint of 2019’s EPS guidance. For reference, our forecast calls for 12% average EPS growth over the next five years.

First-quarter sales growth of 8.3%, to $1.8 billion, was supported by both a same-store ticket value increase of 3.2% and same-store transaction count rise of 1.8%. Consistency across the store fleet was apparent, with all months, geographies, and product categories comping positive over the quarter. The gross margin of 33.8% was about 40 basis points better than we modeled, as Tractor benefited from ongoing sales in seasonal winter goods as well as tactical pricing despite higher logistics expenses. The SG&A ratio, including depreciation and amortization was in line with our 28.1% forecast, as higher wages and deleverage from the ramp of the Frankfort distribution center drove the 20 basis point year over year expense expansion. Overall, this led to an operating margin of 5.7%, which was around 50 basis points (rounding) better than we projected in the company’s seasonally smallest quarter (the first quarter of 2018 delivered 13% of full-year net income).

Even with moderating growth over the remainder of the year, Tractor Supply is set to throw off healthy free cash flow of more than $475 million, helping support the ongoing return of capital to shareholders via dividend (sub-2% yield) and share repurchases. While we currently view shares as modestly overvalued, we still believe Tractor Supply remains one of the better businesses to defend against the ongoing e-commerce threat that are pressuring operating margin performance across the retail landscape. With a rising percentage of sales from CUE categories and private label (33%), substitution of goods remains a lesser threat. Furthermore, the company has an enviable balance sheet in the event of a downturn (given the long economic expansion and late cycle investor perception), with below 1 times debt to EBITDA and a cash conversion cycle that has improved by around 10% over the last three years, driving better working capital efficiency across the business.