Tractor Supply: A Company in a Class by Itself
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Tractor Supply (NASDAQ: TSCO) is a unique company that will probably grow its earnings and operating cash flow for a long time. This company’s primary focus is on recreational farmers and ranchers with above average income and below average costs of living. In other words they target the frugal and rural consumer who wants to have a farm or ranch out of nostalgia.
I have driven by several Tractor Supply Stores but had never been in one. Today, I decided to go the Peter Lynch route and went inside to see what they are all about. I was greeted by friendly and busy associates. In the front of the store I noticed toys and other small items, such as a box disguised as a book to hide personal belongings in. There was also a section of clothing items, such as cowboy hats, blue jean shirts, and boots. They even had jewelry. I also noticed that they sold feed of what seemed like an infinite variety. They had goat feed, rabbit feed, and a whole aisle devoted to bird feed and horse feed. Tractor Supply also had your typical variety of cat and dog food. Livestock and pet feed made up 40% of Tractor Supply’s revenue in 2011. The store also had generators on display which, considering the recent storm we had, I paid particular attention to. Walking along I also noticed chicken wire and an auger machine to drill post holes. So if you want to have a recreational farm or ranch, Tractor Supply has the equipment and soft goods to make that possible.
Fundamentally this company is sound, with some exceptions that I will discuss shortly. Revenue and net income has grown 15% per annum during 2009-2011. Comparable store sales grew 11.5% versus the same quarter last year. The most recent quarterly report shows a negative operating cash flow of $20 million, which took my breath away at first, and then I realized that this was a seasonal phenomenon. Late winter and early spring there is probably not a whole lot going on when it comes to raising and cutting hay or mowing the lawn. As of the most recent quarter, this company had a total debt to equity ratio of 65%. The dividend to free cash flow ratio is 35%.
Free cash flow has dropped from $141 million in 2009 to $89 million in 2011. Normally I would be concerned about this, but they are in the midst of building a new distribution system in Kentucky and making upgrades to their other distribution centers. As the new distribution center comes online and the upgrades are complete, free cash flow should improve. Tractor Supply did research that said the market can support 2,100 stores, which is double their current number of stores; this is simply an investment in their infrastructure. I will watch this part closely, however.
Weighing the Risks
Fundamentally this company is doing okay. It is highly seasonal and dependent on the weather. If winter was longer than normal or summer milder than normal, it could impact this company’s earnings. The market price risk right now is high. The p/e ratio is around 24 as of market close on 07/18/12. Free cash flow yield is around 1.5%*, making it a little expensive. The company operates exclusively in the United States so political risk is minimal.
Yahoo! Finance has Home Depot (NYSE: HD) listed as a publicly traded competitor, but I have to respectfully disagree. Home Depot sells lumber, kitchen appliances, plumbing and things like ceiling fans. All of these items, with the exception of lumber, are meant to maintain a home, not a farm or a ranch. They do sell lawn mowers, though, which is an item that Tractor Supply also sells.
I think the stiffest competition comes from the independent feed and tractor supply shops that you find in rural small town America. I think Tractor Supply has an obvious scale advantage here when it comes to bargaining for lower prices on merchandise. They also have brand name recognition, which customers can carry with them if they move or go somewhere else. Tractor Supply already has stores in 44 states.
Wait and See
I think that free cash flow will improve once the new distribution center comes online and the improvements on the old distribution center are finished. The price of this stock is simply too expensive right now, so I am putting this company on my watch list. If there is ever a Wall Street disappointment that drives the stock south, I will buy. Otherwise, I am patiently playing wait and see.
*Footnote-[Free Cash Flow/Diluted Weighted Average Shares Outstanding]/Share Price on 07/18/12*100
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