Tractor Supply (TSCO) Stock Q1: Not Buying More For Now But Watching

The United States of America is home to many great businesses. As the global epicenter of free enterprise, this makes sense.

When I think of America, I think of the individual ability to dream big and to chase those dreams. I also think of this country’s resolve.

In nearly 250 years, America has faced its share of challenges: Scores of wars, a handful of depressions, dozens of recessions, and at least a few pandemics.

There were stumbles along the way, but American ingenuity and grit have ultimately persevered over all obstacles to date. Of the companies that I cover, few are as American to me as Tractor Supply (NASDAQ:TSCO). The company exemplifies certain characteristics that are as American as American football, apple pie, and the American flag itself.

Just like the country that it calls home, Tractor Supply has seen a lot since its inception in 1938 as a mail-order tractor parts business. Yet, through it all, the company has adapted to each situation and reached new heights.

When I last covered Tractor Supply in February with a hold rating, I liked it for its durable operating track record, sustainable dividend, growth potential, and healthy balance sheet.

My only hang-up at that time was that shares were approximately 13% undervalued. Since I already had a 1%+ weighting in the stock, I wasn’t compelled to add more shares as the total return potential wasn’t enough for me to justify buying more.

Since that time, shares have rallied another 16%. Today, I’ll be reviewing Tractor Supply’s first-quarter operating results and valuation to explain why I’m maintaining my hold rating for now.

Briefly, I still appreciate the business. This is because Tractor Supply’s Neighbor’s Club loyalty program continues to see great growth and the company is taking action to drive further operating efficiency. With shares trading right around fair value, the combination of starting yield and growth potential simply isn’t enough for me to pull the buy trigger just yet.

Tractor Supply’s Business Is Doing Just Fine

I’m not bullish enough on Tractor Supply’s stock to award a buy rating. However, I continue to be impressed with the results delivered by the business. When the retailer shared financial results for the first quarter ended March 30 on April 25, this remained the case for me.

Tractor Supply’s net sales grew by 2.9% year-over-year to a record $3.4 billion in the first quarter. That was $10 million shy of the analyst consensus per Seeking Alpha, but this miss was arguably akin to a rounding error for the company’s size.

In my view, the following remarks from CEO Hal Lawton’s opening remarks during the Q1 2024 Earnings Call were what made these results especially positive:

As it relates to consumer spending, the shift of spending from goods to services continues to be a headwind for our business. In the first two months of the calendar year, consumer services spending growth was nearly 7%, whereas consumer spending on goods growth was less than 1%. CEO Hal Lawton

In an otherwise healthy consumer spending environment, Tractor Supply was theoretically disadvantaged as a retailer. This is because, throughout the quarter, consumer services spending growth far outstripped goods spending growth.

Yet, the company’s comparable store sales edged 1.1% higher during the first quarter. The factor that was largely responsible for this strong result was the Neighbor’s Club loyalty program. Neighbor’s Club customers account for the majority of the company’s sales.

Tractor Supply’s careful attention to this program helped it to grow enrollment from just over 30 million in Q1 2023 to more than 34 million as of March 30. The company’s new rewards redemption levels of $2 and $5 (down from the previous $10 mark) are further improving customer engagement.

This program growth seemed to help attract more customers to Tractor Supply’s stores, as comparable transactions pushed 1.3% higher over the year-ago period for the first quarter. That was only slightly offset by a 0.2% decline in the average ticket in the quarter. Along with the growth in Tractor Supply’s store count, this is how net sales moved higher during the first quarter.

Shifting the focus to the bottom line, Tractor Supply’s prudent cost management paid dividends for the first quarter. The company’s diluted EPS jumped 10.9% year-over-year to $1.83 in the quarter. For context, this was $0.11 greater than the analyst consensus according to Seeking Alpha.

Tractor Supply’s net profit margin expanded by almost 30 basis points to 5.8% during the first quarter. That was due to lower transportation costs and prudent product cost management. Combined with a 2% lower share count from share repurchases, this is why diluted EPS growth outpaced net sales growth for the quarter.

Looking ahead, Tractor Supply has a few things going for it. Shortly, the company expects its Maumelle, Arkansas distribution center to open. That will be its 10th and largest distribution center, which is scheduled to open in June of this year. This will help the company to simultaneously streamline its supply chain and improve customer service.

Glancing out further, Relex announced last November that Tractor Supply selected it to implement a supply chain forecasting and replenishment solution. This could help the retailer to optimize its supply chain and achieve more cost efficiencies.

It’s also anticipated that Tractor Supply will open 80 new stores in 2024. As store openings continue and the company’s supply chain is made more efficient, diluted EPS should keep climbing. This is why I think the FAST Graphs analyst consensus of diluted EPS growing 9% (over the 2024 consensus of $10.40) to $11.36 in 2025 is within reach. As is the 11% growth forecast to $12.62 in 2026.

Tractor Supply’s interest coverage ratio was 22.1 in 2024. Thanks to this high-interest coverage ratio and the stability of the business, the retailer enjoys a BBB credit rating from S&P on a stable outlook (unless otherwise noted or hyperlinked, all details in this subhead were sourced from Tractor Supply’s Q1 2024 Earnings Press Release and Tractor Supply’s Q1 2024 Investor Presentation).

Waiting For A Better Entry Point

Tractor Supply’s recent rally has stretched the valuation a bit too much for my comfort to add to my position. The company’s current-year P/E ratio of 26.6 is moderately higher than the 10-year normal P/E ratio of 23.3 per FAST Graphs.

Now, I don’t think the valuation is quite as excessive as it seems. Tractor Supply’s expanding net profit margins (6.5% in 2014 per page 35 of 88 of the 2018 Annual Report to 7.6% in 2023 per page 59 of 100 of the 2023 Annual Report) do seem to justify a valuation multiple somewhere between the 10-year normal and the current multiple.

Building some conservatism into my valuation, I think a P/E ratio of 25 could be a reasonable assumption for valuation moving forward. This is because of Tractor Supply’s expanding margins and the potential for that to persist in the years to come.

Markets usually look forward by 12 months. So, I will be using a 65% weighting for the 2024 earnings input of $10.40 and a 35% weighting for the 2025 earnings input of $11.36. For more perspective, these weightings are also forward-looking by 12 months.

Working these inputs out, I get a fair value of approximately $268 a share. Relative to the current $277 share price (as of April 29, 2024), this is a 3% premium to fair value. Adjusting for a slight margin of safety for if margins don’t expand as much as anticipated, I would think about buying below $260 a share. This is because I believe such an entry point would provide a better chance for 10% annual total returns moving forward.

The Payout Can Keep Riding Higher

In early February, Tractor Supply upped its quarterly dividend per share by 6.8% to the current rate of $1.10. That’s a far cry from the 23.2% compound annual growth rate over the last 10 years per Seeking Alpha’s Quant System. But as the company more fully realizes cost efficiencies, I think dividend growth can return to the high-single-digits annually.

This is because the company’s 43% EPS payout ratio is below the 60% that rating agencies prefer from the industry.

Annualizing Tractor Supply’s quarterly dividend per share, 2024 dividends would be $4.40. Against the $10.40 diluted EPS analyst consensus, this would be just a 42.3% payout ratio. That should leave the company with the funds needed to invest in supply chain optimization and repurchase shares, while also growing the dividend.

Risks To Consider

Tractor Supply appears to be a steadily growing business, but that doesn’t make it risk-free.

The company’s investments in improving its profitability look like they are paying off. In the unlikely event this changed course, though, Tractor Supply’s valuation multiple could contract. That could lead to underwhelming future total returns.

Another risk to Tractor Supply is that the potential for a recession isn’t completely in the rearview. The first Q1 GDP estimate was 1.6% growth, which was well short of the 2.3% consensus and 3.4% for Q4 per Seeking Alpha. Personal consumption expenditures growth of 2.5% for the quarter also lagged the 2.8% consensus and the 3.3% Q4 figure.

If the U.S. economy slips into a recession, there could be a temporary impact on Tractor Supply’s financial results. This could also weigh on investor sentiment, which could send shares lower in the near term.

Summary: Now Isn’t The Time For Me To Buy More

Tractor Supply comprises a 1.1% weighting in my portfolio. As I noted above, I am confident in the company’s operating reputation, dividend safety, and finances. Until the valuation becomes a bit more favorable, though, I’m going to simply continue holding my shares here.