Welcome Back, Tractor Supply Company

By Will Ashworth | July 25, 2008 AAA

What do you get when you combine a store that sells brand-name coveralls and cowboy hats, with a store that sells livestock feed and tractor parts? The J.C. Penney of the pig pen, Tractor Supply Company (Nasdaq:TSCO).

Tractor Supply Company is the largest operator of retail stores for the recreational farmer in the United States. Located in rural towns and the exurbs of major towns, this Tennessee-based company started out in 1938 in Chicago as a mail-order tractor parts business, then morphing into a retail store in Minot, North Dakota. As their literature points out, "Tractor Supply supports a lifestyle".

From Obscurity to Market Darling and Back Again
In 2002, Tractor Supply bought competitor Quality Stores out of bankruptcy. For the next four years, it could do no wrong, hitting a share price high of $67.60 in March 2006, but it wasn't always this rosy.

From 1994 until 2003, its stock underperformed the S&P 500. Once the acquisition took hold, the business and its stock were off to the races. At least until 2006, when growth in same-store sales started to decline, bringing with it a rapid retreat in the price of the stock. It hit the $27 mark in early July 2008, a four-year low. That's a $40 decline in a little over two years. For buy-and-hold investors, that has to hurt. Fear not, there is some light at the end of the tunnel.

Second Quarter a Smash Hit
On July 23, it announced second quarter sales. To the delight of shareholders, revenue was up 13.6% to $898.3 million from $790.9 million, and same-store sales up 3.4%, and EPS up 16 cents to $1.24, primarily driven by livestock and pet food products. An improvement in the top-line, while managing inventory and expenses, contributed to Tractor Supply's growth in the quarter.

The company also provided guidance for the entire year, which included same-store sales between flat and 2% growth, 88 to 93 store openings, sales between $2.98-3.03 billion and EPS between $2.49-2.55. Zack's and Wedbush Morgan felt the news warranted an upgrade. They raised their rating on Tractor Supply to 'buy' from the previous 'hold' citing store expansion, a better merchandise mix and operation improvements for the better results. The market roared with approval, sending the stock up 11.8% on July 24. For shares that have historically traded around 23.5-times earnings, but now trade around 15-times, this was much needed relief. (Find out more on analysts' ratings in Stock Ratings: The Good, The Bad And The Ugly.)

Who Knew Coveralls Were So Popular?
The average Tractor Supply customer is 45 years old; is just as likely to be a man as a women, is a homeowner, and has a household income 15% above the national average and a cost of living below the national average. In short, Tractor Supply's customers have greater disposable income to take care of their properties.

The average store is 16,000 square feet and stocked with 13,500-15,000 products. With 89 store openings in 2007, bringing the total count to 764 stores in 43 states, it's not surprising revenue for the entire year was $2.7 billion, up from $2.4 million in 2006. In the past five years, it has opened 320 stores, closing only five. According to store count, it's 2.8 times the size of its next five competitors combined. The closest in size, Orscheln Farm & Home, has 147 stores. The company has a goal to have 1,400 stores in operation in the future, and a five-year compound annual growth rate for sales of 16.4%. Should Tractor Supply come close to that figure in the next five years, its stock would once again visit the $60s.

Bottom Line
I have liked Tractor Supply for some time. It's a good business that could be great with a little more retailing pizazz. Tractor Supply's competition is spread out due to the wide range of products. Companies like Wal-Mart (NYSE:WMT) compete for clothing customers. Farming co-operatives and major building supply retailers such as Lowe's (NYSE:LOW) and Home Depot (NYSE:HD) compete for their hardware customers. It is tough to find a large company that competes in all aspects of Tractor Supply's business.

Tractor Supply brings together a range of products like no other. Perhaps that's why the Bill and Melinda Gates Foundation own 2.8% of the stock. Clearly, it's on its game. The numbers from the not-to-distant past bear this out. To me, it's not a question of whether to buy, but rather when. The stock price could drop back into the high 20s with any hint of bad news. However, a third quarter earnings surprise would send its stock through the proverbial roof.

Find out more on disappointing or exceeding net income expectations in Surprising Earnings Results.

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