3 Less Obvious Reasons To Own Tractor Supply

By Will Ashworth | May 23, 2012 AAA
There's a relatively unknown mutual fund company in Omaha that's been managing money since 1929. Known today as Tributary Funds, it manages approximately $800 million across seven different funds. With a four-star rating from Morningstar, its Small Company Fund has 62 holdings, most with market caps between $100 million and $3 billion. One of its largest holdings is Tractor Supply (Nasdaq:TSCO), America's leading retail farm and ranch store. With over 1,100 stores in 44 states, it has no real direct competition. I first wrote about Tractor Supply in July 2008. Since then its stock has gone on a tear, up roughly 564%. There are plenty of reasons to own Tractor Supply. I'll discuss three of the less obvious ones.

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Share Repurchases

Companies repurchase shares for all kinds of reasons. Tractor Supply repurchases shares both as an investment and to reduce the dilutive effect of stock options and employee share purchase plans. Since 2007, it has repurchased 9.1 million of its shares at an average price of about $48.07 a share. If you or I made those purchases, our $437.4 million investment would be worth $893.6 million today. That's a 104% return on investment or 14.34% on an annualized basis.

With negligible debt, great free cash flow and with its stock at an all-time high, you can look for the company to continue raising the quarterly dividend. In early May it raised the quarterly dividend 67% to 20 cents a share. On an annual basis it will spend less than $58 million on dividends in 2012. Including dividends, it has returned $490 million to shareholders over the past five years. If it doesn't buyback more shares, which it likely won't at these prices, it will have the cash available to raise the dividend to as high as 34 cents per quarter and that's without accounting for increasing cash flow.

SEE: A Breakdown Of Stock Buybacks

Store Locations

At the end of 2011, Tractor Supply's store count was 1,085. It plans to grow square footage by approximately 8% annually, which translates into 90 or 95 store openings in 2012. Long-term, its goal is 2,100 stores across the country. That's 10 years, give or take, of triple digit store openings. It's doable though, especially if it's able to make an acquisition or two. Clearly, Tractor Supply management doesn't have a problem with the fact that only 16% of the population in the United States lives in rural areas compared to 72% in 1910.

Several opportunities exist where the population is underserved at present. The biggest need being to fill out its network of stores in the western half of the country, where it currently has 29 Tractor Supply locations in Montana, New Mexico and California and another 25 Del's Feed & Farm Supply in Washington, Oregon, Idaho and Hawaii. Management believes it can open another 253 out west, and if you study the rural population of those states you'll see they are right. In Texas, where it has the most stores of any state at 129, its rural population per store is 29,457. Meanwhile, in California, where it has just 21 stores, its rural population per store is 90,476. To achieve the same density of stores in California as in Texas Tractor Supply would have to add an additional 44 locations in California, alone. According to the 2010 census, Montana's rural population was 436,601, and Tractor Supply could accommodate another 13 stores. That's just two of 12 states in its western region. They've got their hands full.

CUE Products

CUE stands for consumable, usable and edible. In an effort to get customers visiting more frequently, it intensified its focus on animal and pet-related products like pet food, which would increase the number of transactions. Its same-store transactions in 2011 increased 5 and 7.4% in 2010. Thanks to private label brands like 4health, which it introduced in 2010, Tractor Supply was able to thrive during the recession. In 2011, private label brands represented 23% of its total sales, up from 21% in 2010. By providing its customers with another reason to shop at its stores instead of at Wal-Mart (NYSE:WMT) or a grocery store, it's built up customer loyalty while decreasing its advertising spend. That's what I call addition by subtraction.

SEE: The 4 R's Of Investing In Retail

The Bottom Line

Tractor Supply is truly an interesting business because it's near impossible to duplicate the depth and breadth of products available at their stores. As a result, it's difficult to assess their competition. Sometimes it's Wal-Mart, yet at other times it's Home Depot (NYSE:HD), PetSmart (Nasdaq:PETM) or even Kroger (NYSE:KR). It's built a wide moat business whose best years could still be ahead of it. That said, its stock is not cheap so if you buy, expect to hold for several years.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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