What Makes Tractor Supply Such A Powerful Dividend Growth Stock (NASDAQ:TSCO)

Introduction

In my dividend growth portfolio, I still own just one consumer cyclical stock. While there isn’t a law that dictates how many cyclical consumer stocks one needs to own, it won’t hurt to diversify – especially not if the market has some fantastic stocks to pick from. One of them is the Tractor Supply Company (NASDAQ:TSCO), a company I’ve been following for many years.

Hence, in this article, I’ll reiterate my call to buy TSCO on weakness, using its recent quarterly earnings, the economic environment, and its dividend growth characteristics.

So, let’s get to it!

I’m A Picky Investor

I’m very picky. I own fewer than 25 dividend stocks, which cover roughly 90% of my total net worth. In other words, every investment is a high-conviction investment that I intend to keep on a very long-term basis.

As the overview below shows, I own multiple industrial stocks, three energy stocks, two real estate stocks, two financial stocks, and two healthcare stocks.

When it comes to consumer stocks, I own just one consumer cyclical stock and one consumer defensive stock. The reason I own just one consumer defensive stock is that I have a hard time finding a stock that comes close to PepsiCo (PEP), meaning a company that offers both a decent yield and decent growth.

In the consumer-cyclical space, I’m even pickier. After all, a lot of cyclical consumer products rely on trends. This applies to apparel, technology, and similar products. I want to avoid buying a stock that might lose business due to, i.e., a new fashion trend.

When I bought The Home Depot (HD), I knew I was getting a company that sells a wide variety of brands in countless categories. It’s the perfect combination of smart management and long-term growth in home improvement demand. Well, that’s the short version.

In addition to consistently adding to my HD position, I want something that complements that investment. A stock with similar dividend growth characteristics and the ability to remain competitive.

That’s where the TSCO ticker comes in.

A Rural And Smaller Home Depot

With a market cap of $25.0 billion, Tractor Supply is nowhere near as large as Home Depot or Lowe’s Companies (LOW). However, it’s also focused on different customers. This Brentwood, Tennessee, headquartered company is a rural version of Home Depot. As of December 31, the company had 2,333 stores. This number consists of 2,066 Tractor Supply stores, 186 Petsense stores, and 81 Orscheln Farm and Home stores. In February 2021, TSCO acquired Orscheln in an all-cash transaction of $297 million. These stores are not visible on the map below. However, I still kept it in to show the geographic coverage of the much larger Tractor Supply brand.

The average store size ranges from 15,000 to 20,000 square feet. The average Home Depot size is 105,000 square feet.

Its customers are people enjoying the rural lifestyle, which means its product portfolio is dominated by livestock and pet products, hardware and tools, and seasonal items. The numbers below are from 2021, as the 2022 10-K hasn’t been released yet. But given the historic numbers, it’s unlikely that anything major has changed.

Over the past ten years, TSCO has outperformed both the market and its consumer discretionary peers by a wide margin. However, initially, the company was volatile and prone to steeper sell-offs.

Related to that, the company is a fantastic dividend growth stock.

TSCO’s Dividend

The stock behind the TSCO ticker does not have a high yield. Its 1.6% yield is in line with the S&P 500’s 1.6% yield. However, its dividend growth is satisfying and likely to stay that way.

Let me give you a few numbers.

• Over the past ten years, the average annual dividend growth rate was 26.2%.
• Over the past three years, that number has increased to 39.4%!
• On January 27, 2022, TSCO hiked its dividend by 76.9%.

Oh, and don’t forget that TSCO bought back a quarter of its shares over the past ten years.

With that said, hiking a dividend is easy. The tricky part is doing it responsibly, meaning with support from strong growth.

TSCO currently has a 38% payout ratio, which is healthy. The cash payout ratio is 27%.

When looking at the chart below, we see that the company is consistently growing free cash flow and EBITDA. Note that the only reason why free cash flow is not growing between 2020 and 2024E is the surge in CapEx to boost (future) business growth.

These are the 13-year (2013-2025E) compounded annual growth rates:

• Revenue: 10.5%.
• EBITDA: 11.5% (thanks to revenue growth + rising margins).
• Free cash flow: +21.6% (despite no growth between 2020 and 2024E).
• Net income: +12.4%.
• EPS: +15.0% (benefits from buybacks).

If we assume that the company can do $1.0 billion in free cash flow next year, we’re dealing with a 4% free cash flow yield, which supports the 1.6% dividend, future dividend growth, and buybacks.

This brings me to the next part of this article.

Recent Performance & Outlook

The consumer isn’t doing so well. Inflation is high, economic growth is weakening, and rates are high. However, TSCO is still doing very well.

In its fourth quarter of 2022, the company delivered 20.7% net sales growth. Comparable store sales increased by 8.6%, driven by both ticket and transaction growth.

Ticket growth was 6.3%. The transaction count increased by 2.3%. In other words, while a lot of stores mainly benefit from pricing, TSCO saw both higher pricing and more transactions. That is a very healthy sign, especially in this environment! I believe it’s clear proof that TSCO is growing and offering an experience that gives it an edge.

The company’s Neighbor Club now has more than 28 million members. These members represented 75% of 2022 sales. The Neighbor’s Club has expanded by 47% over the past two years. According to the company:

Neighbor’s Club is successfully helping us migrate customers to a higher threshold of spending with us. During the quarter, we reached a new record in the number of high-value customers. Overall, our best customers are shopping with us more frequently and spending more money per transaction.

It also launched a credit card with Visa, which helped the company to cross over $1 billion in private-label credit card sales.

TSCO also broke ground on its new (tenth) distribution center in Maumelle, Arkansas, to support higher volumes of existing stores, the expansion of new stores, and the acquisition of Orscheln. The company believes that its supply chain is a huge competitive advantage. I agree with that, as COVID proved that TSCO was able to withstand severe pressure.

It’s also a good sign that gross margins improved by 28 basis points in 4Q22, as pricing more than offset inflationary pressures like transportation costs.

In 2023, the company expects challenges to continue. After all, we all know what the economy is like. In this case, it seems that the company expects the Fed to achieve a soft landing.

As we planned for the year, we anticipate continuing to operate in an ever-challenging and changing macro environment. Our operating assumption is that the economy in the near to medium-term will remain resilient with flat to modestly positive real growth. Wages are increasing and consumers continue to tap pent-up savings to support spending.

We expect consumers will continue to be judicious in their spend, but resilient, while prioritizing needs over discretionary. We believe inflation has peaked, but will remain sticky as we move through the year. It is our view that an orderly loosening of the labor market will be a key determiner of the country’s ability to return our economy to sustainable conditions in the second half and 2024.

On a full-year basis, the company expects to grow net sales to at least $15.0 billion, which implies revenue growth of close to 7%. Comparable store sales are expected to be 3.5% to 5.5%.

Management also announced share purchases between $575 and $675 million.

We remain committed to returning cash to shareholders through the combination of a growing dividend and share repurchases. For 2023, we anticipate share purchases in a range of $575 million to $675 million, which is estimated to have a benefit of a net reduction in weighted average shares outstanding of approximately 2%.

Valuation

TSCO shares are trading at 12.4x 2024E EBITDA, which is based on its $25.0 billion market cap, $1.1 billion in 2024E net debt, and $2.1 billion in expected EBITDA. The valuation is 13.8x, using 2023E numbers.

This valuation is very fair, considering that the company is expected to grow EBITDA in the high single-digit range on a long-term basis.

I would make the case that $260 is a fair price for the stock. This makes me more bullish than the average analyst, as TSCO’s price target is currently $237.

However, I would not be a buyer at the current stock price. While the stock is trading below what I consider to be fair value, I’m still in the camp of people who do not believe that a smooth soft landing is possible. Especially in the past few weeks, credit conditions have eased. Short-term inflation expectations are on the rise again. Growth stocks are flying. That is not an environment to bet on a dovish Fed.

Hence, I think we could see a correction. If it happens, I might be a buyer.

Takeaway

“Everyone” knows Home Depot and Lowe’s. This includes non-US investors who have piled into these stocks for decades. One stock that is still flying under the radar is the Tractor Supply Company. However, I expect that to change.

Tractor Supply offers a tremendous mix consisting of a decent yield, high and sustainable dividend growth, and a competitive business model that is still far from slow-growing and mature.

While COVID was a great tailwind for the company, it has proven that it can achieve organic growth without these secular tailwinds. It has a loyal and rapidly expanding customer base, a solid supply chain, and the ability to grow even in an environment of terrible consumer sentiment.

I believe that TSCO is trading under fair value and capable to maintain significant long-term outperformance.

However, I remain cautious. I believe the market will offer us a new business opportunity, given my view on the Fed and the bigger macroeconomic picture. Even if my opinion has now become a minority opinion.

That said, I hope that this article helped you to decide whether or not TSCO is right for your portfolio.

(Dis)agree? Let me know in the comments!