I'm Peter Benedict, Senior Retail, Consumer Products and Services Analyst at Baird. Welcome to the 2024 Baird Consumer Technology and Services Conference. Really thrilled that everyone took the time out to come today. Pleased to kick off at least our conference with the guys from Tractor Supply. Tractor Supply is the leading rural lifestyle retailer in the U.S. They have more than 2,250 stores, plus another 200 or so Petsense locations. Sales are expected to approach $15 billion this year, and the stock carries a market cap of around $30 billion. To my right is CEO Hal Lawton. Directly next to me is Kurt Barton, CFO.
Mary Winn Pilkington, who's their SVP of Investor Relations and Public Relations, is, yeah, here in the audience somewhere, along with Joseph Underwood and Tricia Whittemore, who are part of her team. So, no opening remarks here. We're just gonna kick in. Good morning, guys. Thanks for-
Good morning!
Morning.
Thanks for spending time with us. So Hal, let's kick it off. Let's talk a little bit about consumer behavior. I mean, you guys are an interesting business. You sell a lot of needs-based product, but you also have some discretionary stuff. So maybe give us a sense from your seat how's the consumer doing?
Yeah. You know, I think at the highest level, on the macro side, our view is that the consumer is still reasonably strong. You know, you're gonna have low single-digit GDP, still led by consumer spending. Kind of first complication, though, is where they're spending those dollars. You know, for the last 12, 18 months now, it's been over-indexing on services. Year to date, I think services spend as a portion of PCE have been running, like, 6%-7% up year-over-year. We're back to 67.6% of total PCE spend on services. Goods, by contrast, have only been growing 1%-2% for the first 4 months of the year.
PCE data just came out last Friday, so you see this shift out, you know, still from goods to services, still a bit of a recoil from the COVID years of 2020 and 2021. And then the second thing I'd say is, you are starting to see some delineation, at least in our business, on higher income versus lower income, and they got some well documented across retail the last couple earning cycles, if not prior to that. Where you're seeing those who feel like, whether it's stock market, just net wealth in general, feeling the ability to still spend, spend on discretionary, but those in the lower income feeling the impacts of inflation.
To your point, though, Peter, on our business, we're a demand-driven business, so, you know, a little over 20% of our business is animal feed and agriculture. Another 20% is companion animal, dog food, cat food, those sorts of things. And so our customers are shopping us every single day, and they're shopping us for a lifestyle. And, so our customer has continued to be very healthy, very engaged. Net customer counts are up year-over-year, continue to be engagement strong, customer satisfaction strong. Our business has a tendency to be one of the more resilient goods, if you will, oriented retailers. But net-net, I think the, you know, consumer strong, just continuing to be discerning.
So in the last quarter, I think you guys have a big category called CUE.
Yeah
Consumable, Usable, Edible. I don't know whether that's half the business or something. It's a, it's a large percentage. It was kind of the first time in several quarters that it actually grew slower than the overall business. So I don't know, Kurt, maybe talk about that category, what you're seeing in terms of engagement there.
Yeah, Peter, you framed it up well. So, for those that don't know the product assortment really well, we do break up our business in categories, but across all of our categories, as Hal mentioned, a very needs-based, demand-driven business. We have roughly, in between various quarters, 40%-45% of our revenue is in what we call consumable, usable, or edible products. And that's feed, food, it could be lubricants, it could be pesticides, but really, across most categories, there's some form of a consumable. And to your point, in Q1, it lagged the chain average, and it's really been a key part of our growth of our business. It's outpaced, from a unit standpoint, throughout the last 3-4 years, about any other category as you look at our business.
But we went into the year expecting that the consumables would have some level of AUR pressure. We've seen inflation over the last few years in the feed, the food, you know, not too much different than you've seen in grocery, right? And so we expected to see, as we saw, some of the grain prices decline. So AUR pressure is on the feed. And in the pet side of the business, I mean, the pricing is stable, but, you know, the industry itself is rather, you know, stable versus both inflation and growth in the last few years. And so our focus and our expectation for this year is some pressure on AUR, but growth in the units. And that's really the key thing for us, and it's exactly what we saw in Q1.
The primary reason for Q1 and for what we expect for this year to have CUE potentially below chain average is that this year, we'll cycle and still see some disinflationary environment in the consumable side of the business. And we're cycling, you know, some of the largest growth that we've had. And so for us, it's very manageable. It's an ebbs and flow that you can have in an area that can have inflation or disinflation. But the key for us is its traffic driver, and what we really gauge is units or pounds because that's what drives footsteps, and we continue to see growth in that area in almost every category of CUE.
And, that's what gives us confidence in our ability, and that we're gaining market share, and the ability to be able to hold the customer.
So it doesn't sound like anything concerning on a unit standpoint. Let's go to the big ticket stuff, which you guys define as anything, items over $350. That's where units have not been very good.
Mm.
In the first quarter, I think for the first time in maybe two years, that ticked positive. Maybe expand on that, what you're seeing there. Is this the start of something, or you think it was more episodic?
Yeah, we see it more of a sustained resurgence of big ticket. And the way we look at that, and the reason why, is we've had six quarters before 2024 of consistent declines in big ticket products. And really, the two drivers of that, as we saw it, was there were certainly a significant increase during the peak of COVID stimulus in big ticket, in our business and across most of retail. You know, and so we were cycling some of that throughout late 2022 and all of 2023. Also, those two years did not really have ideal weather conditions for our big ticket items.
Right.
So with severe heat, drought, a lot of the items we sell, riding lawn mowers, other products that we sell to help grow and cut, you know, what does grow, really didn't have as much demand. And so we saw it for 2024, and we're seeing it, as we expected is, you're cycling some of the lows. We really expected 2023, it looks like it was the trough on that. With more normalized weather, and new products innovation in areas like riding lawnmower, zero-turns, recreational vehicles, having new product innovation, as well as normalized weather, is really bringing back big ticket. And so we saw a nice growth in Q1, and we expect big ticket to outpace chain average in 2024.
Got it. Great. Hal, maybe back to you. On the first quarter call, you referenced outsized population growth in rural areas. And we've gotten this question over the last 10 or 15 years around, you know, people are trying to figure out, you know, why is Tractor Supply successful? It's like, "Oh, people are moving to rural." Like, of course, there's so much of what you guys are doing, but this has now come back into the focus. We get people asking about rural migration trends, and did they surge during COVID, and now they're gonna go the other way, everyone's gonna go back to the city and go back to office. Maybe talk about what you're seeing there and, and what kind of, what made you make that comment?
Yeah. So rural America, if you step back, if you look at our store base, so 2,250 stores, roughly 90% of our stores are in, a U.S. definition, either ex-urban or rural America, about 10% in suburbia, 0% in urban America. And so to Peter's point, where people live and where people are moving really matter to us, 'cause we have a pretty big skew as it relates to locations of our stores. And what we saw in 2020 and 2021, well documented, you saw kind of an exodus, a significant exodus out of urban and into really ex-urban and suburban and rural.
And while the absolute number of migrations hasn't continued in 2023 and 2024, the net number is still it still shifts significantly to rural America. And both in 2021 and 2022 and 2023, and now even into 2024, that kind of movement, that mobility is really being led by the millennial generation. And, you know, our point of view is that this really wasn't as much a COVID thing as it is just a typical generational norm. The average millennial is now, you know, 31, 32, 33 years old. COVID helped stimulate that generation into the next phase of stereotypical generational norms. But they're doing everything you used to do, maybe used to.
The previous generation might have done it at 25, 27, 28. Now they're doing it at 31, 32. But household formation, getting a pet, buying a house, and as they think about where they're gonna live and buy a house, really affordability becomes a major consideration, really, where the millennial generation are gonna form a home is in Rural America or Ex-urban America. And then secondly, they wanna live a lifestyle that's sustainable, that's environmentally friendly, you know, organic type products and those sorts of things. And that's what Tractor Supply caters to very well with the out here lifestyle that we cater to.
This migration pattern, which started with robustness in 2020 and 2021, but it's continued into this year in the first few months, you know, really has played to our benefit, both from a just-a-numbers perspective, but also the lifestyle that we market to.
Got it. So, a lot of times in retail, there are specific verticals. Like it's easy to understand, you know, what's the consumer electronics opportunity? What's the home improvement opportunity? You guys are different, kind of a rural lifestyle retailer. So that gets down to the TAM, and I think Mary Winn deserves credit for digging into that, a few years ago. Talk about the TAM. I think you guys have about an 8% market share right now. Where do you see the most opportunity? First of all, how did you come up with the TAM, and then where do you see the most opportunity going forward for sure things?
Yeah. So as you said, Peter, a $180 billion TAM, really cut that two ways. The first is by the categories that we sell, so pretty normal kind of bottoms-up build. But then we also narrow it to just the markets that we're in, so it doesn't include, say, demand for dog food in urban America, 'cause we don't sell into that segment. On our customer base and how it kind of makes up that $180 billion TAM, where do we see the opportunities? There's kind of two entry-level customer segments that shop us: one that pursues this kind of country lifestyle living and one that's a pet enthusiast.
So they come in, and they'll either buy garden products, or they'll buy maybe some Carhartt, Carhartt hoodie, or they'll start doing raised bed gardening, or they buy dog food. But then where we really start to win major market share, footsteps, and get big share of wallet is when they become kind of this big backyard enthusiast. Whether it's a one-acre plot of land or whether it's a five-acre plot of land when they start to engage with multi-species, so chickens, goats, rabbits, those sorts of things, that's when they really start to jump into the Tractor Supply lifestyle. As an example, one in five of our customers, actually we had over 30, around 35 million customers shop us, one in five of our customers raises chickens, as an example.
And so when they start to shop multi-category, multi-species with us, that's really when we lock them in and start to get substantial share of wallet. And then, of course, our core farm and ranch customer is where we have substantial share, probably 20%-25% of that market share. But this new backyard enthusiast is over indexed as millennial, over indexed as female. It's where our highest growth rates are, and it's a very exciting segment of our customer base that's you know growing rapidly, and a huge opportunity for us as we look out.
Kurt, maybe pivot over to you here. So a little over 2,200 stores. Last year, you guys took the store target to 3,000.
Mm-hmm.
Domestically. I remember back when you guys took that to 1,800-
Yeah
... everyone was like, "You're crazy." Talk about the next 800. Where they reside, is it new markets, is it existing markets? And then maybe talk about your approach to development, 'cause like last year, you pivoted a little bit to do some more sale-leasebacks.
Mm-hmm.
You started to use your balance sheet a little bit, so talk about that.
Sure. I think a key on our journey of our real estate and our opportunity for markets has always been about two things, principally around the customer, though. The more we've known and learned about the customer that lives this lifestyle, and the more that we're able to gather the level of data and refine that, has always been the points where we've seen that we've accelerated, increased the target. And now that we have 34 million Neighbor's Club members, and the data we have on them. As a comparison, roughly 14 million in 2019.
So the amount of data we have today on our customer is so much greater, and the level of systems and capabilities we have at the square mile level on customer cohort is really driving a lot of what we know and believe we can do for new stores for Tractor Supply. So it's the culmination of all of those that tell, you know, continue to tell us we can do more, we can get to 3,000 specific locations in the United States. In regards to the locations and where, it's still pretty diverse. We've got markets that we now know that we can add a second Tractor Supply store or even a third Tractor Supply store in a town or a market.
But then there's white space, where we don't have a Tractor Supply today, that we're still growing some of those more out West, where we're growing our stores with our distribution network. So we look at it as new stores in white space, adding stores that are drop-in, all very just, you know, just similar in regards to its level of return or productivity. We still got the roughly 800, you know, stores that'll run very similar in regards to its performance. And then, in regards to the sale-leaseback that we announced last year, the real benefit to the new stores is that we're doing sale-leaseback of new stores because we are now switching to nearly 50% of our stores being owned or fixed fee developed. And that gives us more control.
We're able to drive down occupancy cost and really take out some of that risk and cost of a developer that was, you know, part of 100% of our new store model. And so that's giving us a better return, but also, in some cases, it allows us to get into a market that may not have penciled. Because we really are able to drive down the cost of construction, the cost as you flip that into a sale-leaseback. And so it's all been part of a better performance and return on new stores, as well as the ability to get to 3,000 stores. And, in the long term, it will be part of, and it is part of our target to grow our operating margins.
Yeah. So most companies in your position, being the, you know, a big, dominant player kind of in a space, always has a number two or number three that they're going against. I mean, yeah, there's Costco, there's also Sam's Club.
Mm.
There's, you know, Walmart, there's Target, there's... You can go through the list. One of the unique things about your business is there really isn't a number two, with any real scale. And, now that the Orscheln transaction is over, we can talk about it, and the FTC can't say anything. I mean, like, at the end of the day, that was 100-some-odd stores, but that was your largest next competitor. I mean, just talk maybe briefly about the competitive set, who you go against, and then with this Orscheln acquisition, are there others out there that you think, other chains that you think would make some sense to, to kind of find, you know, different places you can go?
Yeah. So, as we mentioned earlier, $180 billion TAM. There's tens of thousands of retail locations in the context of that TAM that we think about it in two buckets: about a third of that TAM, call it $60-ish billion outside of our revenues, is in the what we would call the core farm and ranch channel, the kind of legacy farm and ranch channel. That's dominated really by two sets of competitors, about 8,000 of these co-ops and mom-and-pops that are across the country, and then another 1,000 or 2,000 that are regional chains, chains like Atwoods and Murdoch's, Rural King, Family Farm and Home. They're typically between 50 and 100 stores or 30-100 stores, and they're regional in nature, and that's about a third of our market.
So very fragmented, no one at the same scale that we have. Again, as we have 2,250 stores. Our online revenues are larger than any of our direct head-to-head competition's total revenues, with the exception of one competitor. And then the other, call it, you know, $105 billion of our market is really just a fragmented list of category-specific competitors. So, you know, on the pet side, we'd compete against grocery, we'd compete against mass, we'd compete against pet specialty. You know, on tools and hardware and outdoor trailers and those sorts of things, we'd compete against home improvement and some of the other more hard-line players. Against garden, again, home improvement and mass.
So kind of as you go around our store, we're going to compete against a variety of different competitors. But in total, it's two main segments of competitors, but very fragmented in the context of that, and tens of thousands of locations. And to your point, not really a head-to-head competitor at a national level, which I think, you know, gives us a lot of advantages from a you know, competitive and a defensibility perspective.
Yeah. Kurt had mentioned data earlier, how much more you have in terms of understanding where to put your stores and your customer. Loyalty has been a big story at Tractor over the last several years. I think your Neighbor's Club membership is north of 34 million at this point-
Yeah
W hich is a crazy number. Up 14% year-over-year, I think it's doubled since the beginning of the pandemic. Talk about the kind of success you've had with loyalty, but also kind of what lies ahead, because these loyalty programs kind of have a life of their own, and, and just let us- help us understand the opportunity there.
Yeah, the Neighbor's Club program is a key foundational component of our business model. As Peter said, 34 million members, a very active group, nearly 80% active on an annual basis. So very engaged, healthy customer file. They represent close to 78% of our total sales on a quarter-to-quarter basis. So active, large, robust, and the majority of our sales. We shifted to a tier-based reward system in the spring of 2021. That was coming on the heels of nearly 20 million new customers on a 12-month basis. And so we really used the Neighbor's Club program to lock that customer base in and drive engagement and drive loyalty.
This year, kind of three years on the anniversary, almost, of updating it to a tier-based point system, we changed some of the tiers, changed some of the rewards. We had great success with our top-end customer base. Almost virtually never attrit that customer base, our top end, on an annual basis. The middle bucket is very, very strong. Active, continues to grow in frequency, number, and also in spend per transaction. It's like most loyalty programs, that entry level that you really want to try to stimulate, it's where the largest number is, but less engaged, and we made some adjustments this year for that. We've got a Hometown Heroes program we're launching this summer that acknowledges our military and first responders, fire, police, and EMS.
While rural America is 20% of the U.S. population, it's 50% of our military force. So a big opportunity for us to be able to engage that group. We're excited about that. It'll be launched a couple of weeks prior to July fourth. So there's a lot of customer-facing benefits and engagement in tiers, but on the back end, it's almost as equally as important for us because all this data is up in the Azure cloud. We've got all the various sophisticated software applications on top of it. These applications allow for deep data mining, but also applications that allow for deep personalization. We can do that digitally and digital ad banner ads and, you know, social ads, or we can do it via email or on our website or in the consumer mobile app.
So a high degree of personalization. As an example, 10% of our customers own horses. We know exactly who that customer base is, and we can go spend real time with that customer base. And the other 90% that don't own horses, we don't need to be spending time talking about horses. Another is like 75% of our customers own dogs, so let's talk to that 75% that own dogs, but the other 25%, let's find other ways to market to them. And those are just very modest, very straightforward examples, but, you know, we break our business on a weekly basis into marketing segments of over 50 different customer types to be able to get that tailored versioning.
Got it. Kurt, let's do some financials quickly. So the long-term algo, 6%-7% revenue growth, EBIT margins 10.1%-10.6%, 8%-11% EPS growth. We're not there yet, but maybe talk about some of the structural changes in gross margin that have occurred. Is there anything on the tariff front that we need to be aware of? Because let's assume that comes into the conversation here over the next several months. And then, what are the conditions do you think are required to kind of get you to the high end of that, of that margin range?
Sure.
-over time?
Yeah, I'll start with the, you know, the structural piece of gross margin, and it's been a—it's a great story over the last four years. I'll continue to reference, you know, 2019 as a great, you know, point of view of the recent growth that Tractor Supply has seen. But we've seen 150 basis points growth in our gross margin, and that pretty much makes up, you know, all over most of our operating margin improvement. It's been very strategic and very purposeful, and it demonstrates the, the structural nature of it, that in the gross margin, roughly two-thirds or a little bit over two-thirds of that is from investments we've made in SG&A.
So if all or most of the operating margin came from gross margin, SG&A is not growing, but we've grown the company significantly during that time. We've reinvested in areas like introduction of our field activity support team and our distribution network, which we had to grow. So the investment and pressure on SG&A for those resources have benefited gross margin. So over 100 basis points has come from the benefit out of our field activity support team, which is funded by our vendors. Over 50 basis points is coming from just efficiency and reduced miles in our distribution network. We've literally cut out over 20% of the average miles since 2019 by having new distribution centers in our network, which we needed to grow...
because the total revenue's grown roughly 80% since 2019, and so there's the structural nature of it. The remaining piece of gross margin has been the leveraging of our scale and negotiating great pricing from having great distribution center points, but a larger power of our buying. And what we're seeing now is the additional aspects of gross margin that we're able to have other efficiencies. All of that on the gross margin side has been in the headwinds of a pressure from mix, as I mentioned earlier, Q has grown over the last four years significantly, as well as inflation over the few years. We're still at, you know, higher levels, and inflation by nature has put pressure on gross margin.
So, we've made purposeful investments in SG&A to continue to fuel and fund the business and gain market share. And so it's been very strategic that our growth and gross margin is what's really driving it, but it's all very structural as well. And then in regards to some of the other parts of the question, what really gets us to the high end of our operating margin range? We believe what we've done in the last three years, four years to invest in the business continues to put as we've seen the peak of investments in SG&A. So we see right now we're really positioned well to be able to leverage the fixed costs, leverage what we put into the business, and have less pressure on SG&A.
So we expect we can grow gross margin continually, but less pressure on SG&A. Basically, if we, if we hit our expectation targets on for the long term in regards to our comp sales, and we just need, normal conditions, you know, for our, our comp sales. In this year, we're seeing disinflation and deflation. You're seeing shift from, you know, goods to services. Those pressures are existent this year, and that's why we've, we've set the targets that we've had for this year, knowing that there's some transitory pressure on the business. But for the long term, if we hit our, our long-term targets of 4-5 comp sales, we're able to really leverage the SG&A, and that's what puts us at the, the, the high end of our target range.
Yeah, I think, I think, Peter, that hit all or most of your questions, unless I missed one of those.
Yeah, I mean, the tariffs is you really have that real quick.
Yeah, thank you. Tariffs on that, we've seen the tariffs before, and we've managed it well. To some extent, we're a bit less vulnerable to that, with only about 12% of our products being direct import. You know, some product is also, you know, sold to us domestically, but Tractor Supply is a bit less, you know, vulnerable than, I'd say, most of retail on that. It's you handle it fairly well. You handle it, as you do on another level of inflation, and if we have that situation, it's gonna apply to all of retail, and I think we can manage that, as well as we did in the past.
Yeah. Now, final two minutes. You said 2024 is the year of the garden center. I mean, the side lot transformation, I think, is one of the great remodel programs in retail today. You have now almost less than two minutes. Quick update on what you see from the garden centers, what you see is the opportunity, given your background with that category.
Yeah, one of our very exciting strategic initiatives we have is an ongoing store remodel program. With 2,250 stores, I think, you know, you've got to have a remodel program, once you've reached scale and in retail. One of our inside the store remodel program is called Fusion. We have, at the end of this year, we'll have nearly 50% of our stores in the Fusion prototype. Secondarily, we're also building garden centers where we have the space and the financial model makes sense. And this year, as Peter said, we've kind of coined it as the year of the garden center. We just opened our 500th garden center this past Saturday.
This used to be a kind of open Side Lot space, as Peter was saying. Think about this as a concrete pad, 12-15,000 sq ft. We'd have our agriculture product out there, stock tanks, fencing, those sorts of things, three-point equipment, all just kind of laying on pallets out in the, on the, this concrete slab. We went out, used that space differently, merchandised that equipment, that product a little differently, got it up on racking, got it organized better, and that freed up 5,000 sq ft. That's just kind of found space for us to go build garden centers. Our customers told us in 2019, we were doing research, that the number one category they participate in, that we least address, was live goods, particularly fruits and vegetables, trees and shrubs, things you need for Rural America.
So we went out and built a solution for that. We've been very pleased with the results. When we do both Fusion and garden center, we get high single-digit comp lift on a 12-month basis in our stores. And we've got, you know, the rest, the other half of the chain to go remodel, and, you know, well over another 500 garden centers to go build in the future.
Awesome. Great! Well, listen, that's all the time we have, but they will be available for a breakout in Aster Room A, so please join us for that. But join me in thanking Hal and Kurt.
Thanks, Peter. Appreciate it.