The quality it is. Here to introduce Tractor Supply Company. Today we have with us Hal Lawton, President and Chief Executive Officer of Tractor Supply. Hal has served as President and CEO since January 2020. We have with us too Kurt Barton, Executive Vice President and Chief Financial Officer and Treasurer of Tractor Supply. Kurt has been in the role since February 2019, and we'll start there. Thanks for joining us.
Yeah, thanks for having us.
Thank you. I think if we can just start maybe talking about the health of the consumer, you guys see a really broad swath of the consumer, and we'd love to hear your view on what you're seeing and hearing and what you expect for the second half this year.
Yeah, from our view, the consumer's healthy and resilient, remarkably resilient. You know, you think about the challenges the consumer's been through over the last five, six years, and they've just been remarkably resilient through it. They've evolved, iterated, adjusted, you know, based on the conditions, but, you know, our GDP continues to be strong, consumer spending continues to be strong, and that's what we see in our business. You know, we saw a nice, sequential improvement through the second quarter, last quarter. Talked about how the third quarter was off to a good start. We had positive comp transactions in the first half, positive comp transactions in both quarters, strong new customer growth, total customer growth. You know, they're engaging in our queue business. We had very good big ticket purchases as well, you know, better than expected in the second quarter. The consumer remains strong and very resilient.
Great. Could you maybe differentiate a little bit in terms of the categories in which you're seeing us, right? You talked a little bit about big ticket, which has been a nice headline for you guys in the queue categories. The discretionary areas for everyone have been maybe a little bit more muted, and we wonder if you could talk through each category, how you see, again, that possibly strengthening what the consumer preference is there.
Yeah, for us, I think it's very situational based on consumer need and in the moment. For instance, if I break our bucket, our categories just generically into three buckets for the sake of this discussion, we always talk about our C.U.E. business, consumable, usable, and edible businesses. Those are things like dog food, horse feed, poultry feed, but also categories like fertilizer and grass seed, lubricants for tractors. It's really things that our consumers consume, use, or eat, right? They're needs-based, demand-driven. Those businesses continue to be very strong for us, nice, mid-single-digit comps. They're the transaction drivers in our stores. We aren't seeing trade down at all in those categories. We're seeing just normal everyday behavior in those categories, and we continue to gain share in those categories. The second I'd say is kind of the seasonally related bigger ticket businesses or just seasonally related businesses.
For us, as goes the weather many times, those businesses go. It was kind of a cooler-ish and wetter April and May. Summer came in June and July, and we saw our business pick up. It was not only did we see things like just your normal lawn and garden businesses performing well, but we also saw big ticket like riding lawnmowers performing well, and those were very strong for us. We think we gained some significant share in this space, but also our consumers had a demand and a need for that. Yards were growing fast. People were having to mow their yards a couple of times a week through the end of May, June, and July, and it was kind of an extended season, and we saw strength in big ticket there.
The third category would be just more your core discretionary, not as much seasonally related, let's say something like a gun safe or another category would be like recreational vehicles, a little seasonality. Those two categories were really big for us last year, so we are lapping on top of some growth from last year, but they were a little more muted. I think that's one of the attractive things about Trac Supply is our portfolio of categories. If you look over the last six years, with the comps that we've had, it's always been the case that our C.U.E.'s been really stable, and then we kind of have other dynamics going on in the other 40%, 50%, 60% of the portfolio, but we're able to kind of navigate it because of that.
While we're talking about the health of the consumer, I think we have to talk about tariffs and just what kind of impact that might have. On the last earnings call, you mentioned seeing tariff impacts in the second half and beyond. I think that has to do with how fast you turn and, again, the categories that you're selling. Have you taken any pricing so far in the categories, and what elasticity response have you seen?
Yeah, first I'll say on tariffs, first of all, I'd say there were some unreasonable expectations or maybe not quite grounded in kind of how balance sheets and inventory turns, and the fact there were some thoughts that tariffs might start coming through in both the cost and in pricing in the first half of last year, even the beginning of the end towards the first half. The facts are that the way that all comes through on the balance sheet, every retailer has a different way they do accounting, retail accounting, cost accounting, et cetera. We're cost accounting, but those all have different ways of things flowing in. Also, all of us obviously worked with our vendors to try to navigate different dates.
I think you're starting to see, as you head into the second half of this year, a more kind of tariff cost flowing through people's P&Ls, and you'll start to see more pricing action associated with that where appropriate. For us, we've talked about the portfolio a couple of times today already. We do take a portfolio strategy. We're committed to kind of our overall operating margin rates, but the profitability by SKU may vary depending on how the market conditions and also whatever costing is happening there and whatever retails we think are doable. We have taken a little bit of price, but very much kind of in the context of the market as well. I think you'll see a little bit more through the balance of the year.
I think if you do the math, you're talking modest percentage points or two of price increases across the market, nothing in the high to mid single digits or anything like that in the market. I think you'll see that play out into the first half of 2026 as well, as a lot of these costs are really coming through, as we said, in the second half of this year, and will continue into next year as well as the pricing associated with that. On elasticities, we haven't really seen much elasticity in the market right now. Again, we haven't had what I'd call very material price increases, maybe things somewhere on a handful of SKUs, somewhere in the 5%- 10% range, some others in the low single digit range, and we haven't seen the elasticity impact on those price moves at all really.
That kind of leads us to, just given your size and scale and just strong merchandising prowess, you know, how do you see the tariff landscape playing out competitively? Meaning, you know, are you monitoring price gaps? Are you taking a look or taking advantage maybe of any opportunity there to take market share like you mentioned before?
Yeah, I think we're running the business the way we always do, just in the context of some incremental costs coming through. We have a very sophisticated cost management system, margin management system, pricing intelligence system, and price scraping system. We also have monitoring of elasticity by SKU as well, based on pricing actions we take. Very sophisticated. I think this is, as you deal with tariffs and you have these kind of large amounts of uncertainty coming through, this is where scale will matter and sophistication will matter. Retailers who have more of that will be able to better navigate their P&L, better navigate their inventory, and also, to your point, Kate, take advantage of the market conditions where you might see some pricing opportunity to take share in the market as well.
That's certainly how we always think about it on our key categories, making sure we're the market leader on pricing and setting ourselves up to take share.
If we could maybe just switch to margins and maybe more of like a shorter term conversation, you reported your quarterly results a little bit earlier than a lot of other retail just based on your December year-end calendar. Your expectation for gross margin expansion in the second half is maybe a little bit lower than the first half. Could you maybe walk through some of those drivers and what do you think is maybe the most sustainable gross margin range for Tractor Supply l onger term?
Yeah, Kate, I'll start with a backdrop. The first half of the year, much in line with our expectations, we expanded gross margin by roughly 30 basis points. That was in a bit of a headwind, more than we expected, on strong consumable product sales as Hal mentioned. Those items tend to have a little bit more of a mixed pressure on us, but still a really strong 30 basis point improvement in gross margin expansion. We said even in the beginning when we came into this year that we expected gross margin to grow, but not at the same level in the second half of the year. It's principally three things, and those three things generally apply, much like we thought in the beginning of the year.
None of them really that significant, but we began seeing incremental supply chain benefit last year in the third quarter when we opened up a new distribution center. It's really one of the biggest unlocks when we have a new distribution center. We can get reduced miles, better rates, new lanes, et cetera. We'll lap that in Q3. We also expected to see a bit more pressure on the consumable items that we're selling because we do see that as a key driver. There's certainly the strength of the traffic of our business coming in consumables, and that puts a bit of pressure. Then recognizing as on the topic of tariffs that we expect some pressure in the back half of the year.
The combination of those three things, none of them really that meaningful in movement, puts us still at gross margin expansion in our expectation, but below the 30 basis point improvement that we saw in the first half of the year. It's likely more to be in that 5, 10, 15 basis point improvement in the back half of the year.
I think, and this is just my opinion, but you guys had a December analyst day, where you focused on new investments and longer term strategies. I don't know, I do feel like maybe the tariff discussion has become front and center now, and you're not hearing as much about the longer term strategy as maybe we would have heard back when you delivered it in December. I thought we could take this time to maybe go back and revisit it because you're doing a lot of things. The Allivet acquisition and integration, the final mile delivery, the direct sales, and the localization.
Yep.
I wondered if you could maybe just walk through each initiative for us and how you're prioritizing resource allocation for these initiatives.
Yeah, thanks for giving us an opportunity to talk about the Life Out Here strategy and our kind of second wave of it. In October of 2020, we introduced the first version of our Life Out Here strategy, and there were a number of initiatives that we launched at that time, including our Fusion Remodel Program, our garden center buildouts, our revised Neighbor's Club program, but also some other programs like our FAST team. As we are now in year five of those, each of those initiatives have a couple of years left of kind of tailwinds that they will be generating for us in the business.
As those start to subside, what we wanted to do was have a second set of initiatives, kind of the horizons for growth that would layer right on top of those and continue to drive Trac Supply 's growth out into the back half of this decade. To your point, we launched a number of new initiatives at the beginning of this year, namely, we did an acquisition of Allivet, which is a pet and animal pharmacy company, and we've integrated that into the business and connected that into our Neighbor's Club program. That's one big strategy we have. Over nearly 80% of our customers have dogs. Over 50% of our customers have more than one dog. They have a tendency to be much heavier than the average dog in the country, so it fits very well also with our 41 million Neighbor's Club members.
We've got a lot of synergy to be able to put together on that acquisition and that initiative. The other one, to your point, is direct sales. This is very much, you know, kind of a B2B play for us. If you think about hard lines retail sectors, say auto or home improvement, where there's been a kind of B2B angle they've been able to pursue, it's very similar for us. There's a number of kind of larger farms, equine facilities, kennels, dog breeders, et cetera, that have large annual purchase needs that we can have a direct sales team go out and call on and grab that share and grab that incremental business. We think both of those first two opportunities are a billion dollar in revenue opportunity for us in the future. The third thing is our final mile initiative.
That's really basically rolling out the ability to get items delivered to an end consumer's home in an owned way through Tractor Supply vehicles. We're building that in a hub-and-spoke-like way where every three or four stores, there will be a truck and a trailer that will be associated with that territory, and we'll be able to deliver not only the direct sales orders that I mentioned that will be in the range of, you know, four to, call it, $20,000- $30,000 in size, to even orders that are placed online as well as orders of big bulky things that are placed in our stores. We see that as a fundamental extension of our strategy and kind of next wave of logical customer service that we'll provide. The last one, as you mentioned, was localization. This is really the kind of wave two of our Fusion remodel program.
For the first four or five years of that program, it was really one cookie-cutter-like approach across the country. Now that we've implemented a number of systems related to planograms and store clustering, we're able to overlay that and tailor about 15% of the square footage during a Fusion remodel program to be specific to the needs of that area. If it's more outdoor recreation, we'll lean in there. If it's more equine, we'll lean more there. If it's, say, more of a hardware store, we'll lean more in there from a category and space allocation perspective. Four big strategies that we're pursuing. The first two are more expense-based, or sorry, the first, Allivet was an acquisition, but the next two are more expense-based, and obviously the last one a little more capital-based.
Big initiatives for us, again, all about layering on the initiatives that we launched in 2020 to create multiple horizons for growth for us really through the back half of the decade.
Just my follow-up question to that, obviously Allivet was an acquisition, but how do you view maybe inorganic versus organic when it comes to these four initiatives?
Yeah, I'd start by saying our, from a capital allocation perspective, our number one focus is always investing in the core business. We've had a very proven flywheel, and we want to make sure we don't underinvest in that flywheel as we move forward. After investing in the business, we're very much committed to a dividend for our shareholders at about a 40% payout. After that, we have share buybacks. We typically buy somewhere in the 1%- 2% of shares outstanding a year. From an acquisition perspective, those are typically more opportunistic for us.
We've done a couple of acquisitions since I've been in the role over the last five and a half, six years, and we've had kind of about the same, like once every three or four years, you might see us dip our toe into the water on acquisitions for a modest type acquisition to the extent it's aligned with our strategy. Another example of that was Orscheln Farm & Home, of course, when we acquired them a few years ago.
Maybe that's a good transition to your real estate strategy, because you do plan to open 100 new stores. I think also you acquired some of the Big Lots locations, which I'm not quite sure we've seen you do before. Maybe again, you can compartmentalize just the organic growth versus real estate acquisition, between Orscheln and then maybe the Big Lots stores too.
Yeah, I'll start by saying, a hallmark of Tractor Supply is comp sales growth plus new store growth. That's been a hallmark of us for 30+ years. This is a company that's had one year of negative comps in the last 30 + years. That was in 2009, and it was a -1% comp. This is a company that successfully built between 70- 100 new stores a year for really the last 20, 30 years as well. It's a hallmark for us. On the new storefront, we are very sophisticated in how we approach new stores, both in terms of the real estate location, the financial modeling that goes around it, what we actually build in that location, and then ramping our new stores up to their full maturity curve.
Our new stores in the last year, as an example, as we're ramping up to 100 new stores, back from about 70 or 80 during the COVID years, our new stores are performing incredibly well right now, exceeding our forecast, new store maturity curve getting off to an excellent start, ROICs and paybacks all working out very well. That's what gives us the confidence to build the 90+ stores this year and 100 stores next year. To your point, we did also acquire 18 Big Lots locations. Those locations, we think of them really no differently than we would a retrofit. About half of the stores that we open a year are new, built to suit from scratch.
The other half are retrofit, where we'll go in and take a piece of real estate that's already been developed and retrofit it and make it fit to a Tractor Supply model. The Big Lots stores, that's how we think about them, is really a retrofit. We did the math on, would we be better buying this lease out in the open market after they've gone through the bankruptcy process, or would we be better off taking them through the bankruptcy process? We went through both of those views. Obviously, each situation was a little bit independent, but we ended up settling on 18 of them that we thought made financial sense. They're very easy boxes for us to retrofit. The way they're built in terms of basically a squarish rectangle, we can set them up just, just score excellent.
They work really well for a retrofit for a Tractor Supply .
Most of those stores will be converted and opened to Tractor Supply stores before the end of this year. There may be some that flow into 2026, but to Hal's point, it's easy. It's retrofit stores at the right locations when they're in those markets that we've already identified as part of our targeted 3,200. We love to look at those second use locations and, again, part of our portfolio of driving low cost, efficient, profitable new stores.
How do you think about cannibalization for these stores? You've been very successful and consistent at growing a good number of doors every year. 3,200 is the goal. I would imagine just as things get a little bit more dense, there might be more propensity for cannibalization. How do you manage that?
There's always, you know, some level of cannibalization in our business. When we look at evaluating a new store, when we evaluate the potential to that store, we hold that store's IRR accountable for any level of cannibalization on existing stores. We're still at the spot where there is what we call in most of these locations healthy cannibalization. Stores that started out at $6 million or $7 million, they become $8 million, $9 million, or $10 million stores, and that box becomes tight. We look at that as well as the opportunity to just grow in an overall market. When we look at cannibalization and new store maturation and the level of contribution it gives to our comp sales, the number one metric we look at is how much pressure on comp sales is cannibalization giving, how much benefit are we getting from our new store growth, et cetera.
Net of those, we're still getting good solid contribution to our comp sales. If it gets to the point where you start to get near that, I think in retail, you start questioning, you know, are you getting a little tight on the number of new stores if the cannibalization is outsizing the new store benefit to comp sales? We are not in that position. We continue to have a really good healthy contribution in our comp sales. It's not only part of our top line sales growth, but it'll continue to be one of the many drivers of our comp sales growth.
If we could just ask a question around going back to the December analyst day, you introduced a long-term algorithm, which updated your long-term comp target of 3%- 5%, your sales growth at 6%- 8%, and operating margins of 10%- 10.5%. Given the more volatile environment that we've been in since those targets were put out, how do you think about achieving those targets, and how do you manage through it?
In December, we introduced that next five-year long-term algorithm. We felt then and feel today very confident about our team's ability to hit the long-term algorithm. As a backdrop, we said, to your point, the 3%- 5% comp, the op margin at 10%- 10.5%, and we said 2025 is more of a transition year. We said with a number of the macro pressures, we could see 2025, along with the ramping up of our strategic initiatives, being that transition year. It's very much playing out like that as a transition year. You look at the results coming out of Q2, our expectations for the back half of the year, and on the top line, all trend indications are very much in line with what we said and expected.
We are entering into, and a lot of the reason to believe we are at and achieving the long-term algorithm on the top line of that high low or mid single digit comp sales. Very much hitting our expectations on that. We also said on the operating margin that with our long-term goal of 10%- 10.5%, that at a lower mid single digit comp sales, as we've gone past the peak investment cycle at this point, and even Hal mentioned some of the newer initiatives that are more asset light, we see in a low and mid single digit comp sales that we can grow our operating margin 5 basis points- 15 basis points annually. We're seeing strong growth in our gross margin expansion.
We said this year, as part of our operating margin, we were going to invest 15 basis points or 20 basis points of operating margin to launch these new strategic initiatives. Outside of 2025, with the trend that we're seeing in the business, we believe that we can hit the long-term algorithm and start to also see operating margin expansion with that.
Great, thank you. We are asking every company that sits with us on stage, Hal, you know, we've done this enough times, five questions, and everybody gets the same questions. We've already touched a bit on this in the first question, but health of the consumer, you know, what are your expectations for the environment? A little bit less about your business, more about the environment in the second half of 2025, relative to the first half. Do you expect things to be the same, better, or worse?
the same.
I know you didn't give guidance for 2026, but do you have a view on the health of the consumer for 2026, same, better, or worse?
The same.
Okay. We talked a little bit about pricing with regards to tariffs. We talked a little bit about elasticity. Could you maybe talk about what your plans for pricing is for the remainder of this year and into 2026? As an aside, because I didn't ask this before, should we expect to see much in terms of assortment changes in the back half, given, again, what the supply chain has looked like the last few months?
Yeah, on pricing, I think we continue. I think our merchants and the team now have kind of absorbed tariffs. Still a lot of work, and more dynamic than we probably expected going into the year. I think our team's kind of navigating that now. We've got all the tools set up. We know exactly how that's coming through, moving average costs. We've got kind of the lay of the land with our import providers, with our domestic vendors, and we're kind of navigating that well, monitoring the market, the competitive behavior, and adjusting accordingly. I think we've given our guidance. Kurt just talked about gross margin rate, and very comfortable that we can navigate in that construct. As we move into 2026, I think the first half is going to be much of the same.
The tariffs really for the most part didn't start going through at least our P&L, given our December end, until really the end of the first half. We're going to be cycling that all the second half. I think you'll have a similar set of competitive dynamics occurring then as well. We expect the consumer to be solid through that. I think 2026 is setting up to be a solid year for the country and the economy and for Tractor , particularly if we're going into a little bit of a rate down cycle.
Our third question is around inventory. Can you talk about your expectations for inventory growth in the second half? Do you see or have you seen any disruption in shipments due to the global supply chain?
Yeah, inventory, first off, I'd say it's been a hallmark of success for Tractor Supply . I think, you know, we're one of the maybe only retailers that had not had an inventory situation at some point over the last five or six years. You know, it's pretty much been within [1% or 2%] of comp sales growth each quarter. Our inventory growth, and we'd expect that to continue to be the case. We've also been very fortunate that even in the context of tariffs and some of the supply chain disruptions to have not had issues in our stores in terms of out of stocks. Teams navigated and managed those very well, found alternative vendors where there was necessary, or worked with our existing domestic vendors to adjust accordingly. I don't think you'll see much of that going into the back half of this year.
You know, maybe a few of the seasonal programs, you might see a little lighter bias and some slightly higher inventories because those came out of countries that have higher tariffs. Everybody's kind of trying to figure out those elasticities. Otherwise, I think you're going to, you know, for the vast majority of our business, it's steady as she goes and very straightforward. I think that's how it'll play out for next year as well.
Okay. Our next question is on margins. What is your expectation for non-tariff margin drivers? This is into 2026 again. Freight, wages, materials, do you expect it to be better, same, or worse?
Starting with freight, I think the backdrop is generally freight, both domestic and import, are at or near pre-pandemic levels today. The backdrop puts us in a position with pretty much same, maybe a slight or modest rate increases how I'd expect for 2026. Wages, same. On materials, for us, commodity pricing is probably the biggest material type input cost. Commodity pricing is also at more historic lows at this point. It's hard to predict what commodity pricing is going to be like in 2026, but our expectation would be same to modestly up in 2026 based on the position where it's at today.
Great. Our last question is about the competitive landscape and consolidation. I do think we've seen more bankruptcies and more door closures this year than we've seen in quite some time. Do you think market share consolidation will speed up, slow down, or be about the same in 2026?
I think it'll be about the same. To your point on retail, 2020, 2021, and 2022, I think as the industry went through those dynamics, it delayed some of the inevitable, right? If you go back and you read about retail in 2017, 2018, 2019, there was a lot of store closings occurring and a lot of commentary about future store closings occurring. I think 2021, 2022, delayed that, and you're starting to see that pick up in 2023 and in 2024 and into 2025. I think that will continue as we look forward. The good news for Tractor Supply is we haven't shut a store down in 10 years, over 10 years. All of our stores are incredibly cashflow positive, profitable, doing very well.
We've got significant scale in our industry, and a number of other distinct advantages we've talked about, whether it's our digital assets, our supply chain, our Neighbor's Club program. We take all those competitive advantages, and I think it allows us to continue to gain share. We've been a beneficiary of share for multiple decades now in the industry, and certainly the fragmentation is still out there. I think small businesses struggle in these sorts of dynamic environments, particularly the ones that we compete with, which are mostly kind of operating on a cashflow basis. That all sets us up for some nice dynamics to continue to take share.
Okay, with that, we'll conclude our chat. Thank you.
Great, thank you for joining us today.