Well, good morning, everybody. Thank you for joining us here at the 44th Annual Raymond James Investor Conference. I'm Bobby Griffin, the Lead Hard Line Analyst here at Raymond James. This morning, we're pleased to host a fireside chat with Tractor Supply. With us from the company are CEO, Hal Lawton; CFO, Kurt Barton; and Senior VP of Investor Relations and Public Relations, Mary Winn Pilkington. First, Hal, Kurt, and Mary Winn, thank you for the support. You guys have been long supporters of this conference. We really appreciate having you here. I guess to get us started, clearly, there are a lot of crosscurrents today in the economic environment, but Tractor seems to be navigating those extremely well, capping off a really good 2022 on top of what I would say were two very tough prior year comparisons.
Maybe to kick things off, can we talk about what you're seeing from your core customer and really what do you think is driving the strong performance?
Good morning, everybody, thanks for joining us today. It's great to have a chance to say hello. To Bobby's point, the way to think about our business is a very stable, consistent business. It has its demand driven, needs-based. You know, we feel like, you know, we've got a bright outlook for 2023. We've guided comps for the year between 3.5% and 5.5%, with two to three points of incremental revenue growth due to new store builds and also our acquisition of Orscheln Farm and Home. Nice mid to high single-digit growth rate again for us this year.
If you look back over the company's history, that growth that we're talking about is very representative of what we've had historically. This is a business that's grown consecutively for 31 years. We've had positive revenue growth through the 2000 downturn, the 2008 Great Recession, and certainly through COVID. This is a business that just has a track record of consistency, stability, resiliency, and that's because the underlying financials are demand-driven and needs-based. You know, we're the largest seller of bagged animal feed in the United States, approximately a 25% market share. We're a top five player in pet food. You know, those are demand-driven grocery store-like, their activity drives footsteps in every single day.
In addition to that, all the other categories that we sell as a lifestyle retailer, whether it's apparel, truck kind of type stuff, power tools, agriculture equipment, gardening, all those are things our customers need on a daily basis. Over the pandemic, our revenue growth is grew 70% over the last three years, with the bulk of that growth in 2020 and 2021. Last year, our year revenue growth was 11-ish%. We grew right on top of two years of close to 30% growth for an absolute growth of around 70% over the last three years.
As we look ahead to this year and beyond, you know, our long-term guidance is again through kind of this mid-single digit comps and our consumer remains resilient, our consumer remains strong. We've not seen any, you know, elasticity to pricing, any trade down. We've noted some modest pullback in some discretionary bigger ticket categories. Those are less than 15% of our business. Kind of the other 85% of our business, which is very demand-driven, need-based, things our customers have to have on a daily, weekly basis to run their lives, that business continues to be very strong and solid. We did see substantial inflation last year. I'd also point to our business remains resilient.
Last year, our comp transactions were a minus 0.6%, so basically flat for the year, which, you know, in retail, I think is a standout relative to the rest of the market. Strong underlying customer fundamentals and, you know, we're very positive on 2023.
Thank you. One of the other interesting things that's developed has kind of been over the last couple of years, Tractor's growth with the younger millennial customer. Can you talk about what you're seeing from this customer and really what the maturity curve is like in their spending patterns?
Yeah. One of the big underlying drivers of our business over the last three years has been kind of the embracement of what we call Life Out Here with the millennial generation. To anchor that growth, 70% revenue growth, about half of that, call it 35%, was market growth. The other half of that was market share gain. On the half that was market growth, about half of that, so call it, you know, 15% to 20%, was driven by this millennial cohort that has embraced Life Out Here. To kind of put that in a, you know, kind of bring that in a generalization to life, you know, the average millennial now is 32, 33 years old.
For the last, you know, kind of 8 to 10 years after college, they moved to the cities. Historically, a generation, say a Gen X or a baby boomer, would have done that for five or seven years and then moved out to suburbia as and began their lives in a more stereotypical way. You know, the millennials kind of put off those generational norms for an extra three, four, five years. COVID hits. You know, that generation then began to kind of make up time and, you know, move, say 30, 45 minutes further outside of the city or perhaps to a whole another state, you know, kind of the Sun Belt migration's been much written about. That millennial generation has really embraced what we call Life Out Here.
Life Out Here could be for them just getting a Carhartt hoodie, which we're the largest retailer of that brand in the United States, and maybe they've adopted a pet. Or it could be that they are, you know, embrace gardening and living that sustainable lifestyle they lived as a millennial in the city, just bringing that out to kind of a country suburban lifestyle. Or it could be that they're raising chickens. One in four of our customers raise chickens. We are one of the only retailers that sell live birds annually. Right now is Chick Days at Tractor Supply, and we'll sell 11 million live birds this year. It's a big business for us with all the feed and the hard lines that come along with it.
The Millennial generation has really embraced all those sorts of hobbies and passions and we see that as a very structural element of and driver of our growth.
Then, you know, coming up against the very strong performance the last couple of years, what's a couple of the key initiatives within the store or outside the store that you're excited about and the kind of teams working on? What do you think those long-term potentials are?
Yeah. If you haven't caught on kind of, you know, the word for Tractor Supply. It's our mission. It's the types of customers that we serve, it's also the name of our strategy. We call it our Life Out Here strategy. There's a number of initiatives underpinning that strategy. A couple that I'll call out that are big areas of investment for us. One is our Fusion remodel program, the second is our Side Lot initiative. The Fusion remodel program is a complete remodel of the inside of our stores. It takes about three to four weeks for it to be completed inside of a store. We do it while the store is operating with very minimal disruption.
It is first and foremost a space productivity play, where we're going and optimizing every piece of square footage in the store to kind of mathematically drive an improved lift. We're adding extra space to pet. We're adding extra space to power tools. We're doing some other things to shrink our service footprint and add more space for products. When we do that, we see about a mid-single digit lift in same store sales when we complete the initiative. It's a very nutritive remodel program. In addition to getting that lift driven dominantly through space productivity plus an enhancement for new customers, we're also upgrading the look and the feel of the store, making it a bit more contemporary from a retail perspective.
That's been created a more inviting atmosphere for the millennial generation. The 30s, our average store is a little over 10 years old. We have 2,050 Tractor Supply Stores in the United States. It's bringing the age of those stores back to kind of a newness, if you will. The outside of our store, we expect to have every one of our stores done by 2026 with the Fusion remodel program. We're over 600 stores in already. The Side Lot program is where we're adding a garden center. Think about what you might see at a normal, like a home improvement store or a hardware store or maybe a local garden and nursery.
We're adding a 4,000 sq ft garden center. We add a drive-through buy online pickup and store lane, we also add a feed room where you can drive through and pick up your, you know, pallets of feed that you might need for your animals or pets. When we do both the inside of the store and the outside of the store in combination, we're seeing high single-digit sales lifts in our stores in the first year. Both of them big drivers of our fundamental growth. We think. Well, the guidance we've given is that two-thirds of our store base is applicable to a garden center. We have over 350 stores right now with the garden center.
We're, you know, call it, 15-ish% of the way, close to 20% of the way through our chain.
Maybe switching gears a little bit, Kurt, as any of us have seen going to the grocery store, we're clearly not in a deflationary environment yet. We do get a lot of questions about how Tractor Supply would operate in, you know, a deflationary environment. Maybe can you talk quickly on what you're seeing from pricing today, kind of what the expectations are for 2023, and then we can kind of build off of that?
Yeah. Good morning, everybody. Our position right now, what we see is we expect inflation to be sticky throughout 2023. From our business, from our perspective, inflation has peaked. It's beginning to moderate, by no means are we seeing deflation in our business, whether it's the commodities, the consumables or even the non-commodity based product. We expect this year to still see some level of moderate inflation. The aspects of inflation that has driven over the last couple of years, if you think about it's so structural versus some of the historical areas where we've seen inflation, where in our business it was either mostly fueled by changes in commodity price.
Because it's commodity, because of its transportation, operating expenses, particularly labor costs, all of those costs are fairly sticky and structural at this point. In the primary areas of the consumable parts of our business, we are seeing from grains to petroleum-based product, the prices are relatively stable at this point. You know, we expect to see this year to continue to have some level of modest inflation. I think all of the recent economic data points that are out there continue to show 2023 is gonna have, while at a more modest level, is still having some level inflation environment for us.
Then maybe switching over to supply chain inventory, kind of where are you at today on the supply chain efficiencies within the DC? Tractor's done a pretty impressive job of managing the inventory, given all the supply chain challenges out there.
Yeah, it's a great point. As a point of reference, and then I'll talk about what we've done. You know, to Hal's point, the company's grown 70% in the last three years, and during that time, we pivoted quickly to grow our supply chain. You can imagine what we had to do and have done during these three years, where we didn't open up a new distribution center while we're in the process of building it. We pivoted to pop-up DCs, third parties. The team did a phenomenal job making sure that we leverage our size. I mean, we are clearly, in farm and ranch, the largest provider. We leverage that size. In the last three years, it's been relatively less efficient than the previous years.
We just opened up our ninth distribution center early this year. We'll be opening up soon, within 12 months, the 10th distribution center. We've been investing during this period of time to continue to even build even more robust supply chain. The inventory for the first couple years lagged by far the growth of the business, and we're now really getting to the point now where our inventory per store, when you look at the level of inventory versus sales growth, that it's getting brought back up to where we really feel like we've got the inventory that completely meets the needs of the business versus 2021 would be a great example where it was more hand-to-mouth on the inventory.
Yeah. I think the growth's a great point too. One of the questions we get a lot is when you see a retailer add that type of sales growth in that short of a period of time, is there a catch-up from either capital spending or the SG&A side? What's kind of the capital needs of the business over, call it, the next three to five years, given this new revenue base?
Yeah. I mean, as you recall, we've said that 2022 and 2023 are our peak investment cycles. Really, over the last three years, we've accelerated with the Life Out Here strategy that Hal was referring to, we've significantly accelerated our capital. The important thing is what we've done during these three years of phenomenal growth is take that, we call it our, you know, our COVID dividend, and investing it back in the business, whether that's investing in our labor and our team members, so that we've, you know, seen significant growth in that investment or in the capital side of the business. Hal talked about what we've been doing in technology, our plans for the next three, four years on the Fusion remodels, and then as I mentioned, our distribution center growth.
We've moved from roughly $300 million in capital to $600 million to $700 million in capital. It's peaking right now. We're able to take all the leverage of this growth and be able to grow our operating margin because we can absorb in the impact of additional investments. The next three years will be, those investment cycle. All of that is to be able to fund the Life Out Here strategy. The great thing is we're able to grow the business, invest that additional cash back into it, and be able to sustain and even grow our operating margins during that time. We have been investing, and it's part of the next, you know, the next few years', operating and financial targets.
You guys do have a couple, multi-year targets out there from an operating margin expansion point, as you mentioned. Where do you see more opportunities within the gross margin line or the SG&A line over the next few years?
Over the next few years, it'll be a balanced opportunity between both gross margin and SG&A. It can differ perhaps by, you know, any particular year. We're seeing significant leverage in the core SG&A expenses, as I mentioned. It then gives us the opportunity to balance out the pressure from the investments on SG&A. Next year to two years, there's more likely to see SG&A performing flattish as a percent of sales or slight improvement. We see with all the investments we've made historically in the supply chain, that we have the opportunity between the efficiencies that are now just, you know, starting to see that benefit of the distributions that are driving efficiency in supply chain, transportation costs coming down, where some of the transportation inflation we absorbed over the last couple of years.
We're able to claw back and benefit from some of the moderation in transportation costs and efficiency of our supply chain, I'd say the next year or two is more on the gross margin opportunity. Over the long term, we have opportunities in both to drive that operating margin north.
Very good. Hal, maybe let's switch gears, talk about one of the more recent events, your acquisition of Orscheln Farms. For those that don't exactly know what it is, maybe a quick recap, but then what are you kind of seeing on the early integration and from there?
Yeah, sort of, as I mentioned a couple of times now, we have 2,150 Tractor Supply stores. That includes 80 stores that we acquired from Orscheln Farm and Home. We've given a long-term store target of 2,800. Call it 650 stores remaining to build. Our preferred method of growth is new store builds. But certainly we'll do opportunistic acquisitions, as Bobby mentioned, from time to time. We typically build around 70 new stores a year, 70-80 new stores a year. We've got, you know, the better part of a decade left to go on new store growth.
We think that's an attractive component of our business model is you're gonna get nice mid-single digit comp growth, and you're gonna get an extra two or three points from new store growth to get you to that mid to high single digit revenue growth on an annual basis. As Bobby mentioned, we did acquire Orscheln Farm and Home, and we closed on that acquisition at the kind of beginning of our fourth quarter last year. It's a very exciting business. It's very complementary to our business. The size of the store, the products that they carry, the culture of their teams that they have in the stores are all very similar to Tractor Supply.
Because we've been spending the last two to two and a half years doing our Fusion remodel program, we're able to really just execute a slightly more intense Fusion remodel program in these Orscheln stores and, you know, convert them over to Tractor Supplies. That'll be our main focus for this year, is executing that conversion. We're a handful of stores already underway in that effort. It'll contribute nicely to our revenue growth this year and earnings growth. There's a good bit of synergy upside as well on same-store sales, productivity, as well as operating margin rate. Our stores operate at much higher levels than their stores do.
It was a opportunistic acquisition, and it fit very in addition to the synergies and the kind of similarity to this model, it fit nicely in our store portfolio. They were the first to market in a number of states like Missouri, Kansas, Iowa, and many of those towns were kind of one-store towns, and we were unable to go in there and financially, kind of in a viable way, build a competitive store. Acquiring them and bringing them into our portfolio worked very well. We're excited about it this year. It's gonna be a material impact to our sales and revenue growth and our the value creation that we create.
What about from a market structure? Is there any other opportunities like that, or is it getting tougher and tougher to find those little tuck-in ones that work very well for you?
Yeah. It was a little work to get this one through the FTC.
Yeah.
I don't know that we'll follow that exact same pattern again. Again, we're not a serial acquirer. You know, I think of us more as an opportunistic, kind of reactive acquirer, but certainly always have our pulse on the market. I think there's other opportunities that we might explore over time. Not something you would expect us to do in a, in a large, you know, scale way, anything that would. You know, we're not a proactive acquirer.
Okay. Clearly, with 2,800 store target, a lot of runway left in the store growth. What is kind of That target got moved up, kind of we're seeing Tractor Supply show up in a little bit newer areas of towns and stuff like that. Maybe unpack kind of what drove that. You're seeing them a little bit closer into the city centers, kind of what you're seeing from customers to give you permission to win there. Then on a, on a very long-term basis, do you see an opportunity for this business to be outside the U.S. in any one area?
Yeah. In the, let's see, October of 2020, we communicated that we estimated our TAM to be, total addressable market, to be $110 billion. We updated that at the beginning of last year to $180 billion. $70 billion in growth on our TAM. There was two main drivers of that growth. We went from $110 to $140 billion in growth. $30 billion of that was just core market growth. That goes back to earlier what I was saying about half of our growth rate that we've seen over the last three years has been market driven.
The other $40 billion was because as we are building out these garden centers, we're entering the live goods space. We added that to our TAM as well. Anyway, going from a $110 billion to a $180 billion in TAM growth unlocked the opportunity for us to build more stores. We went from a 2,100-2,200 store target to a 2,800 store target over the last kind of 5-10 years. You know, we're excited about the opportunities we had to build out more stores in the United States. Again, as I said, we do about 70 a year.
We do, I'd say as it relates to other geographies outside of the United States, certainly the type of lifestyle that we serve, exists beyond the United States. I mean, Canada, Mexico, Europe, even in like New Zealand and Australia, you know, people have animals, they have pets, they have farms, they have ranches, they have lifestyles around out here. It's just something we, you know, we evaluate, we look at, we best practice and share with the various retailers in those markets. I think there's opportunity outside of the United States over time, but nothing that to that we're focused on in the here and now.
You know, maybe switching gears again, you know, talking about leveraging CRM data and the Neighbor's Club program, it's really been an area of growth here for Tractor Supply over the last couple years, especially with the surge of demand. Where do you think you are in that journey, and what further opportunities are probably out there to unlock from now this big data set that you guys are developing?
If you're not familiar with it, we have a loyalty program called our Neighbor's Club program. We'd put it up there with any of the best-in-class loyalty programs out there in the United States, certainly think it's a top five loyalty program. The way it operates is it's a tier-based program. The more you spend, the more points you get back on a per dollar basis. In essence, there's a silver, gold, and a platinum level. When you use our private label credit card, then you get incremental points above and beyond that.
In addition to the points that you earn, we also on a quarterly basis provide free services like same-day delivery as well as free trailer rental as well, because a lot of our customers have trailer needs when they're moving, say, a riding lawnmower or fencing or something like that either on their property or they're buying it from us to take home. The Neighbor's Club program has over 28 million members, so it's a very large program. It represents 75% of our total sales, so it's a big part of our sales. Our retention rates in the program are 80-ish percent. It's a highly retentive program, very active customer base.
As you can imagine, when you have that sort of program, it creates a significant competitive advantage. None of our core competitors have anything close to it. In addition to driving customer behavior through the points program and such, and the recognition that comes along with that, the underlying data fundamentals allow us to then go in and target our customers and deliver content and offerings and promotions and that are tailored to their interests. One in 10 of our customers, 10% own horses. The average customer owns five to seven horses. How are we talking to that customer group about all their equine needs? One in four of our customers raises chickens. How are we talking to those customers about their poultry needs? 75% of our customers have a pet.
How are we talking to them about their pets? We have all that data. We know their underlying purchase behaviors. We're able to then go in and target and deliver very relevant content to them. We're able to follow them on their journey. A typical millennial customer that, say, moved from Hoboken out to like Monroe Township in New Jersey as an example, when they move out in year one, call it 2020, 2021, they adopted a dog, they, you know, bought a Carhartt hoodie, and they were living Life Out Here. You know, the next year, they started to do chickens and to buy a coop, you know, now they're expanding into gardening and doing a raised bed garden.
We can follow their journey, and as we see their purchase behaviors adjust, both in a manual way through just segmentation and content creation, but also in using machine learning and AI, we can go deliver the right content for those customers at the right time. It's an incredibly powerful part of our business model, and I think one that's a standout in all of retail and certainly compared to our core competition, which don't really have anything of that level of sophistication.
What about on the vendor side? Have you started to do the work where, you know, you can get a greater share of promotional dollars, maybe even a little bit of like an advertising business or something where the vendors value that type of insight too into the customer?
If I were to step back, we are an everyday low price retailer. If Kurt mentioned earlier our operating margin growth that we've seen over the last three years, moving from an 8.9% operating margin growth rate in 2019, to a low 10% operating margin over the last three years, anywhere between a 10.1%, a 10.5%, and a 10.3%. The vast majority, in fact, all of that operating margin growth rate has been in gross margin. Our gross margin rate, a big driver of that increase has been due to reduced promotion activity.
We, different than some other retailers who saw their promotional clearance activity increase last year, we actually had lesser promotional activity last year than we did in 2021, and lesser promotional activity in 2021 than we did 2020. A big reason for that was because we eliminated print ads. Print ads are a fundamental driver of promotion activity. We used to do about 30 a year. Now we're doing one a year for Black Friday. Because we have less promotional activity, it allows us to then have a partnership with our vendors that's all about driving growth through innovation, through tailored marketing, through new products and assortment. We spend a lot less time on promotions. To your point, the Neighbor's Club data is gold for our vendors.
Working with them to get tailored relevant offerings to stimulate the right behavior at a customer-specific level has been a big win-win for us and our vendors.
Very good. I think we got about two minutes left, so two rapid-fire questions here. One, I can't let Kurt go without a capital allocation question, so hit on those key points and then how ESG is becoming a bigger focus. You guys have been doing a lot of work on that, so maybe one of the two or three quick, high-level focus points over the next few years from the ESG perspective.
Yeah. I'll start on capital allocation. We've got a great capital allocation story. For us, this business produces a tremendous amount of cash flow. Our operating cash flow, roughly $1.5 billion of operating cash flow. We've said we're in peak investment, with $600 million-$700 million in capital, that still leaves just, you know, $800 million-$900 million of free cash flow. We take that free cash flow, invest in share buybacks. We'll drive roughly, we target net about 2% shares reduction through our buybacks, a dividend program that we target about a 40% payout. Between buybacks and the dividends, it's roughly at or about $1 billion.
With our strong capital structure and balance sheet, ultimately, with the growth of the business, that few hundred million dollars that we lever up to be able to do that continues to keep our balance sheet at around or below a two times leverage ratio. With the growth of the business, as we've increased even recently some debt, again, it continues to keep a very low debt leverage ratio and be able to do all of those things, the investment and the return to shareholders.
Very good. Then maybe quickly on ESG?
Yeah. Quick couple minutes on ESG. We talk a lot about preserving Life Out Here. That's really our true north. We believe that, you know, what's good for our customers and good for our communities over the long term is good for us. That comes in many ways. It comes in our giving program. We've given $50 million back to our communities over the last five years. It comes through efforts in sustainability and environment. We have a 25% reduction goal in our carbon emissions by 2025, and then beyond up to a zero carbon emissions goal by 2040.
It comes through reduced water usage, then it also comes through our diversity efforts, which are very dominantly focused on representation, particularly people of color representation in our stores to reflect our communities. It's a key piece. We've been focusing on stewardship and preservation of Life Out Here for over 15 years. We have robust reporting and metrics around it and, you know, it's just a core part of who we are.
Well, thank you. Hal, Kurt, and Mary Winn, thank you for your time, and thank you for joining us.
Thank you, Bobby.