Thesis Summary

·   TSCO has one of the largest beneficiaries of the COVID driven stay-at-home boom and the deurbanization trend.

o   While some of this sales gain is likely to prove sustainable, a regression to the mean seems likely as tailwinds from trip consolidation and the consumers staying at home likely ease in a post-COVID word.

o   Consumer benefits from stimulus are likely to fade in 2022 and consumer wallet share is likely to shift back to services in a post-COVID world.

·   An important point here is that unless sales trends reaccelerate, the upside case for TSCO (discussed below) is already priced in.

o   On Street numbers, TSCO is already trading at peak multiple on what are arguably peak earnings.

·       Store growth not far from saturation point: Management believes that TSCO has the opportunity for 2,500 TSCO stores nationally vs. 2,000 as of the end of 2021 – this suggests there is only 5-6 years of store growth remaining for the TSCO concept. Stagnating store-level productivity before COVID despite positive SSS suggests that TSCO was already seeing returns on new builds decline.

o   Our primary diligence confirms that TSCO likely only has a handful of years of store growth ahead of it.

·       Headwinds to core pet and livestock business from increasing e-commerce penetration in the pet category: Roughly 25% of TSCO’s sales relate to the pet category which is increasingly exposed to Chewy and other E-Commerce players.

Valuation, Returns, and Scenarios

NTM P/E: TSCO historically traded at 18-19x NTM Street EPS vs. Current 25x Multiple

And 11x Street NTM EBITDA vs. Current Multiple of 15x

Importantly, I believe that TSCO is already pricing in an upside scenario where the company sustains the current elevated sales per store seen in 2021 and simply grows off of that base. In this scenario, I also model EBIT margins sustaining at an elevated level.

Both my base case where there is modest regression to the mean in terms of sales/margins and my downside case both point to significant potential downside for TSCO. In my base case I assume a 19x EPS multiple (in-line with historical average) and in my downside case, I assume a 17x EPS multiple (slight discount to the historical average):

Note that while TSCO has received a second request from the FTC for the acquisition of Orscheln Farm, I am giving the company credit for the EPS accretion in my price target math for all 3 cases (worth about 6-7% to EPS assuming acquisition is financed with cash which it likely will be)

Putting it all together, the Risk/Reward for TSCO skews asymmetrically to the downside:

Company Overview

·       TSCO’s core consumer is the ‘recreational farmer’ who lives in a rural or suburban area, maintains a 5-10 acre plot, has pets, and may raise livestock (think having a chicken coop in your yard) or maintain a fruit/vegetable garden. TSCO is effectively a ‘rural lifestyle’ retailer. The company does also serve the professional farmer customer but more for their personal needs.

o   “Tractor in those areas is really looking for a customer base that's mom and dad both work, they have good-paying jobs, and they decided to get out of the city or the suburb and buy five, 10, 20 acres, build a home and a barn and have animals… Okay. They're in between a Walmart or a Home Depot Garden Center. They're not like the John Deeres or the Titan Tires or the real big guys in the ag space. Yeah. It's a hardware store for landowners, small farms, basically… If you own land and have animals, you can get about anything that you need to work on that land and work with those animals and maintain your home at a Tractor Supply” – Former Employee at TSCO

o   “Their target audience is the landowner of five, 10, 15 acres, it’s not the commercial farmers with 15,000- 20,000 acres, or the commercial ranchers. They do some business with that, but those ranches, those farmers do levels that TSC does not compete with” – Former Employee at TSCO

·       The company sells a mix of consumable (pet food, feed, etc.) and larger ticket items in addition to apparel, tools and light agricultural equipment, and seasonal and other general merchandise. Notably, the company’s significant exposure to the big ticket hardware, tools and truck category has made it an outsized beneficiary of government stimulus while the pet livestock and agriculture categories made TSCO an outsized beneficiary of the stay-at-home boom - both trends that we think are unsustainable. TSCO has also branched out into ancillary services for pets in order to better differentiate from E-Commerce.

o   Think of the company as a blend of Home Depot, Cabela’s, and a pet retailer that also happens to sell livestock feed (and even some livestock like baby chicks) and gardening equipment.

o   Average ticket was disclosed at $55.50 as of 3Q21 compared to $46.90 for 2019

o   An expert discusses the breakdown of the livestock and pet category which is nearly half of TSCO’s sales: “Probably 40% is your dog, cat, that's related to typical pet store. You probably have 5%-10% that is bird-related: feeders, bird feed, etc. You probably have another 10%- 15% that is equine, horse-related products, whether it's grooming, feed supplies, saddlery kind of things.  Around 25% or so would be your farm animal, so cattle, chickens, goats, etc.” – Former Employee at TSCO

o   “We're focused on being a more complete resource for pet parents. In store, this includes relevant product assortment and brands, expansion of self-serve pet wash locations across 150 to 200 stores, and the build-out of 50 to 75 additional pet wellness centers. Currently, about 1,600 stores have vet services in-store through our mobile vet clinics. Starting this quarter, pet prescriptions can be fulfilled online at Tractor Supply, as I mentioned earlier.” – 4Q20 Earnings Call

·       Roughly 30% of TSCO’s goods are Private Brand and imports comprise a LDD% of sales. Expert call commentary suggests as much as half of pet food is likely private brand which also serves to provide insulation from E-Commerce Competition.

·       TSCO’s E-Commerce Penetration has ramped from 1% in 2016 to 3% in 2019 to 6% in 2020

o   Disclosures suggest roughly 80% of E-Commerce sales are from BOPUS as opposed to ship-to-home

·       TSCO competes in a fragmented industry – TSCO believes that their TAM for the Farm/ranch category is $110bn suggesting TSCO has roughly a 10% share

o   There is a steep drop-off in size between TSCO and its next largest competitor. Orscheln Farm and Home for example, TSCO’s largest competitor (who TSCO is in the process of acquiring) only has ~165 stores vs. TSCO’s 2,000.

·       Store base is concentrated on the East Coast/Southeast of the country and stores are in a combination of rural and suburban areas:

o   “With the road network, probably the hospitals, probably the Walmart is in that town, so on and so forth. Typically, that's where Tractor would look, the county seat of most rural agricultural counties… and if the county's got good ag numbers, meaning it has a lot of farms, a lot of small farms, a lot of horses, a lot of cattle, sheep, goats. Four-legged creatures equal strong sales dollars for Tractor Supply… If you take the more metropolitan areas of each state, typically, Tractor surrounds some of those more major metropolitan areas where suburbia meets countryside.” – Former Employee of TSCO