Tractor Supply [TSCO] Conference call transcript for 2023 q1
2023-04-27 12:38:08
Fiscal: 2023 q1
Operator: Good morning, ladies and gentlemen, and welcome to Tractor Supply Company’s Conference Call to discuss First Quarter 2023 results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. We ask that all participants limit themselves to one question and return to the queue for additional questions. Please be advised that reproduction of this call, in whole or in part, is not permitted without written authorization of Tractor Supply Company. And as a reminder, this call is being recorded. I would now like to introduce our host for today’s call, Mrs. Mary Winn Pilkington, Senior Vice President of Investor and Public Relations for Tractor Supply Company. Mary Winn, please go ahead.
Mary Winn Pilkington: Thank you, operator. Good morning, everyone. Thanks for taking the time to join us today. On the call today are: Hal Lawton, our CEO; Kurt Barton, our CFO; and Seth Estep, EVP and Chief Merchandising Officer. After our prepared remarks, we’ll open the call up for your questions. Please note that we have made a supplemental slide presentation available on our website to accompany today’s earnings release. Now, let me reference the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. This call may contain certain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the company. In many cases, these risks and uncertainties are beyond our control. Although, the company believes the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations, or any of its forward-looking statements, will prove to be correct, and actual results may differ materially from expectations. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included at the end of the press release issued today and in the company's filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed. Investors should not assume that statements will remain operative at a later time. Tractor Supply undertakes no obligation to update any information discussed in this call. Given the number of people who want to participate, we respectfully ask that you limit yourself to one question. If you have additional questions, please feel free to get back in the queue. I appreciate your cooperation. We will be available after the call for follow-ups. Now, it is my pleasure to turn the call over to Hal.
Hal Lawton: Thank you, Mary Winn, and good morning, everyone, and thank you for joining us today. For today's call, I will go through some highlights of our first quarter. Seth will then share some merchandising initiatives and updates and Kurt will review the quarter and our outlook in greater detail. Before we get started, I'd like to thank the Tractor Supply team for their ongoing commitment to each other and our customers. No matter the operating environment or how the seasons of the year unfold, this is a team that is always there for our customers and our communities to be the dependable supplier for the Out Here lifestyle. For nearly 85 years, our business has proven to be resilient, stable and very consistent, as we provide needs-based, demand-driven product categories as a lifestyle retailer. Now, let's turn to a review of the business for the first quarter of 2023. We grew net sales by nearly double digits at 9.1%, with comparable stores up 2.1% and diluted earnings per share of $1.65. We had 7 points of non-comp sales growth in the quarter. The two primary drivers were new stores and the Orscheln acquisition. We opened 17 new Tractor Supply stores and the Petsense by Tractor Supply stores in the quarter. And the Orscheln integration is running ahead of schedule. Our comp sales results were below our expectations. We attribute just over 200 basis points, the majority of our sales miss to a delayed start to the spring and to a lesser extent, a milder January. We continue to closely review customer data for trends and changes in their behavior. While select discretionary categories were below in the chain average, this was offset by stronger demand in our consumable, usable and edible products. We believe our customers remain resilient, but are being judicious with their spending as they seek us out as a destination for value and are buying closer to need. Excluding our seasonal categories, our sales were in line with our expectations, and our core business remains very strong. Our comparable store sales growth was driven by ticket growth of 2.8%, offset by a decline in transactions of 0.7%. Importantly, our comp transaction trends improved each month of the quarter and were positive in February and March, with strong performance in our year-round categories. The strength in our year-round categories was driven by CUE products, which exhibited ongoing impressive demand this quarter. These products are needs-based and demand driven and are what drive trips and transactions to our stores. Across companion animal and livestock, we had strong performance. The strength we've experienced over the last three years in our CUE customer trends remains robust, as we continue to gain material market share. In companion animal, we continue to see substantial share gains throughout the category. And we're seeing sequential increases in the number of customers shopping us for this category each week, each month, each quarter. In livestock, our Chick Days event is shaping up to be the largest ever for us, with the poultry category up strong double digits. Not only are we seeing growth from existing customers, we're also seeing robust growth in new customers to the category, driving both trips and ticket. One exciting aspect of the new customers to the poultry category is that they're gravitating to our unique offering of premium breeds and organic feed products for their chicks. Chick Days is a great gateway for our new customers to explore Tractor Supply and use this as a resource for all things related to homesteading, beyond poultry to categories like gardening. Big ticket declines were driven by seasonal trends and to a lesser degree, ongoing pullback in discretionary categories. The slow start to spring impacted outdoor power equipment, which weighed on our big ticket results and average ticket. The most significant pressure was in zero-turn tractors, generators and trailers. Our customers have a long history of buying these items based on need. Current trends support that we are seeing purchasing consistently closer to the season or moment in need. Overall, our big ticket trends were very similar to what has been reported in the recent March retail sales data. Our mobile app currently represents more than 20% of our digital sales. The app is now ranked in the top 100 shopping apps on the iOS store. This is a major recognition of the progress in our ONETractor strategy to offer our customers a more seamless shopping experience. Our customer scores continue to run at all-time highs. Overall, our customer experience metrics continue to keep momentum into 2023, with strong improvements over the last quarter and year-over-year. Our store teams are doing a tremendous job servicing our customers. Our Neighbor's Club just celebrated last week a significant milestone with over 30 million members. As our points-based program enters its third year, the strength in Neighbor's Club continues to exceed our expectations. Our members are comping at a faster rate than our overall performance, and we continue to see strong growth and retention in our high-value customers. As mentioned previously, the Orscheln Farm and Home integration is going very well. I had the opportunity recently to visit one of our first store conversions to the Tractor Supply brand. There was excitement across both our team members and, importantly, our customers as they recognize that we're committed to providing the region with an elevated product assortment, a meaningful loyalty offering and enhanced digital shopping experience and so much more that Tractor Supply is able to offer. During the quarter, we opened our ninth and largest distribution center in Navarre, Ohio. The ramp of the distribution center is right on schedule. With the opening in the new DC, the integration of 81 Orscheln stores and addition of new TSC stores, we capitalized on the opportunity to realign the store servicing areas across the DC network to balance transportation costs and DC capacity, while improving service levels to our stores. It is great for our DC network to have this new capacity to better position our inventory and better service those stores, and allow us to reduce our freight costs, which you'll hear more about from Kurt. At Tractor Supply, our purpose as a company is to serve Life Out Here. As we celebrate our 85th anniversary this year, we remain steadfast in our commitment to preserve and protect our way of life. Two weeks ago, we issued our fourth annual Stewardship Tear Sheet, highlighting the actions and progress that we've made on our sustainability, DE&I and community commitments. I am proud of our progress towards our ambitious stewardship goals, but know there is more to be done as we work towards achieving our net-zero and other goals heading towards 2040. To wrap up, while our first quarter sales were below our expectations, we have a lot of the year still ahead of us. The American consumer broadly remains challenged, but we believe that our customer remains resilient. Spring continues to be cooler and wetter as we've turned into Q2. That said, we're encouraged by quarter-to-date trends, with comps mid-single digit and comp transactions positive. Based on our experience and the nature of our needs-based demand-driven business, we continue to believe that the best way to look at this business is on the half, as the timing of spring impacts the first half of the year. While we acknowledge that the softer sales in January will not be recouped, we are pleased with our lineup for spring and summer. As a company, we have numerous levers to continue to gain market share and numerous levers to effectively control expenses. We continue to see significant opportunities for growth and earnings growth as well. With the majority of the year remaining, we are reiterating our guidance for fiscal 2023. Before I turn the call over to Seth, I'd like to share some background on Seth and the merchandising team at Tractor Supply. Seth is an 18-year veteran of Tractor Supply, having held roles across marketing, finance, e-commerce and merchandising. He has a passion for this lifestyle and has served as our Chief Merchant since 2020. Given our record sales growth over the last three years, we recently completed a realignment of our merchandising product categories and promoted two Vice Presidents to Senior Vice Presidents to better support the growing needs of our business. Seth will provide a review of our sales by category and our plans to continue to gain market share. Now, I'll turn the call over to Seth to discuss some further insights.
Seth Estep: Thank you, Hal. I'm excited to share with you some insights into our merchandising categories and market share position. We are committed to driving sales productivity as we deepen our relationships with our customers. I'd like to start by congratulating Nicole Logan, SVP of Animal and Softline divisions; and Randall Dodds, SVP of Seasonal and Hardline divisions on the recent promotions. They each bring significant retail and industry experience that complement their tenure at Tractor Supply. These new roles each have three merchandising divisions reporting to each of them. It is exciting to have this new organizational structure to allow us to operate at greater scale, have deeper category insights and enhanced strategic partnerships. Overall, we're now organized into six merchandising divisions. So let's start with our largest division, companion animal, that represents more than 20% of our 2022 sales. This business includes both the consumables and hard lines across companion animal. Around 75% of the Tractor Supply customers have a pet, and approximately 50% have more than one pet. Also, our customers dog weight on average about 20 pounds more than the US average. With the ongoing humanization of companion animals, these key structural tailwinds support our positive outlook on this category. We are a destination for pet customers, with a comprehensive and differentiated assortment at an everyday low price, and we continue to gain share. For example, our growth in pet food, treats and litter continues to lead the market in both dollar and pound growth, gaining another 33 basis points of share in Q1. Our business model of private brands, strong national and differentiated partners, club pack sizes and legendary customer service sets us up to continue gaining share, perhaps even more if we see the consumer more pressured for value. Moving on to our second largest division, livestock and equine, which represents just under 20% of sells. This is a key category for farm and ranch, and we continue to consistently outperform the market. Of note, this category is almost solely the consumables portion of our lifestyle seed categories. In other words, this business does not include fencing, which, in many ways, can be considered containment for large animals. With strong exclusive brands like DuMOR and Producer's Pride, along with national brands from Purina, Cargill, Triple Crown and more, we continue to innovate across our key categories of poultry, equine and cattle. We are the clear leader in this space, with approximately 20% market share. Broadly, one out of every five bags of animal feed is bought at Tractor Supply, and we continue to take share, consistently outperforming the market by 5 percentage points. Next up in our category lineup at an equal weighting are our seasonal and our truck tool and hardware divisions. We are excited to get our spring seasonal business off and running. This is an area where we think we have substantial share opportunities. We are a leader in core categories like outdoor power as the destination for Zero Turn Mowers and categories like grass feed and fertilizers. Also, our live goods assortment is included in this division. As of today, we have more than 350 garden centers ready for spring, with the vast majority just entering year two of operations. Where spring weather has cooperated, we are very excited about our customers' response to the expanded product offering and layout in our Fusion and Garden Center stores. More broadly, this season, we are offering a differentiated garden assortment of live goods, including vegetables and plants, soils, mulch, and chemicals tailored to Life Out Here. We like our initial reads for seasonal products where the weather has turned and are excited for the spring season. Our fourth division is truck, tool and hardware that includes lifestyle items like trailers, power tools, welders and truck accessories. Historically, in tools, we have serviced as a convenience play in power tools and hardware. As part of our Fusion layout, we have made significant investments in corresponding progress on elevating our power tool selection, and it has resulted in one of the highest sales lift categories in our Fusion stores. The additions of Makita, Bosch and Dremel, coupled with being the exclusive retail destination for Porter-Cable power tools, has allowed us to have consistent share gains over the last three years. Up next is our Ag and Outdoor Recreation division, which includes categories such as fencing and sprayers as well as our outdoor sport categories. We are in the business of helping people maintain their land and contain their animals. We have the largest share in the country and have outgrown the market by mid-single digits. And for outdoor recreation, we are very excited about the growth prospects for this segment as we test an expanded assortment in several Orscheln Farm and Home stores. Our final segment ranked on sales volume is clothing and decor, which has exhibited rapid growth since the pandemic, trending well above the company average. This business includes apparel, footwear and farmhouse decor. As one of the largest retailers of Carhartt, along with other brands like Wrangler and Colombia, our customers are finding our assortment meets their workwear needs and their lifestyle. For years, we've known there was a market opportunity in women's workwear at Tractor Supply. And the team has leaned into this category, and the shopper is responding. While still off a relatively small base, our women's apparel business grew 24% in Q1, led by growth in our exclusive brands of Blue Mountain and Ridgecut. We will continue to look for ways to grow these high-margin categories by growing both leading national and best-in-class exclusive brands. In closing, with our new alignment and additional resources, Tractor Supply is well positioned to continue to be the market leader and operate with speed, agility and efficiency to capture growth and drive sales productivity. We are in the midst of one of the most exciting times at Tractor Supply as we are in the spring season. And I hope you get a chance to get out to our stores and see all the exciting merchandising experiences and product innovation. Now, I'll turn it over to Kurt.
Kurt Barton: Thank you, Seth, and hello to everyone on the call. I will add on to Hal's comments about the quarter and our outlook for the year. Let's start with our first quarter results. Regarding the cadence of comp sales for the quarter, we started out with a soft January. Last year's January was strong, so we expect it to start soft, but we did not anticipate that the month would be the second warmest in 30-plus years. February was more normalized and in line with our expectations, but the mild winter continued to pressure results. To put it in perspective, our heating categories were down nearly 50%, insulated outerwear was down over 30% and emergency response categories were also down significantly. As a result, our winter seasonal products were down double digits for the quarter. Our expectation was that as we moved through the quarter, we would see a more normalized spring selling season unfold, where we saw the majority of the shortfall was really in the last three weeks of March, which were abnormally wet and much cooler than normal, as well as winter weather continued in the Midwest and Northeast. To put it in historical context, March was the coldest in four years with below-average temperatures nationally, the wettest in eight years and the snowiest in 30 years. Correspondingly, our spring seasonal products were flat to the prior year, well below our expectations. Sales in the quarter benefited in the high-single digits from retail price inflation. Most of this inflation reflects retail price changes that were put in place in the second half of 2022 that we have not lapped as of yet. The benefit of price inflation to our average ticket growth was offset by three key factors: First, the majority of the pressure on average ticket all revolved around seasonal goods. This includes the softness in big ticket, declines in seasonal, which runs at a higher average ticket and higher winter clearance. Second, faster growth in consumable transactions, in particular companion animal and poultry, which typically have a lower average ticket. And then third, to a lesser extent, a reduction in units per transaction in impulser add-on items like dog treats and candy and snacks. Moving down our income statement. Gross margin was 35.5%, an increase of 52 basis points from 34.9% last year. We were very pleased with these results. We remain committed to being the everyday low-price leader in our markets. Promotional activity was in line with last year with a modest increase in winter clearance, as we looked to exit the season clean. Moderating freight costs for import and domestic shipments provided a net gross margin benefit. Our price management initiatives and lower freight costs more than offset the impact from cost inflation and product mix from the robust growth of our CUE categories. As a percent of sales, SG& A expenses, including depreciation and amortization, increased 119 basis points to 28.1% from 26.9% a year ago. For perspective, about half of this growth was anticipated for our strategic initiatives. As a reminder, our planned investments included higher depreciation and amortization from the step-up in capital spending to support our growth agenda, and the addition of our new distribution center and the impact from the Orscheln acquisition. The remaining increase in SG&A as a percent of net sales was primarily attributable to deleverage, given the moderate comparable store sales growth. As we've mentioned, the quarter was trending in line with our expectations, leading up to the last three weeks of March, providing limited opportunities to adjust the cost structure. Specifically, we chose to continue to fully fund payroll for the last two weeks of the quarter to support the spring season, utilizing the hours to get ahead on product assembly and other sales driving tasks. For the quarter, operating income was essentially flat with last year, with a modest decline in net income. Diluted EPS was $1.65, also flat with the prior year's first quarter. We opened 17 Tractor Supply stores and three Petsense by Tractor Supply stores in the first quarter. This represents a significant improvement in the cadence of our new store openings. Turning now to our balance sheet. Merchandise inventories were $3 billion at the end of the first quarter, representing an increase of about 12% in average inventory per store. This increase is primarily attributable to inflation, a better in-stock position from last year and the delay in the spring selling season. We are pleased with how we exited the winter season and the quality of our inventory as of the end of the first quarter. With strong annualized cash flows, we continue to maintain a healthy balance sheet, with a leverage ratio of around 2.0 times. Our guidance for 2023 is unchanged. We continue to expect full year sales of $15 billion to $15.3 billion and project comparable store sales to increase 3.5% to 5.5%. As we manage through the first half of the year, we expect to see comp sales towards the top half of our guidance for the second quarter. We anticipate some increased pressure on discretionary categories, but are pleased with the growth in CUE products along with DIY categories like repairs and maintenance. Let me share further insights on the outlook for the remainder of the year. We anticipate Q2 and Q3 to have the strongest comp sales growth potential, while Q4 is expected to be closer to the low end of the guidance range due to the strong compares to the prior year. Operating margin performance is expected to improve as we move through the year with Q4 having the highest potential, principally from the lap of the onetime acquisition-related costs of Orscheln. As a reminder, our Novar, Ohio, distribution center is expected to begin to benefit gross margin in the second quarter with the ramp up in the second half of the year as we capture freight savings. The benefits in gross margin will be offset by approximately 15 basis points of negative drag on SG&A as the cost of the distribution center are reflected in SG&A. We have confidence in our earnings in a variety of sales scenarios. For example, at times, a cooler and wetter start to the spring can provide an extended selling season. We've seen this type of seasonal cadence before such as 2013, and we are cautiously optimistic of the upside it can bring to the third quarter. Regardless of the state of the consumer, we are confident in the resiliency of our business model and our ability to manage the business. In a scenario where we do not make up miss January sales, we see opportunities for further operating leverage. Specifically, we are seeing an easing of our supply chain capacity constraints, which should drive additional efficiencies in the second half. And we now anticipate greater accretion for porcelains in the back half. We are raising our accretion assumption to $0.15 per share compared to our prior expectation of $0.10 per share. To sum it up, for the full year, we continue to guide toward net income of $1.13 billion to $1.17 billion, and diluted earnings per share of $10.30 to $10.60. Over my 23 years with Tractor Supply, it has been proven time after time weather can be transitory. And the best way to look at our business is not by the quarter, but by the halves of the year. In this environment, what sets Tractor Supply apart is our ability to effectively manage the top line and bottom line while investing in our Life Out Here strategic growth drivers. And with that, I will turn the call back to Hal.
Hal Lawton: Thanks, Kurt. Tractor Supply has a proven business model that has been resilient over many business cycles. Throughout our 85-year history, we have successfully navigated all types of business environments and have emerged stronger each time. We continue to see positive migration trends to our markets. This marks the third consecutive year of positive population growth in rural America. This reflects an increased desire to seek out more space and take advantage of the affordability that country suburban, exurban and rural markets offer with a lower cost of living and the ability to live Life Out Here. It is our view that the sense of community found in our markets, and perhaps more importantly, the ability to secure a piece of property at a reasonable price, has ensured the rural migration trend is one that's here to stay for the time being. The millennial generation has embraced Life Out Here. Our customers have been resilient thus far in the face of slower macroeconomic growth, elevated inflation and higher interest rates, and they prioritize their lifestyle and passions. With significant growth and market share opportunities, we are excited about the balance of the year and remain confident in our business. My thanks and appreciation go out to the team for their dedication to living our mission values every day. And now, we'd like to open up the call for questions. Thank you so much.
Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Steven Zaccone with Citigroup. You may proceed.
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Operator: Absolutely. The final question comes from the line of Peter Benedict with Baird. You may proceed.
Mary Winn Pilkington: Thank you, Peter. Operator, that will conclude our remarks today. Thank you to everyone for joining us. We look forward to speaking to you on our second quarter call in July. I'm around all day, so please reach out if there's anything that I can do, and I look forward to speaking to you. Thank you.
Operator: That concludes today's Tractor Supply Company's conference call to discuss first quarter 2023 results. Thank you for your participation. You may now disconnect your lines.
