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An Undervalued Brick-and-Mortar Retailer

Jaime M. Katz, CFA

Jaime Katz: Narrow moat Tractor Supply continues to trade a compelling discount to our $84 fair value, in 4-star territory. The company released solid first-quarter results despite a spring that has yet to arrive across many of its geographies, capitalizing on an increasingly nimble supply chain to keep cold-weather gear in the network where appropriate. Moreover, this implies that spring sales remain postponed in many areas, potentially leading to a warm-weather season that is compressed into the second quarter and comps that could be around 3%, similar to first-quarter comp store sales of 3.7%. The first quarter was the third sequential quarter of same-store sales growth above 3%, a key level where Tractor Supply can leverage expenses, although we caution investors that the rest of the year is forecast to deliver comps below this quarter's metric.

While some of the categories that Tractor Supply operates in are relatively mature, we view the breadth of its offerings and potential for growth of its current consumer base, as well as increased penetration of new consumers, as positive factors that could drive top-line growth. We project that total sales can grow at 7% over the next five years supported by low-single-digit comparable-store sales and mid-single-digit square footage growth. On the cost side, our assumptions incorporate modest margin expansion of about 20 basis points annually on average after 2018 leading to an operating margin of 9.4% in 2021. Besides lower costs attributable to opening new distribution and third-party logistics facilities ahead, Tractor Supply should be able to tactically allocate its advertising spend, drawing on information from the 7.6 million members in the Neighbor's Club loyalty program the company launched nationally just one year ago.

For investors seeking exposure to the consumer discretionary industry, we think Tractor Supply remains one of the best-positioned brick-and-mortar retailers in operation, thanks to its differentiated product mix, loyal customer base, and defensibility against e-commerce competitors, thanks to the high weight/value proposition of their products.