Is Tractor Supply Company a Buy?

Shares of Tractor Supply (NASDAQ: TSCO) have had a volatile year so far in 2018, with returns ranging from a 24% loss to a 21% gain. But investor sentiment has turned positive lately, as the retailer's strong spring selling season set it up for accelerating sales growth for the full year.

Below, we'll discuss a few of the reasons to take a closer look at Tractor Supply's stock today, along with a few of the biggest risks in buying shares right now.

Tractor Supply investment metrics

Winning in its niche

Tractor Supply is a rural lifestyle retailer that caters to recreational farmers and ranchers, a niche that isn't well covered by major chains like Walmart. About half of its annual sales comes from products aimed at caring for livestock and pets. Hardware, truck, and tool products account for about a quarter of the business, and the remaining 25% is split between seasonal offerings and apparel.

By focusing on consistently delivering lifestyle products for an underserved shopping category, Tractor Supply has established a strong, defensible market position. You can see evidence of that positioning in the fact that sales have climbed consistently over the last five years, rising to $7.3 billion in 2017 from $5.2 billion in 2013. An expanding store base played a big part in those gains, but the retailer has also seen dependable growth at its existing locations. Sales at established stores rose 2.7% last year and are on pace to improve by at least as much in 2018.

Tractor Supply pays a substantial dividend that currently yields 1.4%. It has hiked that payout in each of the last eight years.

Risks and valuation

Like most of its brick-and-mortar retailing peers, Tractor Supply's business is being impacted by rising demand in the digital sales channel. Spending in support of its e-commerce business pushed its operating margin down to 9.4% in 2017 from 10.2% a year earlier. Management expects that figure to slip again in 2018. CEO Greg Sandfort and his team believe these investments are crucial to the long-term success of the business, but investors will want to watch margin trends for signs of stabilization in the quarters ahead.

Customer traffic growth has slowed in recent years, with a 2.2% increase in 2017, compared to 3.3% growth in 2015. Further declines here would pressure sales and might force management to slow its pace of physical expansion, which is now at 50 to 100 new locations per year.

Investors are being asked to pay a premium for Tractor Supply shares compared to peers like Walmart and Target. That might seem odd, given the much larger sales bases that these retailers enjoy. However, Tractor Supply is significantly more profitable thanks to its product and customer focus. Despite Tractor Supply's recent margin decline, its 9.25% operating margin over the past four quarters trounces Target's 5.67% and Walmart's 3.95%.

Investors have to balance that attractive earnings profile against drawbacks that include intense seasonal volatility and uncertainty around the size of Tractor Supply's long-term sales footprint. Yet if the company can maintain its modest growth momentum without sacrificing too much earnings power in the shift toward multichannel retailing, it should continue generating healthy returns for investors from here.

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Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Tractor Supply. The Motley Fool has a disclosure policy.