At this time one year ago the Dow Jones Industrial Average and S&P 500 were both setting record highs at the 17,000 and 2,000 levels. We believed this market strength was somewhat contradictory to economic fundamentals, which were mixed at best. In our Investment Comments we stated that “extraordinary monetary stimulus from the Fed is being curtailed, but economic growth appears locked in the same 2%-ish range that has existed during this muted recovery. Stock prices are at an all-time high despite only modest growth in corporate sales and profits.”
The major market indices are once again nearing or breaking all-time highs. Similar to last year, stock prices remain elevated despite a mixed economy and weak-to-modest corporate earnings growth. Global GDP growth estimates for 2015 continue to be revised moderately downward, while second quarter U.S. corporate earnings are expected to fall 4.5%, but to rise 2.2% excluding the brutal energy sector. A relief rally may explain the market’s latest move, as the instability concerns in Greece and China have again been kicked down the road. Investors may also be optimistic that corporate earnings can beat analysts’ lowered bar like they did in Q1. At the same time, the price of oil has resumed its slide, potentially giving consumers more confidence that low gas prices are here to stay, and once again providing a tailwind for sectors like the domestic retailers.
One of the three companies we profiled in the August 2014 IAS issue, Tractor Supply Company (NASDAQ: TSCO), is a perennially strong, purely domestic retailer that targets recreational farmers and ranchers. It is the largest consumer farm specialty retailer in the U.S. and functions as a destination spot for a lot of its customer base. Due to its predictable growth story and management’s consistent execution, the stock almost always carries a premium price tag. However, a pullback in the shares last summer led us to suggest buying the dip, with the following rationale:
“We think a window of opportunity has opened up after a recent pullback. We see this as a chance to participate in one of the best and most visible growth stories in retail…We think sales growth can continue in the 10% range for a few years. What really excites us about Tractor Supply is the amount of earnings leverage it can potentially drive from that sales growth.”
If you owned Tractor Supply over the last year, you certainly participated in the growth of this strong retailer. Since we highlighted the company last August, the shares have delivered a 50% return compared to the S&P 500’s 10%. The shareholder value created by this company over the long run has been even more extraordinary. Tractor Supply shares have produced a 36.4% compound annual return over the past 15 years compared to just 4.4% for the S&P 500. That means a buy-and-hold investment of $1,000 in Tractor Supply common stock 15 years ago would be worth $105,000 today, compared to just $1,900 if you had invested the funds in the S&P 500 index. Wow.
The timing of our IAS profile piece on the company ended up being almost the exact bottom in the stock, save a slight dip below $60 in the Ebola-inspired market turbulence of last October. However, the first potential catalyst for the stock in August of last year fell flat as the market responded mutedly to 2Q14 sales and EPS growth of just 9%. Comps were only up 2% and management only reiterated its full year guidance, and even guided towards the low end of the EPS range. The tepid Q2 results and guidance seemed to confirm the market’s general consensus that this epic growth story was finally petering out. In our News of Companies following the earnings release, we noted that the reiterated guidance range “puts the stock at a 2014 P/E of about 24 or 25, which is probably fair. If growth improves from here, however, the stock should make gains.” And boy did it ever.
Q3 sales increased 12.6%, with comp store sales up 5.6%. EPS increased 20%, and the shares gapped up $10, or 16%, to $70/share on the day of the announcement in the second half of October. The results were doubly impressive as they were up against especially difficult comps from the year prior. The strong quarter proved that the market had become far too pessimistic on Tractor Supply’s future growth prospects, and it was off to the races from there.
The shares continued their rally, taking out new all-time highs around $90, when the company reported a strong Q4 that matched the prior quarter’s 12% top-line growth, 5%+ comp store growth, and near 20% EPS growth. As usual, management set conservative guidance, calling for midpoint 9% sales growth and 13% EPS growth in full year 2015, leaving room for some strong “beat and raise” quarters. As predicted, Q1 and Q2 2015 results both beat expectations, as the company reported two more quarters of remarkably consistent 12%+ sales growth and 5%+ comp store growth. Like clockwork, after the beat in Q2 management raised its full year guidance to call for 10% sales growth and 14.5% EPS growth at the midpoint. Despite the strong first half and raised guidance, the shares continue to consolidate in the $90-$95 range. Considering they trade for a mighty rich trailing P/E of 34-35 now, upside from this range may be difficult to come by in the near term.