For investors who can stomach the volatility that goes along with stocks that was especially prominent in 2022, there is the potential to build substantial wealth over the long haul.
But this is only if investors pick well-run businesses with tremendous growth runways. The rural lifestyle retail company Tractor Supply (TSCO 1.04%) fits this profile to a T in my opinion. Let's dig into the company's fundamentals and valuation to better understand what makes it such a compelling buy for dividend growth investors.
Another quarter of rapid growth
The COVID-19 pandemic had numerous impacts on society that we have only begun to recently see. It's no secret that remote work became more popular than ever before as a result of the pandemic. Indeed, 66% of Americans indicated in a recent survey that they would consider moving to a rural home or subdivision if telecommuting is a work option. This suggests that there will be a significant rise in demand for rural lifestyle products.
Tractor Supply has been in business over 80 years and has a presence of more than 2,200 stores across its Tractor Supply and Petsense (i.e., a small-box pet specialty retailer) brands in 49 U.S. states. This makes the company the largest player in the rural lifestyle space.
Perhaps it is no surprise that Tractor Supply continues to do exceptionally well, considering the rural migration in recent years. The retailer's $4 billion in net sales in its fourth quarter ended Dec. 31, 2022, was an astonishing 20.7% growth rate over the year-ago period. Even factoring in the 6.8% boost that an extra week in the quarter had on net sales, the growth rate was almost in line with the 15.3% clip recorded in the year prior.
Tractor Supply was able to log 8.6% comparable-store sales growth during its fourth quarter. Thanks to strong demand from shoppers, the company was able to pass higher costs on to consumers. This resulted in a 6.3% growth rate in the comparable average ticket for the quarter.
But a 2.3% year-over-year increase in the comparable average transaction count demonstrated that consumers weren't fazed by increased prices. Along with 39 new Tractor Supply stores and six new Petsense stores, this explains how the company's net sales grew so quickly in the quarter.
The company's diluted earnings per share (EPS) soared 25.9% higher over the year-ago period to $2.43 during the fourth quarter. Due to a slower rate of growth in cost of merchandise sold (20.2%) than net sales, Tractor Supply's net margin edged 10 basis points higher to 6.8% for the quarter. Paired with a 3.1% reduction in the company's outstanding share count via share buybacks, this is what allowed diluted EPS growth to outpace net sales growth in the quarter.
Due to future store openings and a growing rural lifestyle market, analysts believe that Tractor Supply's diluted EPS will compound at a 10.1% rate annually over the next five years. Putting this into perspective, that is just above the specialty retail industry average earnings growth forecast of 10%.
Image source: Getty Images.
A competitive dividend with massive long-term upside
Tractor Supply's 1.6% dividend yield is in line with the S&P 500 index's 1.6% yield. But the retailer appears better positioned to deliver future dividend growth.
This is because Tractor Supply's dividend payout ratio was just 37.9% in 2022. Such a manageable payout ratio means that the company can retain enough capital to complete accretive acquisitions, execute share repurchases, and reduce debt. That's why I anticipate Tractor Supply will hand out dividend raises around 10% each year for the foreseeable future.
Tractor Supply is a wonderful business, trading at a well-earned premium
Amid the market downturn, Tractor Supply has performed well: The stock gained 3% over the past year, while the S&P 500 dipped 11% during that time.
Yet Tractor Supply still looks like a convincing buy for dividend growth investors. The stock is trading at a forward price-to-earnings (P/E) ratio of 19.4, which is moderately above the specialty retail industry average forward P/E ratio of 16.3. Given that Tractor Supply is the largest player in the rural lifestyle niche and boasts double-digit earnings growth prospects, this isn't an unreasonable valuation.
