Tractor Supply (TSCO 3.26%) is an interesting retailer. While it is geared toward farming, even selling baby chickens, it isn't exactly focused on full-time farmers. That's partly why it has been able to keep expanding its store base for many years, drawing in both hobby farmers and general consumers.
Higher interest rates are changing the equation for this retailer's growth and making expansion more expensive, but Tractor Supply thinks sale/leasebacks will save the day.
Tractor Supply continues its rapid pace of growth
In 2022, Tractor Supply added 63 new stores under its main nameplate. It added a net of eight new stores under the Petsense by Tractor Supply name. The retailer also bought 81 locations from Orscheln Farm and Home and it expects to rebrand those locations to Tractor Supply by the end of 2023. That's a lot of growth for one year. In 2023, the company plans to expand by around 70 stores or so. Looking out to the future, management hopes to increase that annual new store pace to 90 a year by 2025.
Image source: Getty Images.
There are a lot of risks here, not the least of which is over-expansion. That said, same-store sales in the second quarter of 2023 were up 2.5% year over year. That's less than half the level of a year earlier, but given the concerns about an economic slowdown, it is still a pretty solid number. More importantly, it shows that stores open for more than a year are continuing to attract customers, which hints that management hasn't overstepped on the growth front yet.
But there is a problem with opening so many stores -- it's expensive. When interest rates were near historic lows, the cost of building a new location could be taken in relative stride. Now, however, interest expense is a big headwind. Tractor Supply management thinks it has a solution.
Sale/leasebacks pave the way
Tractor Supply management prominently discussed sale/leasebacks in the company's second-quarter investor presentation. The basic transaction is that Tractor Supply agrees to sell a store to a real estate investment trust (REIT) like Agree Realty (ADC -0.48%), or another investor, and then instantly rents the property back under a long-term lease. The net lease structure of such deals means that Tractor Supply is responsible for most property-level operating costs, which basically makes this more of a financing transaction than a property sale.
This is a win/win for REITs like Agree, which has actually done some recent transactions with Tractor Supply, and for Tractor Supply. Agree, for its part, gets a good customer and locks them in for a long time. From a simple perspective, Tractor Supply raises cash without having to take on debt. It can use that cash to pay for its expansion efforts. Meanwhile, depending on how long it has owned a property, it may actually end up making money on the sale. That's not the big benefit here, but it is a nice little bow on top of the deal. All in, the cost of expansion is kept as low as possible.
Because of the net lease structure, meanwhile, Tractor Supply gets to maintain the properties it sells. So the retailer can make sure that what are arguably its most vital physical assets remain in tip-top shape. And as long as the location continues to perform well, there's no reason why it would want to get out of the lease.
More growth than originally expected
Tractor Supply thinks leaning more heavily on sale/leasebacks is such a benefit that it has increased its long-term store count target from 2,800 to 3,000. That's a 7% increase, which is fairly substantial. The current store count is around 2,180, as well, so there's ample room to keep growing in the near future.
As with any fast-growing retail concept, investors need to watch to make sure management doesn't bite off more than it can chew. But, so far, it looks like Tractor Supply is doing just fine. Add in the sale/leaseback approach, to keep expansion costs down, and there's a good reason to be positive about the company's store prospects.
