Tractor Supply continued on its post-recession recovery, with a 13.4 percent sales increase in sales to $3.6 billion anch.o.r.ed by a same-store sales growth rate exceeding 4.5 percent. Driven in part by sales of branded feed lines and other consumables, operating margins improved from 7.8 percent to 9.2 percent on a gross margin increase from 32.3 to 33.1 percent, both sizeable figures and sizeable increases in the big-box retail world. The company expects further gross and operating margin improvements through better inventory management, private-label brands, and other initiatives, and expects a FY2011 earnings per share increase in the 16 percent neighborhood on top of FY2010"s 42 percent. The company has bought back about 10 percent of its shares since 2006 and plans modest buybacks going forward. Additionally, it paid its first cash dividend$.28in FY2010.
Reasons to Buy
TSCO serves a growing, specialized niche in geographies often ignored by other retailers. They carry a specialized mix of merchandise that occupies a broad s.p.a.cepart big-box hardware, part garden shop, and part feed store. Their unique target market nonetheless has broad geographic distribution, giving TSCO room for growth, and they plan to grow more than 10 percent a year, with a target of 1,800 units.
TSCO"s financials are rock solid, with practically zero debt. They have learned how to fund growth organically, and have put 450 stores on the ground in the past seven years without incurring debt, and have ama.s.sed $273 million in cash besides, again an unusual feat in the ma.s.s retail world. The company has scored high double-digit growth in sales, profits, and cash flow, and the dividend initiation rounds out this success story.
TSCO carries a higher percentage of house brands than you would find at a typical hardware retailer. They earn higher gross margins on these products and build rebuy loyalty in the process.
Reasons for Caution
There"s not a lot holding them back at this point. TSCO"s growth is bound to attract compet.i.tion. The sooner they can build out to their target size, the better they will be able to protect margins. The stock has performed very well in the past three years, so investors may want to choose their entry points carefully.
CONSERVATIVE GROWTH.
Union Pacific Corporation
Ticker symbol: UNP (NYSE) S&P rating: BBB+ Value Line financial strength rating: A Current yield: 1.6%
Company Profile
Union Pacific has been a familiar name and logo in the railroad business since its inception during the Civil War. With about 32,000 miles of track covering twenty-three states in the western two-thirds of the United States, today"s Union Pacific Railroad, the primary subsidiary of the Union Pacific Corporation, describes itself as "America"s Premier Railroad Franchise."
With 25,000 customers, a large number in today"s era of trainload-sized shipments, UP has a more diversified customer and revenue mix than the other rail companies, including the other three of the "big four" railroads: BNSF, Norfolk Southern, and CSX. Energy (mostly coal from the Powder River Basin area of Wyoming) accounts for 22 percent of revenues; Intermodal (trucks and containers on flatcars), 20 percent; Agricultural, 19 percent; Industrial, 16 percent; Chemicals, 15 percent; and Automotive, 8 percent.
The company has long been an innovator in railroad technology, including motive power, communications and technology automation, physical plant, community relations, and marketing. The company operates with one of the lowest operating ratios in the industry, 70.6 percent, meaning that operating costs account for 70.6 percent of total costs, allowing a good contribution to the substantial fixed costs of owning and running a railroad. This success has translated to a spike in operating margins discussed below.
The company also invests a lot in marketing and community relations. One example is the steam powered excursion train program, where the company operates excursions on selected track segments for the benefit of lineside communities and members of the shipping community. It recently employed Facebook and Twitter to collect 179,000 inputs on where to run the next excursion, a great buzz builder. It also lends support to historic events involving the company, such as the 2009 "With Malice Toward None: The Abraham Lincoln Bicentennial Celebration" exhibition at the Library of Congress. These may seem like fairly ordinary efforts conducted by a major U.S. corporation in the interest of branding and public relations, but for the railroad industry, these activities stretch the envelope, hence the highlighting here.
Railroads have quietly been learning to use technology to improve operations and deliver better customer service. New tools can track shipments door to door, and the railroad will accept shipments and manage them door to door, even over other railroads or with other kinds of carriers. Customers can check rates and routes, and track shipments online. These services, combined with high fuel prices, has led to a migration from trucks back to rail and intermodal rail services.
Financial Highlights, Fiscal Year 2010
Not surprisingly, car loadings sagged in FY2009, with revenues taking about a 21 percent dip from the banner year of 2008 and earnings taking a similar hit. Although some components of the traffic base, like coal for electric utilities, are relatively stable in bad times, the railroad as previously mentioned serves a diverse industrial and commodity base, and with its service to Pacific Rim ports, is also more sensitive than most to changes in international trade.
An increase in economic activity increases volume and car loadings, which helps not only to generate revenue but also absorb fixed costs more effectively, and at the same time, strengthens pricing. Railroads must not only compete with each other, but also with trucks, and when capacity is fully utilized, base rates can go up, and the railroad on top of that can use fuel surcharges as a device to at least, if not more than, recover costs. Such was the case in FY2010 and continuing on into FY2011. Revenues were up 20 percent in FY2010 and are projected up another 11 percent in FY2011; earnings were up 53 percent in FY2010 and another 18 percent, to $6.50 per share, in FY2011. A key earnings driver was the increase in operating margins from the high 20s since 2000 to the high 30s in the past two years, which is of course related to cost reductions, the pricing environment, and volume.
The company has been aggressive in repurchasing shares, and recently authorized the repurchase of 40 million shares through 2014, about 8 percent of outstanding stock. They have already repurchased about 60 million since 2005.
Reasons to Buy
It"s hard not to like a company that grows earnings 16.5 percent and dividends 10.5 percent on a mere 3.5 percent compounded increase in revenue over the past ten years. UP has managed its business well to become more efficient and at the same time more "user friendly" to its customers and to the general public. As fuel prices increase and new short- and long-distance intermodal services move higher-valued goods more quickly and cost effectively than trucks, we see a steady shift toward this business. The company has a good brand and reputation in the industry.
Reasons for Caution
Railroads are and will always be economically sensitive. They are also vulnerable to negative publicity. A single event like a derailment or spill can put them in a bad public light, or worse, tangle them up in regulation and unplanned costs. One example is the "positive train control" requirement emanating from a 2008 Southern California accident where an engineer ran a red signal while texting, resulting in twenty-five deaths and a $13 billion congressional mandate for all railroads to install the devices. The breadth of this requirement has since been attenuated somewhat but still serves as a reminder of what can happen. Finally, railroads are and always will be extremely capital intensive, meaning high fixed costs for physical plant and equipment. A decline in volumes or even a shift to other transportation requirements can be costly and hard to recover from.
AGGRESSIVE GROWTH.
UnitedHealth Group
Ticker symbol: UNH (NYSE) S&P rating: A- Value Line financial strength rating: A+ Current yield: 1.2%
Company Profile
UnitedHealth Group is the parent company of a number of health insurers and service organizations. They are the second-largest publicly traded health insurance company in the United States, with over $94 billion in revenue reported in 2010.
The company operates in four business units: The first, and largest, business unit is Health Benefits, which includes UnitedHealthcare, Uniprise, Ovations, and AmeriChoice.
UnitedHealthcare sells health insurance plans to companies and individuals, Ovations provides Medicare benefits and benefits targeted to individuals aged fifty and over, and AmeriChoice provides benefits to Medicaid clients. The company, mainly through this unit, has been an active acquirer of other familiar health care and insurance brands, including Oxford Health in 2004, PacifiCare in 2005, Sierra Health Plans and Unison Health Plans in 2008, and AIM Healthcare Services in 2009. Taken together, these operations generated approximately 92 percent of UNH"s overall revenue in 2009. As of January 1, 2010, UNH provided services to over 24,000 employer-sponsored health care plans.
The remainder of the company"s revenue comes from its health services businesses, which consists of OptumHealth, Ingenix, and Prescription Solutions. OptumHealth is a comprehensive care management and services company targeted at end consumers. Ingenix provides clinical health care data, a.n.a.lytics, research, and consulting services to other health care providers. Prescription Solutions is a pharmacy benefit management program.
Together, the four business units serve about 70 million individuals in the United States.
Financial Highlights, Fiscal Year 2010
UNH"s revenues grew 8 percent year over year to $94.1 billion, a growth rate of 7.6 percent, with earnings of $3.90 per share, representing a 20 percent growth rate. The earnings per share figures reflect the integration of acquisitions and a gradual improvement in operating margins due to benefits of scale and overhead synergies from acquisitions, also an ongoing active share repurchase program, which took about 30 million, or 3 percent of the float, out of circulation, These factors are likely to continue into 2011, and the company is guiding for between $99 billion and $100 billion in revenues. However, the company is guiding earnings a bit lower at $3.67 due to public sector employment reductions and lower Medicare/Medicaid reimburs.e.m.e.nts. Also, the company expects insured members to use the health care system a bit more as recessionary pressures ease, upping costs a bit.
Reasons to Buy
The company is one of the most solid enterprises in the health insurance industry. The year 2011 got off to a good start with a much better than expected earnings report from rival Aetna. We think many of the fears of reform and other changes will not come to affect UNH or other carriers as much as expected, so recent share prices of between ten and twelve times earnings seem to be a bargain. Of course, it also looks unlikely that demand for the core producthealth care and health insuranceisn"t going away anytime soon.
The scale of UNH"s operation gives it tremendous leverage when negotiating for the services of health care providers. Hospitals are strongly motivated to join UNH"s network, as doing so will provide a.s.surance of steady referrals.
The national unemployment rate appears to be turning to the good. After more than a year in the neighborhood of 10 percent, mid-2010 unemployment rates are in the low 9 percent range. As more people return to work, more employer-based insurance programs will require servicing.
The company recently raised the dividend from $.03 to $.48 and is changing from a yearly to a quarterly dividend cycle. This represents a large shift in approach to shareholder value, as the previous dividend was little more than ceremonial. The high level of share repurchases amplifies this shareholder return signal.
Reasons for Caution
Since 2007, the company has paid over $3 billion in fines, legal costs, and settlements pertaining to legal actions brought against them by various private and public agencies. The company is still legally exposed as a result of some actions taken by previous management with regard to Medicare payment rates. Current management appears to be serious about cleaning up the messes left behind, but the investor should be aware of this risk of additional litigation.
In addition, public sector sentiment toward the health insurance industry is hardly favorable these days; additional regulation beyond that already built into the recent health care legislation seems likely, and some insurers have been asked to roll back or delay rate increases by state insurance commissioners in response to angry const.i.tuents. These companies will have to be on their best behavior to prosper. Finally, we worry a bit about the potential effects of fiscal pressures on the public sector, and could see both employment and benefit reductions there.
CONSERVATIVE GROWTH.
United Technologies Corporation
Ticker symbol: UTX (NYSE) S&P rating: A Value Line financial strength rating A++ Current yield: 2.0%