July 2023
During a two-week visit in late March 2023, Walter Scott investment managers Alistair Ceurvorst and Jamie Zegleman attended 21 company meetings across five sites in the southern US region – from Miami, Jacksonville, Atlanta and Nashville through Springfield to Dallas and Austin. Here they discuss their findings.
As always, meeting with companies is a vital part of our research process. On this occasion, it provided additional value in hearing from businesses and their customers on whether the major macroeconomic factors were having any effect, if at all. At the same time, supportive fiscal policies like the Chips Act and Inflation Reduction Act (IRA) had begun to take effect.
Banking crisis not yet a crisis
On this trip, we visited Jack Henry Associates, which provides core banking software to small community US banks. Meeting with management at the company’s headquarters in Springfield, Missouri, they were somewhat optimistic on the banking crisis situation. The CEO suggested that Silicon Valley and Signature Bank were very specific cases and he did not believe this was reflective of endemic risk-taking in the wider community banking sector.
Jack Henry’s customers include approximately 950 commercial banks and savings institutions, and 700 credit unions. Its largest customers account for between 50-100 basis points of revenue and they typically have a US$35 billion balance sheet. Jack Henry believed this diversification would help to insulate it from those potential banking risks.
Changing consumer habits
From our discussions with Dollar General, the discount grocery retailer, it’s clear that consumer behavior is changing and many shoppers are feeling the pinch of the inflationary environment. Customers are choosing more private label goods and shopping more regularly in “value alley,” the company’s one-dollar aisle (where comparable sales were up 30% year over year in the fourth quarter 2022).
Long term, the company believes it can continue to pursue its goal of expansion. Dollar General works with surgical precision to analyze zip codes with incomes, population density and competition positioning to ensure the right locations. Growth is underpinned by white space opportunity but also broadening its offering with different formats, such as fresh produce which attracts customers in higher income brackets too.
Retailers’ resilience
In our view, two other seemingly unassuming businesses with impressive customer insights and the resilience to withstand a potential weaker environment are O’Reilly Automotive and Tractor Supply. O’Reilly is a specialty retailer of automotive aftermarket parts, tools and equipment, with almost 6,000 stores in 47 states and 42 in Mexico.
We believe O’Reilly’s extremely strong customer-focused culture is also an advantage. Added to this, the company has a sophisticated inventory system that keeps track of customers’ preferences and sales trends to get the right products where there is demand. On our tour of an O’Reilly distribution center, we were able to witness this competitive advantage first hand.
We had a similarly positive experience visiting a Tractor Supply store in Tennessee. It is the largest retailer of farm supplies in the US, operating in 49 states. On our visit, the store manager took the time to stop and speak to numerous customers that he clearly knew well, including the owner of a pet goat, who was bringing it in for its regular shampoo. This was definitely the most bizarre and probably most memorable part of our trip!
Talking with Tractor Supply’s CEO and CFO, it was interesting to hear how market growth over the last three years has been driven by higher rates of pet ownership and rural/interstate migration. These trends have brought new customers to Tractor Supply and represent an ongoing annuity stream going forward. Hence, why they are comfortable that, while growth will slow (relative to recent years), there shouldn’t be a sudden drop off. Over the long term, they believe the market should grow at around 2% and Tractor Supply should be able to outgrow this materially, via same-store sales of 4-6%.
Interstate migration
On the topic of interstate migration, we saw first hand how the southeastern states are booming, with the appealing combination of warmer weather, lower taxes and a more business-friendly environment. Visiting Tesla’s Gigafactory in Austin was a prime example of this. The sophistication of automation in action was impressive – although there remains a meaningful amount of human interaction in the process too. Currently, Tesla employs about 8,000 people at the site, but this is expected to increase to 15,000 when the site is fully finished.
As the largest distributor of heating, ventilation and air-conditioning systems in North America, it wasn’t surprising to hear from Watsco that the company has seen increased air-conditioning unit sales with the migration to the Sun Belt. It’s also a beneficiary of improved efficiency regulations, and now federal and state level support via the Inflation Reduction Act, which will incentivize consumers to install more energy efficient units. Watsco has been investing through the pandemic in distribution, inventory management and price management technology which they should be able to leverage in coming years.
Reshoring is for real
Probably one of the biggest talking points of the trip was, unsurprisingly, around supply chains and the reshoring/ near-shoring developments taking place in the US. Undoubtedly, supply-chain challenges brought about by Covid-19 have changed corporate mindsets. No longer is cost the single focus, but diversification and security of supply are now critical. Government support in the form of the IRA and the Chips Act is incentivizing businesses to make the necessary changes.
Regardless of the somewhat challenging economic environment, we believe that there are still plenty of high-quality US based businesses with strong brands, robust balance sheets and the ability to innovate. These companies are not simply surviving, but exploiting the current inflationary environment to their advantage. Based on our discussions in the US, we returned to Edinburgh with a real sense of optimism.
1 Source: Reshorenow.org; Reshoring Initiative 2022 Data Report, as of March 2023.
2 Source: US Census Bureau, 2022 National State Population Estimates, as of December 2022.
3 Source: USDA-Foreign Agricultural Service, U.S. Agricultural Exports Hit Records in FY 2022, as of November 2022.
4 Source: World Population Review and USDA, Beef Production by State, as of April 2023.
5 Source: Dollar General corporate information. As of June 2023.
6 Source: Tractor Supply Company corporate information. As of June 2023.
7 Source: O’Reilly Auto Parts corporate information. As of June 2023.
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