Will Brick And Mortar Stores Beat Out Amazon?

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Amazon (NASDAQ: AMZN) is the undisputed king of Internet retail. Wal-Mart (NYSE: WMT) is the world's leader in brick and mortar retail. Although Amazon has no intention of building stores, Wal-Mart has been trying to take on Amazon on the net for years. Could the low-cost leader's stores be the Amazon killer?

Missing the Boat

There's no question that Wal-Mart missed the boat on the internet retail revolution. Since there are so many other brick and mortar stores that made the same mistake, it's in good company. However, that doesn't mean it's looking the other way. The company has been surveying the retail landscape and its operations, looking for the right way to integrate its brick and mortar and online businesses.

Showrooms

Owning physical stores is an expensive proposition, and one that creates an instant disadvantage. For example, Best Buy (NYSE: BBY) has famously been fighting the “showrooming” effect. Since the electronics retailer basically sells commodities, customers often go into its stores to look at items and then order them online at a cheaper price.

This trend has forced the company to compete more aggressively on price and to rework its business model. That's been bad for Best Buy and helps to explain why the company has been bleeding red ink.  The company's shares have advanced from the low teens to over $25 over the last six months or so, but it still faces huge headwinds.

Best Buy is making the right moves, but it isn't clear that it will be able to compete with both online retailers and brick and mortar competitors. For example, the company's profit margins reached a high of about 5.5% in 2007, but have more than halved since. That's a huge drop, and even if it can regain some of that lost ground, the business isn't what it once was. Investors should sit on the sidelines until the bottom line gets stronger.

The Magic of Stores

Macy's (NYSE: M), meanwhile, has used its stores to good advantage. While it too sells commodities, it has shifted its selling approach since the 2007 to 2009 recession. It has been pushing salespeople to engage with customers to improve the shopping experience, turning Macy's into a store in which customers want to shop.

That's been a huge benefit, with the first quarter marking the 13th consecutive quarter of same store sales growth of 3% or more. That's driven top and bottom line growth and a more than doubling of the profit margin since the recession ended. The shares have been hitting multi-year highs recently, but growth investors might still find the shares interesting. The price to earnings ratio is only around 14 and sales prospects remain solid. Conservative investors, however, should probably wait for a pullback.

Distribution

Amazon's big business is really distribution and fulfillment. The company's scale here is why it is a leader in the online space. That said, its margins started the century in the mid-single digits, but have now fallen into the 1% to 2% range as expansion costs have taken a toll on the bottom line. These expenses helped pushed earnings into negative territory last year.

The shares, meanwhile, are priced for perfection, trading near all-time highs. Should anything go wrong, investors will likely jump ship. Conservative and moderate investors are best served looking at other options.

Interestingly, Wal-Mart is also a distribution wizard. While scale is one of the most often cited strengths at the retail giant, its ability to cost effectively get wares to consumers through its massive store network is vital to its ability to keep costs low. It's started looking at using that to its advantage in the Internet space.

More Hubs

Amazon uses a collection of large warehouses to fulfill its orders quickly and efficiently. Wal-Mart started with a similar model, but has been shifting its thoughts on the matter. Now it is experimenting with viewing its stores as the warehouses. It is using technology to pick the best store from which to fill an order, then getting an associate to pluck the item from the shelf and mail it.

That potentially puts Wal-Mart's “warehouse” just down the street from its Internet customers. That saves mail time, reduces inventory costs, and reduces the need for dedicated warehouses. If Wal-Mart can pull off the technology and systems to make this work, it could quickly start to gain ground on Amazon.

In fact, the company's margins are currently in the 6% range, several times larger than Amazon's. That gives Wal-Mart a huge head start on the bottom line at the same time that Amazon has been sacrificing its margins for growth. If Wal-Mart can use existing stores to fulfill online sales, it should be able to build its online business without sacrificing its margins like Amazon has been. 

And, while Wal-Mart may not be able to overtake the giant in developed markets where Amazon has great brand recognition, it does create a model that it can apply to up and coming markets. For example, the company purchased a majority stake in Chinese online site Yihaodian and already has around 400 stores in the country. If it can turn those stores into virtual warehouses, it can start to build a business in a market that Amazon has had trouble figuring out.

Lumbering or Nimble Giant?

Wal-Mart shares have been hitting all-time highs of late and don't offer the same value they did at the start of the decade. However, if the company can get a handle on the Internet by using its stores as fulfillment centers, there could be notable opportunities for growth ahead. And its around 2.5% yield should still interest income investors.

To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they’re planning to ride the waves of retail's changing tide. You can access it by clicking here.


Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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