Physical Retail vs. Amazon

In the evolving battleground that is retail, the number of brick and mortar stores falling victim to “Amazonification” is increasing at an impressive rate.  There is an element of racing to the bottom with ongoing margin deterioration for these businesses as free delivery combined with rock-bottom pricing significantly dampens profitability prospects.  It is interesting to watch how the traditional retailers are preparing themselves for war with Amazon.

In our view, it will not end well for everyone; that said, there will be survivors within the food/household essentials market.  It is within this space where retailers are utilizing a combination of technology, people and non-replicable services to differentiate their shopping experiences from online ordering.

There are notable strategies being applied by some of the largest traditional retailers to curtail Amazon’s growing market share. How well these new approaches work remains to be seen.

Walmart

The early stage rollout Walmart’s online grocery platform to nearly 1,000 stores, in our eyes has been impressive.  Customers have access to up to 80,000 items from the grocery, household essentials and other categories that can be selected online and delivered car-side in a designated holding area for no additional charge (tips are also prohibited). 

The customer places an order for pick-up with a 1-hour window for some time in the future. The online platform bakes in some intelligence based off of ordering patterns and a growing CRM system, further improving the consumer experience.

Key Differentiator vs. Amazon – PRICING

Customers receive Walmart’s best pricing with no additional charges (Prime subscription, delivery, etc). Walmart has between 6-10 associates per store putting together customer orders, using specially designed shopping software and carts to speed the process. Out of stock and appearance-based goods (produce, etc.) are left up to the associate, with input from the customer.

From our observation, it appears that Walmart has begun gathering a loyal following with this new service, given the quantity of held orders we saw during our recent company visit.

Walmart claims that an average “full load” shopping trip can take up to 2 hours and with this new system, customers can place repeat orders within, minutes saving a ton of time. The average online order size is roughly 50% greater than an in-store purchase thus offsetting some of the additional labor expense. (Source: Online Grocery Program – Walmart)

Bottom Line
While this impressive system is nice on paper, we don’t necessarily see how it is additive to the bottom line given the additional labor and equipment requirements. Nonetheless, we believe many consumers will appreciate the low prices and time savings.

Home Depot

Home Depot, in Cambiar’s view, is more immune to online competition. They are; however, facing the threat of intense price pressure within easy-to-ship commodities and items with simple price discovery. 

Home Depot has built an impressive collection of private label brands across categories, which feature higher margins and tougher comparison shopping options.  That said, Amazon has been successful in dislocating similar markets (such as computer and audio/visual peripherals) during the past couple of years with their roll-out of the Amazon Basics private label.

Key Differentiator vs. Amazon – SERVICES

Similar to Walmart, Home Depot is pushing to differentiate their shopping experience by offering services that are nearly impossible to duplicate without a significant physical presence.  Examples include tool rental, just-in-time delivery, and loading/unloading services.

Bottom Line

While there is an opportunity to build margins from additional service offerings, we see many of these initiatives as reactionary, which suggests that they may not be a huge driver for comps going forward.

Throwing Mud at the Wall

Many other broadline retailers are experimenting with a variety of expensive initiatives.  Brand-specific store-within-a-store pop-ups have shown signs of driving customer loyalty, but do not necessarily improve sales per square foot metrics.  Stores like Target that have gone through extensive store remodels/refreshes do make for a more comfortable shopping experience for the in-store consumers, but we would argue that shopping from home in your pajamas is even better.  Some retailers are also pushing more store exclusives to make comparison shopping more difficult and to drive incremental traffic; but instant price discovery for comparable items has never been easier.  More than 80% of consumers now regularly browse stores with their smartphone out, often looking for reviews or better online pricing. (Source: Pew Research)

Bottom Line

It remains to be seen if any of these efforts will stem share loss or margin compression.

Food for Thought: Grocery-Anchored Shopping Centers Represent the Front Lines of the Amazon Conflict

We believe the acquisition of Whole Foods validates Amazon’s need for physical retail and their desire to set up a “last mile” distribution architecture. Whole Foods provides Amazon an excellent step into grocery, but also allows them to be much closer to consumers’ homes. “Last mile” distribution to residences and workplaces is very expensive, and Amazon’s push to morph Whole Foods stores into mini-distribution centers, we believe, will be difficult given numerous lease restrictions and covenants.  In our view, there are two takeaways from this deal as it relates to grocery-anchored REITs: 1) The other grocery chains will not sit still and will look to improve their physical presence through bigger/better stores and more locations; 2) Amazon’s WFM buy does get them 450+ stores but is not enough to sufficiently blanket the country for last mile distribution. Amazon could look to partner or acquire other retailers with smaller footprints – maybe a drugstore, c-store, or even a bank. If you think about it, Amazon should just partner with or somehow acquire (not going to happen) the United States Postal Service given their distribution, numerous post offices, etc.  It is also worth noting, that according to our research, a majority of U.S. strip centers are now privately held.  During the last 20+ years, the publicly-traded REITs have whittled out the weaker centers within their portfolios and now only own some of the best of the best assets, including many grocery-anchored centers.  One thing is certain: the demise of physical retail space has been greatly exaggerated.

Conclusion

The war between physical retail and Amazon will be drawn out and likely result in numerous bankruptcies and statutorily lower margins for the industry.  While investors seem to have given Amazon’s infinitesimally low margin direct-to-consumer business major support by bidding the stock up from roughly $300/share in early 2016 to more than $1050/share in July of 2017, it will be curious to see how the stock reacts if retail product margins continue to be near breakeven levels over an extended period.  It is worth noting that Amazon also has the very successful AWS (Amazon Web Services) division with industry-leading margins yet AWS represents a smaller piece of their overall business.  Amazon’s 2017 200+ P/E and 26x EV/EBITDA multiples clearly do not reflect any ongoing concerns about profitability (source: Bloomberg).  From our calculations, “Amazon immune” retailers also have performed very well during the past several quarters, and now trade at a 60% premium to the “Amazon vulnerable” concepts.  Amazon has shown a desire to continue to dislocate sub-segments within retail, which has let investors’ imaginations run wild.  Will there be a day that Amazon delivers prescription medication directly to your door?  What about auto parts?  How about gas for your car?  At this point, there is no clear line on how far Amazon will go, especially as the company’s profitability is not a priority.  Successful retailers will continue to fight the good fight, but it remains to be seen what this means for longer terms margins and growth prospects.