Amazon (AMZN) and Wal-Mart (WMT) are revolutionizing retail. These two juggernauts are both notable for the streamlined logistics that undergird their low-cost price model. Value conscious consumers are either making the trek to the local Wal-Mart on the outskirts of town, or logging on to Amazon from the convenience of their own home to load [virtual] shopping carts full of deals. The New York Times critiques a study dating back to 2005 claims that Wal-Mart business practices translate into a 3-percent decline in overall U.S. consumer prices. The Wal-Mart effect therefore generates $2,500 in savings for American households.
Competitive advantages for Wal-Mart and Amazon effectively serve as wealth transfer payments within American society. At present, Main Street America is being torn in multiple directions. Although Wal-Mart employs 1.2 million U.S. associates, these people only earn an average full-time hourly wage of $9.98. Further, Amazon has stolen share from traditional retailers, but it has also created millionaires out of everyday folks, such as the self-published Amanda Hocking. Our new normal for retailing is also demanding the municipal officials revisit traditional city planning schemes. For example, sprawling shopping malls are being replaced with intimate town centers.
As investors, it is critical that we get in front of these developing trends and plan strategically. Fittingly, this new normal for retail coincides with a "Lost Decade" of meager stock market returns. Financial markets remain effectively at a standstill, where deflationary cost-cutting practices intersect Federal Reserve monetary easing.
Both Wal-Mart and Amazon compete for business on price. From its humble 1962 beginnings in Northwest Arkansas, Wal-Mart has grown into the world's largest retailer, grocer, and private employer. Behind sheer size alone, Wal-Mart is rewarded with price concessions from suppliers who are happy to fill enormous orders. Lawmakers will also extend tax breaks for Wal-Mart, in exchange for creating jobs for constituents. Meanwhile, Amazon applies Wal-Mart's business model to Web 2.0 technology. As an online retailer, Amazon bypasses payroll costs for trained staff, expensive leases for showroom space, and burdensome sales taxes for its customers.
Taken together, Amazon and Wal-Mart are $347 billion businesses that hawk consumer electronics, books, automotive parts, clothing, music, and groceries at a deep discount. Granted, savvy shoppers who patronize Wal-Mart and Amazon are able to reap significant savings as individuals. For society at-large, however, trickle-down and multiplier effects vanish amid deflationary business practices. Long-term success for Wal-Mart and Amazon requires that many of our trained labor, management, and small business jobs be replaced with overseas call operators, entry-level clerks, and elderly greeters taking down slightly more than minimum wage. At present, The Federal Reserve remains as our only counter against this deflationary cycle.
Federal Reserve Board and U.S Economy
Earlier this month, Ben Bernanke and the Federal Reserve Board highlighted weak job growth and deteriorating consumer confidence as emerging trends in a midyear report to the U.S. Senate. Today's bleak economy arrives in the aftermath of an unprecedented zero federal funds rate campaign alongside the move towards a semi-permanent $2.8 trillion balance sheet that began in Q4 2008. On July 23, 2012, the ten-year treasury yield touched a record low at 1.44 percent. Investor capital is flowing out of Europe and into U.S. Government debt still regarded as a safe-haven. At these levels, technocrats have no ammunition left to manage recession.
For savers, these trends are unprecedented events. Wage increases are non-existent, while interest rates on savings are zero. Cheap money policies are propping up an oil and gasoline boom, while also sparking hyperinflation for education costs. Federal Reserve policy will remain accommodative to the financial sector, which accounts for more than 20 percent of our GDP.
Within this economic environment, Americans clamor for job creation and immediate point-of-sale savings at all costs. In 2011, Illinois Senator Richard Durbin sponsored the Main Street Fairness Act. The Main Street Fairness Act proposed a uniform tax code for online sales, which would close the competitive gap between brick and mortar retailers and Amazon. This bill, however, has stalled in Congress, as E-Bay argues that small businesses lack the manpower for online tax collection.
American citizens are likely to reject proposed tax increases amid recession. Traditional businesses will remain at a competitive disadvantage against built-in tax breaks on Amazon purchases. Consequently, the public sector risks suffering from lost sales tax revenue. On the outskirts of town, Wal-Mart looms as a viable option to attract traffic, provide entry-level jobs, and pay its fair share of taxes.
This is a new normal for retail and we must invest accordingly.
The Bottom Line
All investments within the retail complex remain in jeopardy of steep losses. Best Buy (BBY) is an example of a 90's story stock that failed to re-engineer itself alongside the New Economy. In another defining event for survival of the fittest capitalism, Best Buy is quickly going the way of its now obsolete Radio Shack (RSH) and Circuit City predecessors. This Big Box retailer is losing the siege on both fronts to Wal-Mart and Amazon. In a scathing piece, Larry Downes and Forbes Magazine degrade Best Buy as little more than a showroom. Downes claims that cost-conscious consumers visit Best Buy only to handle merchandise, before heading out to Wal-Mart or logging onto Amazon to make purchases.
Over the course of the past seven years, Best Buy shares have imploded from $55 to $20. In response, embattled Best Buy executives pledge to close dozens of stores and terminate thousands of workers to cut roughly $1 billion in costs. Going forward, Best Buy stock will underperform.
Best Buy is merely the canary in the coalmine for traditional retail. The Barnes and Noble (BKS) business model is also in jeopardy and its stock should be avoided. Amazon and Apple's (AAPL) digital content model challenges old school print publishing.
Commercial real estate investment trust (REIT) shares are in danger of collapse. Desperate savers have been buying into REITs as means to generate yield amid this zero-rate environment. Shopping mall owners Simon Property Group (SPG) and Tanger Factory Outlet (SKT) shares trade for 30 and 70 times earnings, respectively. Both of these stock valuations far exceed economic reality. In 2009, The Wall Street Journal, blamed recession for transforming American shopping malls into "ghost towns." More recently, The Economist describes the retail sector as "overbuilt" to the point where numerous shopping malls are beyond revitalization.
As is the case with any technology company, Amazon is a historically volatile investment. Currently, Amazon shares trade for $225, or 185 times earnings. To justify this lofty Wall Street valuation, Amazon net income would need to more than double over the next few years. Interestingly, earnings actually declined into 2011, when Amazon made only $631 million. In 2010, Amazon collected $1.15 billion in profits on $34 billion revenue. Although the e-commerce model is revolutionizing retail, Amazon stock is overvalued at present and in jeopardy of price correction heading into recession. Over the long term, however, Amazon shares will significantly outperform stock market indices. As an alpha stock, Amazon performs especially well amid economic recovery.
Wal-Mart is now a leading economic indicator that integrates e-commerce alongside its traditional brick and mortar retail operations. Wal-Mart, similar to Microsoft and Exxon, is a global behemoth that deviates little from the general script. Wal-Mart shareholders should remain content with a stock that slightly outperforms the S&P 500 Index and pays out healthy dividends.
In this new normal for retail, Wal-Mart is a conservative, beta stock.
Disclosure: I am long AAPL.