It's Time To Find Out If Wal-Mart's Biggest Asset Is Its Store Base?

| About: Walmart Inc. (WMT)
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Like all retailers, WMT is facing stiff competition from Internet-focused retailers.

WMT has long said its stores are a key advantage.

The grocery pick up roll out will help to prove if this is true.

Image Source: Wal-Mart

Wal-Mart Stores (NYSE:WMT) is the world's largest retailer. But that hasn't saved it from the inroads being made by Internet retailers like online giant (NASDAQ:AMZN). And as Amazon encroaches ever further into the retail world, brick and mortar stores like Wal-Mart have to fight harder and harder to keep their customers. That's remained true even as Wal-Mart claims its stores are a competitive advantage. The company's grocery pick up foray might just help prove this out.

Internet pain
There's no question that the retail landscape is changing dramatically because of online shopping. Going into a store or mall will never be replaced, it's just too much fun. But that doesn't mean that the world we live in today will remain the same.

This is one of the reasons why I believe a company like Taubman Centers (NYSE:TCO), with a small portfolio of high performing enclosed malls, is a better bet than a mall REIT with a big portfolio. It's a lot easier to make sure a small portfolio of malls is drawing a crowd than to ensure that 200 malls are all pulling people in.

But the online/offline fight has been getting increasingly intense and reaching into areas that once might have seemed ill-fit for online shopping. For example, after several high profile implosions early in the days of the Internet, buying groceries online appears to be gaining traction. Grocery stores are playing a big roll in that, but Amazon is rolling out its own service, too. That's a real problem for Wal-Mart, which is one of the nation's largest grocers.

Image Source: Wal-Mart Location, location, location
For years Wal-Mart has touted its stores as a huge benefit on the distribution front. Don't underestimate this issue, Amazon spends more on fulfillment than it does on technology. Fulfillment costs have gone up 25% in each of the last two years, and rose nearly 35% in 2013. Fulfillment costs were 12.5% of sales last year. This is a big expense item for the online giant.

So, while Amazon may be growing fast, Wal-Mart may actually be on to something if it can turn its roughly 5,000 domestic Wal-Mart and Sam's Club stores into distribution hubs. And on that front, it's testing what could be the killer "app," or, in this case, brick. It's rolling out curbside pick up for groceries to roughly 200 stores across 30 cities.

This test won't make or break Wal-Mart or, in all honestly, stop Amazon's ascent in the retail sphere. But it very well may create a niche that holds the line for Wal-Mart as Amazon increasingly tries to topple the giant's grip on consumers.

The biggest draw for this service, however, looks like it will be the one thing that Wal-Mart is best known for: Price. Both Amazon and Wal-Mart offer the online ordering of groceries bit and the fact that someone else does the grunt work of picking out all the stuff you want. But remember all those fulfillment costs Amazon faces? Well it hasn't exactly figured out how to get groceries to its customers for as little as Wal-Mart is charging for its store pickup service, which is free. In fact, I'm pretty sure Amazon is going to have a hard time matching that.

For example, for Amazon Prime customers the cost is $6 per box full of food-but all of the food is really pantry stuff, nothing that would spoil. And delivery, which can take a couple of days, is relatively slow. Amazon Prime Fresh customers, meanwhile, have access to food that would spoil but have to pay $299 a year, which comes with free shipping on orders over $50 and all the other Prime goodness (like movies and music streaming). But, ultimately, Amazon is trying to pass fulfillment costs on to customers for what are basically heavy and bulky items.

Now, to be fair, Wal-Mart's pick up service may be free for customers, but it comes with costs for Wal-Mart. After all, it has to pay people to pick out groceries for you and bring them to your car (not to mention the cost of maintaining the associated website). That's no different than the costs that Amazon is facing, though driving food to a person's house will, clearly, cost more than walking out to a car parked next to a physical store. But, in the end, the question may really be can Wal-Mart preserve enough volume (maybe even expand it) to make up for the margin compression inherent in its "free" model?

If the answer to that question is no, then Wal-Mart will likely shift course and either start charging a fee or just go with delivery at a cost over store pick up. But here's something to think about, Amazon can only do groceries in just so many places if it hopes to benefit from economies of scale. Basically, it needs large metropolitan areas. Wal-Mart, because it has stores littered throughout the country, can probably make a go of its pick up service in places that Amazon is years away, if not longer, from touching.

A litmus test
I believe it will be important to watch the success of Wal-Mart's pick up service to see if it can gain a toehold against Amazon's grocery delivery services. If the answer is yes, it means Wal-Mart's brick and mortar stores could turn out to be as important as the company says they are. If Wal-Mart abandons grocery pick up, it's a bad sign and might mean that Wal-Mart's future will include a smaller store base than exists today. If you own Wal-Mart or Amazon, this is a competitive battle worth watching.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.