Can This Traditional Retailer Survive Against Amazon?

Source: Macy's annual report

If you look across the retail landscape, you're bound to spot a few landmines. While the S&P 500 index has advanced 3% year to date, retail stocks in the index are down more than 5%. And while retail investors have been running for the hills, now may be the time to pick up a diamond in the rough. 

Department store retailer Macy's (NYSE: M  )  appears to be one of the gems. It competes with a host of retailers, including Kohl's and J.C. Penney on the discount side and others like Nordstrom and Neiman-Marcus that go head-to-head with its more upscale Bloomingdales. But it wasn't any of these rivals that Macy's took an early swipe at during a recent Nomura conference. The jab that it did take says a lot about where Macy's is headed and which company poses the greatest threat. And the winner is none other than online retail behemoth Amazon.com (NASDAQ: AMZN  ) .

They're coming, they're trying, they're working on it. But I think not having stores [is a] disadvantage for [Amazon] in the apparel world. 

Indeed Amazon is coming. And it is looking more and more like a department store retailer every day. Toward the end of last year it opened a 40,000 square foot studio in the New York borough of Brooklyn dedicated to fashion. Amazon snaps thousands of on-model pictures and videos a day featuring the latest fashion trends. It's the online retailer's ambition to become a "great department store," according to Amazon Fashion President Cathy Beaudoin cited in The Seattle Times.

Amazon Fashion, where the online retailer sells premium brands, is a business that's "booming," according to Amazon's annual report. So it's no surprise that Amazon wants a bigger piece of the pie. In 2012, the U.S. apparel industry achieved $370 billion in sales, and slightly more than one-tenth of that originated from the web, according to Forrester Research data cited in the Times. So there's market share to be had in e-commerce, and Amazon may seem to have the obvious advantage in this arena. But it's not a slam dunk.

While not an apples to apples comparison in light of the breadth of markets Amazon operates in, let's take a look at how both companies have grown market share over the past five years. 

Sales Chart
Company  2013  2012  2011 2010 2009
Macy's $27.9 bln $27.7 bln $26.4 bln $25 bln $23.5 bln
Amazon  $74.4 bln  $61 bln  $48.1 bln  $34.2 bln  $24.5 bln

*Source: Macy's and Amazon's annual reports

He said, she said
If Macy's is right, the very thing that differentiates the traditional retailer from Amazon -- its 800-plus brick-and-mortar locations -- could be its ace in the hole. Macy's is seeking to leverage its stores with its web presence so that there's more overlap and less of a divide between the channels. If successful, Macy's could just prevent Amazon from ever dominating the department store category. But if Amazon is right, it has the upper hand because of its "unlimited shelf space," as Beaudoin told the Times

If there's one thing Macy's knows best it's who shops at its stores. At corporate events, the company repeatedly refers to this individual as "she," and Macy's is striving to make the shopping experience as seamless as possible for her. 

Macy's rolled out an order online/pick up in store initiative (which works exactly how the name suggests) in test markets to solid demand--so solid, in fact, that the company now plans to roll the program out to all of its U.S. full-line retail locations by July.

Bridging the gap between online orders and in-store pick-up gives Macy's yet another opportunity to sell customers something else. And based on the anecdotal results (Macy's decision to expand this program and recent remarks at a Telsey Advisory Group conference), customers are taking Macy's up on this. That's not something that a single fashion studio will accomplish for Amazon. 

This same themes carries over to returns. Even when returning an item purchased online, customers prefer to visit a physical Macy's location for the transaction as opposed to shipping the item back to the retailer. Once again this gives the retailer the opportunity to upsell or inspire an impulse sale that an online retailer like Amazon misses out on. 

Where to invest
Look, when you invest in a Macy's, you're going to get more modest market growth in comparison to some of the high-flyers, including Amazon. Macy's is projecting 3% comparable sales growth in fiscal 2014 on the high end. But it's also expecting profits, whereas Amazon is guiding for a second-quarter loss on between 15% and 26% year-over-year sales growth. You've got to pick your poison, so to speak. The good news is that analysts have a median price target of $64 on Macy's, according to Thomson/First call, and for Amazon the median price target is $425; Macy's is trading at about $58.72 while Amazon is currently hovering at close to $315 per share.  

Boring is beautiful
While Amazon apparently wants to look more like Macy's, the stocks couldn't be on further ends of the risk spectrum. With Macy's, you get profitability, stability, dividends, share buybacks, and some growth. Amazon, on the other hand, is a sales machine but it's been nothing but inconsistent on the profitability front.

Macy's has more than a century and half history yet has managed to remain relevant and stable. It's one of those companies that may get overlooked because it's always been there. But in an industry otherwise plagued by controversies, missteps, and excuses, boring can be beautiful. Add to that the 2.1% dividend yield and a $2.5 billion share-buyback program, it's looking like a safe bet. Macy's has lived to tell about numerous industry hurdles, ranging from an excessive discounting environment to an overbuild of stores. Something tells me it will survive Amazon as well.

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