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After a holiday season that ended up seeing stronger sales than we and others had expected, the battle for primacy in e-commerce is set to get a lot more competitive in the coming years.

Overall, retail sales this holiday season were up, year over year, despite some selectively-challenging economic conditions and a 7% unemployment rate. The sales yielded unusually low profit margins, however, as retailers, fearing a weak season, began aggressively discounting their wares in the final weeks. Indeed, United Parcel Service (UPS) and FedEx (FDX) had trouble dealing with the wave of sales brought on by discounts for last-minute shoppers. Indeed, some shoppers at Wal-Mart Stores (WMT - Free Wal-Mart Stock Report) and Amazon.com (AMZN) did not receive their Christmas presents on time this year. While the retailers laid the blame on the package delivery companies, some point out that the stores had pushed the limits of what could be delivered before December 25th, by pushing deadlines too close to the holiday with last-minute promotions to raise volumes. Furthermore, with a significantly shorter holiday season this year (there were six fewer shopping days between Thanksgiving and Christmas this year than last), there was minimal room for error.

The fumble in delivery times highlighted this year’s surge in online purchases. Whereas e-commerce represents about 6% of overall U.S. retail sales, according to the Department of Commerce, this holiday season saw about 14% of aggregate sales taking place online. While online retail generally accounts for a higher proportion of sales during the holiday season than the rest of the year, this year’s figure saw a double-digit surge over last year’s, despite relatively flat sales at brick-and-mortar stores.

In the e-commerce industry, Amazon still reigns supreme, accounting for a multiple of the retail site visits of its nearest competitor on that metric, Wal-Mart. Indeed, despite Wal-Mart’s decade-long presence in Internet commerce, Amazon’s online sales are still a large multiple, as well. Wal-Mart has renewed its efforts to catch up with its biggest competitor in the field, but with a different strategy. While Amazon is currently ahead, Wal-Mart plans to use its stores and distribution centers to gain an advantage over competitors by establishing the industry’s strongest fulfillment network. Whereas Amazon’s model is based on fulfilling orders from its warehouses, Wal-Mart can rout orders to its own stores that are often far closer to customers.  Time will tell whether this model can eventually shake Amazon from its perch atop the e-commerce industry.

For now, Amazon shares are riding high as the company appears set to have achieved a 23% advance in revenues for the full year 2013. However, its earnings are still significantly lower than in previous years due to a decline in margins, which is attributable to its expansion efforts. Specifically, it has been heavily investing in Amazon Web services, as well as adding capacity for the company’s fulfillment operations. After this period of heavy investment, the company appears set for double-digit top-line growth in the coming years and lessening cost pressure. Profit margins should begin to turn around in earnest over the coming quarters. Indeed, we expect the company to set an all-time record for earnings per share in full-year 2014 and experience double-digit growth in share net out to 2016-2018. However, at the stock’s current, lofty price, we do not project particularly good shareholder returns for the near term. 

As of our last report, Wal-Mart planned to have $10 billion in global online sales in 2013, which it hopes to increase to $15 billion by 2014, as its commitment to offering the broadest product selection at the lowest prices, while taking advantage of its distribution system and proximity to customers, should give it a competitive advantage in the growing field. Its brick-and-mortar operations, however, are seeing a slowdown after several solid years. In particular, international expansion is slowing, as developing economies, such as China and Brazil, have hit rough patches following many years of leading global growth. Furthermore, the company has put the brakes on plans to expand into India through local partners, as that country’s deregulation of its retail industry has, thus far, proven to be insufficient to attract foreign investment on a major scale. A bright spot, however, is the company’s Neighborhood Market stores. Wal-Mart plans to more-than-double the number of these outlets by fiscal 2016. The locations, which are best described as a mix of a drug store, dollar store, and grocery store, compete directly with supermarkets, have relatively high profit margins, and have an advantage in regards to lower distribution costs, as they can be stocked with inventory from Wal-Mart’s own supercenters. Wal-Mart shares are currently trading at a conservative valuation, with the P/E ratio standing well below the Value Line median for all stocks.

In short, after a holiday season in which the ability to fulfill orders in a timely fashion was more difficult than retailers had expected, the industry’s behemoths will find themselves locked in a competition to provide the best fulfillment, product offerings, and prices for e-customers going forward. The already competitive industry is set to get even more challenging.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.