Supervalu's key asset: Save-A-Lot

ST. CLOUD - Looking for mayonnaise at the new Save-A-Lot grocery store here?

You won't find Hellmann's or Kraft, but Portmann's is plentiful. It's right by the Kurtz brand ketchup and not far from the Panner peanut butter. In-store brands are particularly big -- they're cheaper.

The supermarket, while covering the food pyramid, runs extra-lean: It has a fraction of the items found at a conventional grocery store and a fraction of the employees. Even plastic bags cost consumers 3 cents apiece.

Save-A-Lot, a national deep-discount grocery chain, is a jewel for its troubled owner, Eden Prairie-based Supervalu Inc. With the grocery giant looking at selling assets, Save-A-Lot is perhaps its most marketable. Conversely, the chain will be critical for Supervalu's future if the firm isn't sold outright or in pieces.

But Save-A-Lot is facing its own challenges. The bulk of the stores are run by independent licensees, and some say the wholesale prices they're paying Supervalu are rising too steeply. And the chain -- like the rest of Supervalu -- is facing increasingly intense competitive pressure.

"Everyone selling groceries is our competitor, and in the last few years, everybody is trying to play in this arena," said Santiago Roces, Save-A-Lot's chief executive.

From Target to dollar stores to broad-line retailers like Menards, low-cost food offerings abound.

Save-A-Lot has been an important asset since Supervalu bought it in 1992. It's more profitable than Supervalu generally, and it has lots of growth potential -- unlike most of the rest of the firm.

Recently ousted Supervalu CEO Craig Herkert made Save-A-Lot a cornerstone of his plans, with a goal of adding 80 to 90 stores annually. That's been scaled back as Supervalu's woes multiplied, and the company aims to add 40 stores in its current fiscal year. Still, expanding St. Louis-based Save-A-Lot is a priority.

"I think Save-A-Lot can be a growth engine for a long time," said Jim Hertel, a managing partner at supermarket consultant Willard Bishop. "There is probably room to double or triple the store base."

There are only two Save-A-Lots in Minnesota, in St. Cloud and Duluth. But with 1,340 stores nationally, Save-A-Lot is second only to Wal-Mart in the number of grocery outlets. Of course, a Save-A-Lot requires far less investment than a traditional supermarket.

Supervalu's conventional stores average 52,000 square feet and have 40,000 to 50,000 items, with lots of choices in sizes and brands. A Save-A-Lot averages 15,000 square feet and has about 1,500 items, often one size or brand per category. And about 80 percent of those brands are in-house.

Thrifty clientele

The St. Cloud Save-A-Lot is owned by St. Cloud-based Coborn's Inc., which operates around 40 traditional supermarkets, primarily in Minnesota under the Coborn's banner. The company has run three other Save-A-Lots -- in Dubuque, Iowa; Freeport, Ill., and Beloit, Wis. -- since the early 2000s.

About 70 percent of Save-A-Lot outlets are owned by licensees like Coborn's, which commit to buying groceries from Supervalu's wholesale operations, while the other 30 percent are corporately owned. Their clientele is the same.

"The Save-A-Lot customer is more driven by price," said Bruce Miller, a Coborn's district manager. He did a recent price survey of 64 equivalent, private-label items at the St. Cloud store and a local Wal-Mart, and found Save-A-Lot to be 15 percent cheaper.

But Wal-Mart, the usual winner in supermarket pricing surveys, is particularly known for rock-bottom prices on a wide selection of national-brand goods. And it's just the leading edge of the discounting juggernaut in the grocery business.

Aldi, which has a concept very similar to Save-A-Lot's, has upped its growth rate in the United States in recent years, and now has more than 1,200 outlets. Dollar stores, which are growing at an explosive rate, have been boosting their food offerings.

"The demographic [Save-A-Lot] is after is increasingly being served by literally tens of thousands of dollar stores," said Chuck Cerankosky, a stock analyst at Northcoast Research. Cheap food has become a competitive weapon for broad-line retailers, be they dollar stores or Target.

All that competition has played a key role in Supervalu's tumbling fortunes, since its chains -- aside from Save-A-Lot -- generally have higher prices. But in Supervalu's last quarter, even Save-A-Lot got dinged.

Its same-store sales, which usually increase, were down 3.4 percent compared to a year earlier and its operating profit fell. The news shocked some stock analysts who follow Supervalu.

"Former hidden jewel Save-A-Lot appears much less attractive than we originally believed," JPMorgan Chase analyst Ken Goldman wrote in a research note. "How can a hard discounter's [same-store] sales decline with unemployment so high?"

The bad quarter certainly didn't ease the discontent brewing among some Save-A-Lot licensees.

"When growth became their number-one priority rather than operations, they lost some focus on pricing and promotion in their existing stores," said Tom Jamieson, a western Pennsylvania-based Save-A-Lot licensee with 10 outlets.

Jimmie Gipson, head of the largest Save-A-Lot licensee, agreed on the pricing issue. Supervalu, as wholesaler to Save-A-Lot stores, "had kept its costs pretty much in line for several years, but I think they've lost a little of that focus."

Wholesale price increases trickle down to retail, pressuring Save-A-Lot's deep-discount concept, said Gipson, CEO of Bowling Green, Ky.-based Houchens Industries, which owns more than 200 Save-A-Lots. "They've been heading away from their niche, and that's trouble."

For licensees, "it's certainly a squeeze and a very challenging time right now," Gipson said.

Sale potential

Gipson and Jamieson said the best outcome -- for licensees, at least -- would be spinning off Save-A-Lot into a co-op. But to do that, licensees must band together and find financing -- possibly in tandem with a private equity group. "That's a big apple," Gipson said.

Save-A-Lot seems likely to attract potential corporate buyers. The chain "is a natural sale candidate with its standalone nature," Citigroup analyst Deborah Weinswig wrote in a research note Friday.

She believes Save-A-Lot could fetch up to $2 billion, though there are some obstacles, including heightened competition and "potential internal issues," including recent management turnover. She was referring to the exit of the chain's veteran chief operating officer.

Supervalu declined to comment on the disposition of Save-A-Lot or any of its operations.

But Roces, who was hired by Herkert as Save-A-Lot's CEO just 15 months ago, said he's aware of licensee concerns. "Their success is our success. We are trying to do everything we can to listen to them."

The chain is focusing on cutting costs and streamlining operations even more, Roces said.

Much of the dry goods in a Save-A-Lot outlet -- from cereal to potato chips -- are hauled onto the floor in the boxes in which they arrived. Cardboard is cut away, making the goods available to consumers sans shelves.

Since shelves don't need to be stocked, labor costs are less. The company is working on a similar concept for milk and eggs, in which pallets are wheeled directly into coolers, eliminating the need for stocking cooler shelves.

"We're focusing on reinvigorating the strengths that made this company so successful," Roces said.

Mike Hughlett • 612-673-7003