Wal-Mart (WMT) operates about 2,750 supercenters, which average 186,000 square feet, and feature a full grocery selection. Indeed, this category accounted for 51% of sales in the fiscal year ended January 31, 2010. This percentage has trended higher for the past ten years. This development is in line with the company’s expanding supercenter count, along with a concurrent decrease in the number of its traditional discount stores. This strategy generally has served Wal-Mart well over the past ten years or so. Lately, though, competition from small-format grocery chains, where the overall store count is increasing at an accelerating pace, appear to be hurting the giant discounter’s same-store sales.

Heretofore, one of Wal-Mart’s main competitive challenges came from the expanding  discounter, Target (TGT). That retailer currently operates about 250 SuperTargets, which are similar to Wal-Mart’s like-sized facilities, and it is in the process of rolling out an upscale (in terms of presentation and assortment) grocery line in its 1,500, or so, general merchandise stores. At present, though, a main concern for Wal-Mart  is increasing competition from small-format discount grocers, including SUPERVALU’s (SVU) Save-A-Lot and the U.S. chain of Germany-based ALDI.

SUPERVALU’s CEO, Craig Herkert, who formerly headed Wal-Mart’s Latin American operations, plans to double the number of Save-A-Lots, to 2,400, over the next five years.    These units average only 15,500 square feet. About 75% are owned by licensees, which are required to invest about $400,000 for each location; many have added sites subsequent to their original franchise. Meanwhile, ALDI’s U.S. subsidiary  plans to open 100 stores this year, including 30 in the Dallas/Ft. Worth  Texas market, which is one of Wal-Mart’ strongholds. The chain currently has more than 1,000 units. Both Save-A-Lot and  ALDI  have fared quite well since  the onset of the last recession in late 2007, thanks to their relatively low prices, which generally compare quite favorably with  Wal-Mart’s offerings. They reflect the two chains’ no-frills formats, the purchase of close-out and special situation merchandise, and the development of private-label brands covering most of their goods.

Moreover, the so-called ‘’dollar stores” carry  basic household necessities, and their recent success in attracting customers  and adding units appear to have been another contributing factor behind Wal-Mart’s  same-store sales decline of 1% in the last half of fiscal 2009 (ended January 31, 2010). The four most prominent in this category are Dollar General (DG), Dollar Tree (DLTR), Family Dollar (FDO), and 99 Cents Only (NDN). Produce grown mainly in 99 Cents Only’s headquarters state, California, comprises a relatively high percentage of the discounter’s sales. On the other hand, general merchandise, consisting largely of household commodities and basic apparel, has traditionally been the mainstay of the other three dollar stores. However, in order to increase customer traffic via food and drink offerings, they are adding refrigerated equipment in their stores. Notably, Dollar Tree expects to have a refrigerated section in 40% of its stores by the close of fiscal 2010.

In response to the aforementioned competitive inroads, Wal-Mart is considering new formats for its domestic operations. The previous introduction entailed a chain, dubbed Neighborhood Markets, whose average sized unit is 42,000 square feet.  Since initiating this concept 12 years ago, the company has only about 160 of these stores, representing slightly less than 1% of its domestic selling space. That said, management appears to be considering opening stores that are much smaller that the Neighborhood Market format, which would be similar to those in Wal-Mart’s Mexican operation.  In our view, though, the increasing challenges presented by the six small-format retailers listed above will continue to pressure Wal-Mart same-store sales growth for the foreseeable future. Too, we don’t expect a meaningful profit contribution from a Wal-Mart chain based on a smaller footprint than of Neighborhood Market for a while. Much of the company’s expected sales and profit growth over the coming 3 to 5 years is based on its expanding International division. So, shareholders should be prepared for a rough ride stateside, which will likely continue to make for impressive headlines, but solid growth overall, as foreign expansion picks up the slack. Smaller retailers, meanwhile, may finally get to play the role of David to Wal-Mart’s perennial role as Goliath.