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Cigarette Sales Are Soaring at Dollar General, Showing Why Retailers Are Addicted to Tobacco

By John Maxfield - Mar 18, 2014 at 6:05PM

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In the middle of last year, Dollar General began selling tobacco products. Since then, both its customer count and average transaction size have increased.

The anti-tobacco movement can hoot and holler all day long about the well-known negative impact of cigarettes, but the reality is that the tobacco business is too lucrative to disappear anytime soon. Few companies demonstrate this better than Dollar General ( DG 2.87% ), where sales have shot higher since the chain began stocking cigarettes in the middle of last year.

According to Dollar General CEO Richard Dreiling, cigarettes have increased the size of the retailer's average transaction by 28%. A basket without tobacco products typically adds up to $10.77. A basket with them comes to an average of $13.75.

When Dollar General first introduced tobacco products in the second quarter of 2013, roughly one-third of cigarette sales involved no other product, one-third included a single other item (a "smoke and Coke"), and the final third was part of a larger basket.

Fast-forward to today, and only 26% of cigarette sales don't include at least one other item. More important, 44% now fall into the third and most lucrative category.

Dollar General is also seeing traffic count increase as customers discover that it's in the tobacco business. Dreiling addressed this on the company's latest conference call:

If you look at the fourth quarter, we're one of very few retailers who called out the fact that we still had transaction growth. So I feel, as we move through the back half of the year, that tobacco is going to continue to do what it's been doing, deliver -- it's going to deliver transactions and then, more importantly, the attachment rate is continuing to grow.

Finally, there's reason to believe that tobacco products inherently fuel future same-store sales growth. This is because their prices are in a near-constant ascent. "The manufacturer increases the cost, which we turn around and then ... pass on to the consumer," explained Dreiling. "So there is a built-in comp there."

My point here is not to make excuses for the tobacco industry or companies that sell its products. If anything, I can't help but wonder about the morality of doing so given that cigarettes are responsible for the deaths of an estimated half-million Americans each year and cost the country upward of $300 billion annually in health care expenses and lost productivity.

Yet it's impossible to deny that companies such as Dollar General -- and any other publicly traded retailer that sells tobacco products -- are stuck between a rock and a hard place. On one side, they have the health of their customers. And on the other, they're obligated to maximize profits to shareholders.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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