Nestle better insulated from cost inflation than rural-heavy rivals: ICICI Sec's Manoj Menon

FMCG and retail stocks are under pressure as inflation concerns and weak monsoons threaten India's consumption narrative. Nestle India shares plunged 8% on Thursday amid growing worries of cost inflation.

However, Manoj Menon, head of research and consumer analyst at ICICI Securities is of the view that diversified and premium-focused businesses such as Nestle could benefit from steady urban demand. In contrast, Dabur India and Emami are exposed to the risk of weak rural incomes.

Retail giant Avenue Supermarts (DMart) is also struggling with margin woes and intense competition from quick commerce (QC) companies. Rather than attempting to replicate 10-minute delivery models, Menon said that DMart's strongest defense is leveraging its price advantage where QC networks cannot compete profitably. Edited excerpts:

DMart’s margin for the September quarter (Q2FY27) came as a disappointment, falling 30 bps (basis points) year-on-year to 7.3%, in the backdrop of cost pressures and stiff competition from QC companies. Avenue continues to scale store additions, but productivity remains subdued. It remains uncertain whether newer store ramps can offset this drag without diluting overall return ratios. What underlying factors are weighing on DMart's retail productivity?

DMart’s retail productivity is under pressure. This is mainly due to competition from quick commerce and changes in DMart’s store network. Store-level analysis shows that about 80% of DMart’s trade areas already overlap with quick commerce services. These services are taking away frequent, small top-up purchases because they are more convenient.

At the same time, mature metro stores are reaching their physical capacity during peak hours. DMart’s rapid expansion—adding about 85 stores in FY26 to reach 500 stores—has also led to some cannibalization. New stores in tier-1 and tier-2 markets are growing faster than the company average, but they start with lower sales and take longer to reach full potential. In addition, high-margin general merchandise and apparel (GM&A) has stayed at about 23% of revenue, providing limited support to overall store sales.

Management has acknowledged that smaller-basket shoppers are migrating to QC due to convenience, a behavioral shift they expect to persist. You have also pointed out that the bigger risk for DMart is QC progressively increasing basket size and taking a greater share of planned household purchases. Given this, what changes can DMart bring to its existing offerings/model to defend its market share?

Instead of changing its core business model to copy 10-minute delivery services, DMart’s strongest defence is to increase its price advantage in areas where quick-commerce companies cannot compete profitably. Management’s main priority is to keep prices lower for weekly and monthly grocery shopping, so value-conscious households have no financial reason to move planned purchases to convenience apps.

At the same time, DMart is expanding its store network in a disciplined way, with a target of adding about 15% more stores each year. This will bring stores closer to customers in underserved areas, reduce travel inconvenience, and use the lower property and operating costs in tier-1 and tier-2 markets to protect returns.

On the digital side, DMart Ready supports the main business instead of becoming a high-cost growth channel. It focuses on scheduled delivery of large orders within six hours in densely populated and profitable areas. DMart is also strengthening its non-food FMCG and GM&A ranges, where dark stores do not have enough shelf space or supply-chain scale to compete effectively.

With inflation pinching household budgets hard and weaker monsoon, how are value-focused retailers having a wider presence in tier-2 and tier-3 markets expected to fare in H2FY27? Are margin compression risks intensifying? Which retailers would be more impacted?

Value retailers in tier-2 and tier-3 markets will perform differently in H2FY27 depending on whether they mainly sell essential goods or discretionary clothing. High food inflation and weak cash flow in rural areas are forcing middle- and lower-income households to spend more on basic food. As a result, fewer customers are visiting stores for non-essential items, and people are buying clothes less often.

The risk of lower margins could rise for value apparel retailers as store operating costs remain high. At the same time, raising prices in price-sensitive semi-urban markets can reduce sales volumes. This forces retailers to offer large discounts to clear unsold stock. Therefore, regional and semi-urban value fashion chains such as V-Mart Retail, Style Baazar, and City Kart are likely to face greater pressure on margins.

In comparison, large grocery discount retailers such as DMart and mixed-format retailers such as Vishal Mega Mart are likely to be more resilient because price-sensitive customers may shift to discount stores to reduce their household grocery spending.

El Nino conditions and rising raw-material costs are key risks to growth and margins of FMCG companies. Which FMCG companies are likely to be the worst hit from a near-term perspective? And which ones are likely to do well, and why?

Uncertain weather and higher commodity costs will affect mass-market companies focused on rural areas more than premium companies focused on urban markets. Companies that depend heavily on rural sales, which make up 35%-45% of their total revenue, and use agricultural raw materials that are becoming more expensive are likely to be hit hardest. These include Dabur and Emami, which are exposed to weak rural incomes.

In contrast, urban-centric diversified and premium-focused businesses such as Nestle are likely to perform better. These companies could benefit from steady urban demand, strong brands that support price increases and growing demand for premium products, which help protect gross margins from uncertain rural conditions.

The Nifty Smallcap 100 and 250 indices have risen by about 10% each so far in 2026, while the benchmark Nifty 50 index is down 13%. Small cap mutual funds recorded a third consecutive month of robust inflows in September, drawing a record ₹9,038 crore, according to AMFI data. What factors are driving investor appetite for higher-risk smallcaps, and conversely, what is causing large caps to fall out of favour?

The strong rise in small caps, while the benchmark index remains weak, is mainly due to steady buying by domestic retail investors and changes in investment by FIIs. Record monthly SIP inflows invested in small-cap funds create regular domestic demand for high-growth sectors focused on India. These include defence indigenisation, renewable power, capital goods, and domestic manufacturing, where many mid- and small-sized companies are reporting earnings growth of more than 20% and have fewer shares available for trading.

In contrast, large caps have become less popular mainly because FIIs can sell them easily when moving money to other global markets. Large caps are also affected by weak earnings in major index sectors. Private banks are facing pressure on net interest margins and slower deposit growth, IT services companies are seeing delays in discretionary technology spending by businesses, and large oil and gas companies are dealing with refining margins that remain within a limited range.