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Economy Finally some respite in inflation expected

30 December 2011

Falling food inflation can force headline inflation to fall below 8% Food articles inflation is expected to be in the negative zone for the last two weeks of December The weekly primary articles inflation data for the w/e 17 December 2011 was very encouraging driven by a sharply declining food articles inflation rate, which has the potential to rein in the headline inflation rate in spite of unabated core inflation. Led by a likely deflation in food articles over the remaining part of December, we believe the headline WPI inflation rate for December 2011 will come in at 8% or even lower. Assuming a sequential increase of c1% in the WPI Food Articles index for the last two weeks of December (compared to an average sequential decline of 0.6% in the current month so far) and a sequential increase of c1% in the overall WPI Primary Articles index, we believe the headline inflation rate for December 2011 will be marginally under 8%. This is based on certain other assumptions including an increase in the core inflation rate to 8.26% (November 2011: 7.88%), maintaining last months trend, and the fuel & power group inflation rate remaining anchored at last months level of 15.5%. If the December core inflation rate declines to 7.7% (which was the average core inflation rate during the last 6 months) then the headline WPI inflation rate too is expected to drop to 7.7%. Core inflation the key to a sustainable moderate headline inflation rate The stubbornly high headline inflation rate witnessed over the last two calendar years has been driven by high inflation across the three major commodity groups, viz. primary articles, fuel & power and manufactured products. Since January 2010 until November 2011 the WPI inflation rate averaged 9.58%. Within this period, from January 2010 to February 2011 the primary articles inflation rate was significantly higher at 18.91% compared to 12.09% during March to November 2011. However, a high headline inflation rate persisted through the entire period as the relatively lower primary articles inflation was offset by an increased level of manufactured products inflation during March to November 2011. The manufactured products inflation rate averaged 5.48% from January 2010 to February 2011 to subsequently increase to an average of 7.62% during March to November 2011. The non-food manufactured products inflation, which is also called the core inflation, increased from 5.23% during January 2010 to February 2011 to 7.71% during March to November 2011. We do not expect the RBI to cut policy rates in January While the expected decline in the headline inflation rate is certainly a positive factor the continued high levels of core inflation is a manifestation of demand-side pressures. We believe the Reserve Bank of India (RBI) will keep the policy rates unchanged in the next calendar years first monetary policy in January as it will like to ascertain first if the fall in headline inflation is sustainable, which will depend to a great extent on a moderation in the core inflation rate.
Exhibit 1: WPI primary articles inflation (weekly)
Week ended Primary articles Food articles Non-food articles Minerals Weight 20.12% 14.34% 4.26% 1.52% W/e 03-Dec-11 5.48% 4.35% 2.12% 19.06% W/e 10-Dec-11 3.78% 1.81% 1.37% 21.35% W/e 17-Dec-11 2.70% 0.42% 0.28% 23.00%

Economist: Ritwik Bhattacharjee

Source: Office of the Economic Adviser GoI, Khambatta Research

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Tel: +91-(0)22 4027 3300

Khambatta Securities Ltd.

MEMBER OF EQUITY & DERIVATIVE SEGMENTS DEPOSITORY PATICIPANT

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Economy
Exhibit 2: WPI primary articles indices (4WMA)
205

30 December 2011

195

185

175
22-Jan-11 22-Mar-11 22-May-11 22-Jul-11 22-Sep-11 22-Nov-11

Primary Articles

Food Articles

Source: Office of the Economic Adviser GoI, Khambatta Research

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Tel: +91-(0)22 4027 3300

Khambatta Securities Ltd.

MEMBER OF EQUITY & DERIVATIVE SEGMENTS DEPOSITORY PATICIPANT

THE STOCK EXCHANGE, MUMBAI NATIONAL STOCK EXCHANGE OF INDIA LTD. CENTRAL DEPOSITORY SERVICES (I) LTD.

Fax: +91-(0)22 6641 3377 www.khambattasecurities.com

Economy
Guide to Khambattas research approach
Valuation methodologies

30 December 2011

We apply the following absolute/relative valuation methodologies to derive the fair value of the stock as a part of our fundamental research: DCF: The Discounted Cash Flow (DCF) method values an estimated stream of future free cash flows discounted to the present day, using a companys WACC or cost of equity. This method is used to estimate the attractiveness of an investment opportunity and as such provides a good measure of the companys value in absolute terms. There are several approaches to discounted cash flow analysis, including Free Cash Flow to Firm (FCFF), Free Cash Flow to Equity (FCFE) and the Dividend Discount Model (DDM). The selection of a particular approach depends on the particular company being researched and valued. ERE: The Excess Return to Equity (ERE) method takes into consideration the absolute value of a companys return to equity in excess of its cost of equity discounted to the present day using the cost of equity. This methodology is more appropriate for valuing banking stocks than FCFF or FCFE methodologies. Relative valuation: In relative valuation, various comparative multiples or ratios including Price/Earnings, Price/Sales, EV/Sales, EV/EBITDA, Price/Book Value are used to assess the relative worth of companies which operate in the same industry/industries and are thereby in the same peer group. Generally our approach involves the use of two multiples to estimate the relative valuation of a stock. Other methodologies such as DuPont Analysis, CFROI, NAV and Sum-of-the-Parts (SOTP) are applied where appropriate. Stock ratings Strong Buy recommendations are expected to improve, based on consideration of the fundamental view and the currency impact (where applicable) by at least 15%. Market-perform recommendations are expected to improve, based on consideration of the fundamental view and the currency impact (where applicable) between 5% and 15%. Underperform recommendations are expected to improve up to 5% or deteriorate, based on consideration of the fundamental view and the currency impact (where applicable). Disclaimer You are reminded that investment advice provided by Khambatta Securities Ltd. is for your general information and use and is not intended to address your particular requirements. Any advice or recommendations contained in this report may not be suitable for you and are not intended to be relied upon by you in making (or refraining from making) any specific investment or other decision. Such decisions should only be made on the basis of independent advice from an appropriately qualified adviser. Research analysts working for the company are subject to stringent confidentiality and security policies and are located in secure-access premises which may be in the proximity of professionals conducting similar work for other firms. The company is not nor has been nor will be engaged in investment banking and does not make markets in any of the securities covered in this report or have any investment banking relationship with the firm whose security is covered in this report. No employee or contractor of the company is permitted to personally buy or sell stock in the company covered in this report, and neither the analysts responsible for this report nor any related household members are officers, directors, or advisory board members of any covered company. No one at a covered company is on the Board of Directors of the Group or any of its affiliates. This report is not a solicitation to buy or sell any security and past performance is no guarantee of future results.

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