inflation 30dec11

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30 December 2011Economy

Kham bat t a Secur i t i es L td .MEMBER OF EQUITY &

DERIVATIVE SEGMENTS

DEPOSITORY PATICIPANT

THE STOCK EXCHANGE, MUMBAINATIONAL STOCK EXCHANGE OF INDIALTD. CENTRAL DEPOSITORY SERVICES (I)LTD.

Tel: +91-(0)22 4027 3300

Fax: +91-(0)22 6641 3377

www.khambattasecurities.com

Falling food inflation can force headline inflation to fall below 8%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 rateThe 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.

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 nextcalendar 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 Weight W/e 03-Dec-11 W/e 10-Dec-11 W/e 17-Dec-11Primary articles 20.12% 5.48% 3.78% 2.70%

Food articles 14.34% 4.35% 1.81% 0.42%

Non-food articles 4.26% 2.12% 1.37% 0.28%

Minerals 1.52% 19.06% 21.35% 23.00%

Source: Office of the Economic Adviser GoI, Khambatta Research

Finally some respite in inflation expected

Food articles inflation is

expected to be in the

negative zone for the last

two weeks of December

We do not expect the RBI to

cut policy rates in January

Economist: Ritwik Bhattacharjee


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Exhibit 2:

WPI primary articles indices (4WMA)

175

185

195

205

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

This space has been intentionally left blank


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Guide to Khambattas research approach

Valuation methodologiesWe 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 ratingsStrong 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 toaddress 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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