Mumbai: The earnings rebound that started in the first quarter of fiscal 2010 steamed ahead for the three months ended September, signalling that a recovery in the world’s second fastest growing major economy remains on track.

Average profit growth at companies which constitute the 50-stock Nifty, the benchmark index of the National Stock Exchange, has been the best in seven quarters, helped by cost cuts and lower raw material prices, even though there has been a decline in sales growth. A fresh round of earnings upgrades, especially for the next two fiscal years, is likely, analysts said.

Interest rate reductions by the Reserve Bank of India (RBI) and government stimulus packages have helped revive demand and propel the Indian economy, which the central bank expects to grow by at least 6% in the year to March. India’s pace of growth is second only to China among major economies.

Profit at firms in the narrower 30-stock Sensex, India’s bellwether equity index, grew by 10.96% on average in the three months ended September, the best in five quarters. All Sensex firms are part of the Nifty.

For a broader sample of 1,545 firms that have so far announced their September quarter earnings, profit grew by 44.9%, the best in three years.

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“The trend is positive," said Ajay Parmar, head of research at Emkay Share and Stock Brokers Ltd. “Quality of earnings is better since companies posted this growth despite falling other income (typically investment income)."

Operating profits grew marginally faster than net profit at 13.87%, suggesting firms had managed their operations better. Prices of raw materials such as steel, aluminium and rubber, which had declined sharply earlier this year due to slow global demand following the credit market seizure, also helped.

One area of concern, however, is tepid sales growth. In fact, sales growth declined by 2.05% for Nifty firms. Although Sensex firms posted 5.7% growth in sales, for the broader sample of 1,545 firms, the drop in sales growth was even sharper, 7.8%.

Still, the outlook for the rest of the fiscal remains positive due to a lower base of sales and profit growth in the corresponding months a year ago, even as the economic recovery gathers momentum, said analysts.

Earnings upgrade

“We expect earnings upgrades to continue on an overall basis," wrote Prabhat Awasthi, Nipun Prem and Sanjay Kadam of Nomura Financial Advisory and Securities (India) Pvt. Ltd, in a 28 October report. “Apart from the strong recovery in the industrial and capex cycles, the growth in profits should also be aided by the favourable base effect in the coming quarters."

For the purpose of this analysis, earnings of 43 Nifty firms and 28 Sensex companies available for the past 30 quarters were looked at. These numbers, sourced from Capitaline database, are stand-alone earnings for firms and don’t include that of their subsidiaries.

Excluding banks, financial institutions and oil and gas companies, the collective average earnings for 32 Nifty firms slipped to 7.28%. Oil and gas firms’ earnings depend on volatile international crude prices and a subsidy sharing mechanism by the Union government. Banks and financial institutions have a different earnings model as non-interest income is a part of their regular earnings, but for manufacturing and service sector firms, income generated from peripheral activities is excluded from profit calculations.

Of the seven banks and financial institutions listed in the Nifty, five reported double-digit profit gains. State Bank of India, the country’s largest lender, posted a 10% growth in its September quarter net profit while its closest private sector rival ICICI Bank Ltd reported a 2% gain and Reliance Capital Ltd reported a fall in profit.

Among sectors, auto firms posted a spectacular show while metal companies such as Hindalco Industries Ltd, Jindal Steel and Power Ltd, Tata Steel Ltd and Sterlite Industries (India) Ltd reported sharp profit falls mainly because of depressed commodity prices. India’s second largest two-wheeler maker Bajaj Auto Ltd has reported its best operating margin for the quarter at 22%, from 13.5% a year earlier. Its net profit vaulted 117%, beating Street expectations for the second quarter in a row. The country’s largest two-wheeler maker, Hero Honda Motors Ltd, posted a 95% rise in profits, selling at least a million units for the second quarter in a row.

Information technology firms fared well but telecom companies disappointed. Analysts are optimistic about performances over the next few quarters despite signs of rising inflation and tighter credit supply.

In its review of second quarter monetary policy last week, RBI kept policy rates unchanged, but prescribed tougher norms for lending to the real estate sector and asked banks to invest a greater portion of their deposits in government bonds. RBI has signalled that it may raise rates sooner than later.

However, not too many analysts believe RBI will be in a hurry to raise rates. “Credit growth is still subdued," said Deepak Jasani, head of retail research at HDFC Securities Ltd. “We don’t believe interest rates will rise dramatically."

Despite the better-than-exp- ected earnings reports, the equity market tumbled in the past week. The Sensex lost 5.44%, in line with world markets.

“Corporate India’s healthy track record in terms of return on equity as well as greater proportion of domestic demand component in earnings is a positive," said Sivasubramanian K.N., a fund manager with Franklin Templeton Investments’ local unit, in an email interview. “Having said that, valuations need to be validated by fresh earnings and economic data."

The Sensex is trading at 19.28 times its estimated earnings for fiscal 2010, above its long-term average, after doubling in value in the first half of this fiscal year.

With another round of earnings upgrades, analysts and fund managers believe it’s wise to buy when the market dips.

“Momentum and volatility indicators suggested a correction and the correction has happened pretty fast," wrote Ridham Desai and Sheela Rathi of Morgan Stanley in a 30 October report. “The earnings cycle is turning, valuations are okay and liquidity is fine."

Graphics by Sandeep Bhatnagar / Mint