Mumbai: Average profit growth in the three months ended 31 December has been the best in eight quarters at companies that make up the 50-stock Nifty, the benchmark index of the National Stock Exchange. While the momentum is likely to be carried forward to the next quarter, the market is concerned about the Budget and a possible rollback of fiscal stimulus.  

Profit at firms in the narrower 30-stock Sensex, the Bombay Stock Exchange’s bellwether equity index, grew by 18.63% on average in the three months, also the best in eight quarters. All Sensex firms are part of the Nifty.

Sales for the Nifty firms grew 21.43% for the three months ended December after declining for the previous three quarters. To an extent, sales were boosted by the 90% revenue growth posted by Reliance Industries Ltd, India’s most valuable company. Still, a broader sample of 1,106 firms posted an average 11.65% growth in sales, indicating the underlying economic recovery, say analysts.

“We believe the earnings cycle is turning and broad market earnings are likely to outpace the narrow market in terms of growth," Morgan Stanley India Co. Pvt. Ltd’s Ridham Desai and Sheela Rathi wrote in a 19 January research note. For the broader sample of 1,106 firms that have so far announced their December quarter earnings, profit grew by 31.75%, less than the 43.94% gains posted in the previous quarter—the best in three years. Company earnings that faltered in the last fiscal year after the global credit crunch have received a boost this fiscal from government stimulus packages and a series of interest rate reductions by the Reserve Bank of India (RBI). In its latest credit policy review, RBI raised its estimate of gross domestic product growth in fiscal 2010 to 7.5% from 6%.

“We are seeing that earnings have fully recovered. The fiscal stimulus package has helped," said Raamdeo Agarwal, joint managing director at Motilal Oswal Financial Services Ltd. “This (earnings growth) will likely continue because of the base effect."

Unlike the previous two quarters, when profit growth was driven by cost cuts and gains from low raw material prices, increased sales too contributed in the three months ended December.

Economic indicators support the revenue numbers. For instance, the HSBC Purchasing Managers’ Index, a leading indicator of demand, increased to 55.6 in December. A reading of 50 indicates expansion. India’s factory output gained 11.7% in November, the most in 25 months. What has also helped firms is the reduction in interest costs, which fell 26.17%. However, with inflation rearing its head and the central bank signalling an exit from its loose monetary policy by increasing banks’ reserve requirements, the advantage may not last long, analysts say.

On Friday, RBI raised the cash reserve ratio (CRR) by 75 basis points and indicated that year-end inflation may reach 8.5%. The Wholesale Price Index has climbed to 7.31% for December, driven by an increase in food prices.

“We will have to see how excise rates, raw material prices and interest costs (at these levels) continue," said Ajay Parmar, head of research at Emkay Global Financial Services Ltd. “As of now, I don’t think you will enjoy low interest rates after some time."

“Capacity shortages are back, raw material prices are rising and the pricing power of corporates is high," wrote Prabat Awasthi and Nipun Prem of  Nomura Financial Advisory and Securities (India) Pvt. Ltd in a 27 January note. “Corporations have started to releverage, and so have consumers. Inflationary forces are building up." For the purpose of this analysis, earnings of 41 Nifty firms and 27 Sensex companies available for the past 30 quarters were considered. 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 31 Nifty firms increased to 31.06%. 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.

Graphic: Yogesh Kumar / Mint

“The markets are over-valued," Jyotivardhan Jaipuria, head of research at Bank of America–Merrill Lynch, said in a recent interview. “The pace of earnings upgrades is also slowing down."

Jaipuria and other analysts said that the markets would look for signals from the Union Budget at the end of February when the government would decide whether to continue with the fiscal stimulus package or rollback excise duty cuts.