Earnings Hit High – Heading Higher – Morgan

The earnings season looked tepid – but the headline numbers hide the underlying strength. For example, excluding ONGC, Bharti and RCom, Sensex earnings were up 36%, its best performance in four years. The quality of earnings was also quite strong – net financial income’s share in pre-tax earnings fell to a near 8-year low.

Earnings growth in the broad market (3,038 companies) slowed down (as expected), though it was particularly damaged by the
energy sector (ex-energy growth was at 22%). Earnings at the aggregate level appeared to be in line with expectations — though the variations at the sector level are noteworthy.

The macro and micro environment remains supportive of earnings. At the micro level, operating leverage, pricing power and healthy balance sheets should help. The favorable macro combines strong growth and a sympathetic WPI/CPI environment. Morgan Stanley expects BSE Sensex earnings growth at 22% and 18% for F2011 and F2012, respectively, from a top-down perspective.

Morgan’s Sensex EPS estimates are Rs 1100 for FY11 and Rs 1300 for FY12, thus the Sensex is trading at a forward P/E of 16.8 still lower than the historic 21 P/E in Jan-08.