By Robin Wigglesworth

After a difficult year, Gulf companies are beginning to show signs of recovering from the downturn, with third-quarter earnings figures making largely heartening reading. The results for 385 companies that have reported so far indicate an overall 25 per cent year-on-year decline in profits, according to figures compiled by EFG-Hermes. This is a marked improvement from the 48 per cent slump in the second quarter.

Quarter on quarter, earnings rose 7 percent between July and September. While this is less than the 14.4 per cent jump in the second quarter, it still indicates an improving trend. “The organic growth is actually impressive,” says Emad Mostaque, a fund manager at Pictet Asset Management. “Obviously financial companies have been hit by provisions and petrochemical companies are hurting due to low prices, but otherwise things seem to be normalising. It’s looking pretty good overall.”

Companies in the United Arab Emirates, one of the hardest hit countries in the region, were among the better performers this quarter. While profits fell 15 per cent year on year, earnings rose 27.7 percent compared with the second quarter. Analysts say Emirates NBD, the UAE’s largest lender by assets, was a particular highlight. It reported a surprising 3 percent increase in profit to Dh1bn ($272m) and indicated that full-year earnings would be in line with 2008.

On the other hand, Abu Dhabi Commercial Bank’s net profit slumped 90 percent to Dh44m, and Dubai Islamic Bank reported a 30 percent year-on-year decline in earnings to Dh299m. “ADCB and DIB disappointed, but most results have been in line with forecasts or better than expected,” says Yong Wei Lee, head of Middle East and North African equities at Emirates Investment Services.

Financial companies dominate the Gulf bourses, and have been hurt by the global downturn and the default of two leading Saudi conglomerates, but are signalling recovering health. While non-performing loans are not expected to peak in the UAE until 2010, Mostaque says they “probably won’t be as horrendous as everyone thought” and Qatar and Saudi Arabian banks are over the worst.

Fund managers are looking forward to an even rosier fourth quarter, which will look “fantastic” compared with the last three months of 2008, he says. The reaction of investors has been mixed. MSCI Barra’s Bahraini, Kuwaiti, Omani and Qatari indices have all dropped this month, while stocks in Saudi Arabia and the UAE are up overall, helping the MSCI GCC index to a 1.6 percent gain this month.

Still, this year the Gulf has underperformed other emerging markets, which have benefited from gushing international capital inflows. This is largely because of the Gulf’s dominance of local retail investors, who - burnt by the regional property and equity market downturn - have still not regained full confidence.

“The key factor to a potential [stock market recovery] will be the rebuilding of local balance sheets and increasing levels of confidence for local investors,” Mostaque says. “Increasing levels of foreign investment would be the icing on the cake.”