Moody’s sees UAE property firms’ adoption of IFRS 15 as positive

Ratings agency Moody’s has said that the adoption of the accounting standard IFRS 15 by real estate stalwarts such as Aldar and Emaar Properties is a positive step as it will help increase analytical transparency within these firms.

The agency said in a recent report that the adoption of IFRS 15 will help in “appropriately reflecting the companies’ financial performance.”

“We believe that in general it will help to narrow the large difference that we sometimes observe between United Arab Emirates developers’ EBITDA and operating cash flows,” Moody’s noted.

Under IFRS 15 rules, property developers will now recognise revenue when a certain percentage of construction is completed for a given project. Previously revenues were calculated based on the number of units that were completed and handed over to the customers.

The shift to IFRS 15 could especially be beneficial to those purchasing off-plan property in the country.

“The structure of the UAE’s real estate development market is such that customers purchasing off-plan residential apartments/villas need to pay installments that are typically linked to the project’s construction milestones,” Moody’s said.

“IFRS 15 will help better align earnings and cash flows and in our opinion leads to financial results that better reflect the underlying activities of UAE property developers.”

IFRS 15 is also expected to smoothen overall revenue recognition and reduce earnings volatility, positively impacting results of those firms that do not have a recurring revenue business.

Moody’s anticipated that the transition to IFRS 15 will be made by firms which foresee a positive impact on their earnings.

For instance, adoption of IFRS 15 had a minimal impact on Aldar’s financials with revenues growing by just 2.6 per cent in the first half of 2015 while Emaar’s revenues showed a growth of 7.9 per cent in the first quarter. This is a meaningful increase for the latter, noted Moody’s, since just half of those revenues came from Emaar’s property business where IFRS had the most impact.

The report also noted that the difference in revenues of the two developers could be explained by their respective development pipeline.

“Aldar’s UAE development backlog totaled Dhs 2.4bn (excluding land plot sales) as of the second quarter of 2015 versus Emaar’s Dhs 21.9bn as of the first quarter of 2015,” the report said.

The transition to IFRS could also offer a better indicator on UAE developers’ financial standing.

“Earnings before interest, tax, depreciation and amortization has historically been a lagging indicator for UAE property developers which have significant development pipelines because revenues have traditionally been recognised when units were handed over while a significant portion of the associated cash flows had already been received over a period of time,” the report said.

“In addition, EBITDA is sometimes an ineffective way to measure a developer’s
debt leverage or interest coverage, and can often be extremely volatile in a way that EBITDA-based credit metrics could fluctuate significantly over a short time period (even if a company is using percentage-of-completion accounting).

“Using a volatile credit metric as a tool to measure the credit strength of a company can be challenging and is one of the reasons that we on occasions utilise alternative measures such as debt to capitalisation or cash flow based leverage metrics.”

Long term benefit

Companies are required to adopt IFRS 15 from January 1, 2017 but the deadline could possibly be extended to 2018.

But analysts have noted that companies in sectors such as real estate and telecoms could speed up their transition to IFRS 15, considering the accounting benefits it provides to their earnings.

In a recent report by the audit firm KPMG, it was noted that property firms specifically could adopt IFRS 15 quickly as it recognises revenue based on the percentage of units completed, essentially giving their earnings a boost.

However Moody’s cautioned that a change in revenues bought about by the accounting policy might not necessarily change to credit ratings of a company.

“As is the case with adoption of any new accounting standards, we do not expect the changes to affect credit ratings because a change in reporting does not change underlying financial conditions,” the report said.

“However, if increased disclosure in the new accounting standards reveals additional information not previously considered in our analysis, ratings could be affected. Also, how some companies respond to the accounting rule could have an effect on their credit quality and ratings if business practices evolve in response to the new standard, causing changes to a company’s results and credit profile.”