Shuaa last week announced profits of Dh74 million for 2017 versus a loss of Dh132m in 2016. Quite the turnaround. As always, it is important to examine such large differences in financial performance. So our first step is to look where this came from, an increase in revenues or a decrease in expenses.

Revenue dropped 32 per cent to Dh135m for the year from Dh174m in 2016. That is not a good sign seeing as there was a positive swing of Dh206m when it came to the bottom line figures. What’s really made the difference in terms of profitability is therefore a decrease in expenses, which came down 71 per cent to Dh90m from Dh310m previously.

Our analysis therefore leads us deeper into the expenses for now; looking a little closer at the figures we can see two material changes. The first of these is a decrease of 29 per cent in general and administrative expenses to Dh90m from AED 127 million. This drop is explained further in the notes to the accounts, which show that the majority of the reduction comes from a decrease in employee salaries and fringe benefits.

However, such a drop is not due to a reduction in headcount, which actually grew to 182 in 2017 from 173 from previously. Assuming that the quality of Shuaa’s employees remains the same or has even increased (something that seems achievable in the current buyer’s market) then this is quite a skilled move of cutting human capital costs without cutting human capital.

The second material change in expenses is an increase of about Dh170m in net provisions. Shuaa’s provision charge (i.e. the amount they booked as bad loans) was Dh143 million in 2016. In 2017, by contrast, Shuaa listed a Dh27m provision gain. That’s to say, they recovered so many previously designated bad loans that not only did they not need to have any charges in 2017, they actually recovered an extra Dh27m in bad loans. Now, 2017 was a better year than 2016, but was it that much better? Or did Shuaa massively overprovision in 2016?

Let’s look at the effect of changes in provisioning charges and write backs on the quality of the Shuaa’s annual profit figure of Dh74m. Clearly the Dh27m in write backs is not a “normal” event; if we take it out, our potential “quality” bottom line figure drops 36 per cent to Dh47m.

But when you look at the 2016 provision charges of Dh143m, is it reasonable to assume no charges when looking for high quality, recurring revenue? Not really. Let’s assume for a moment that Shuaa’s 2017 provision charge would be 50 per cent of what it was in 2016, based on improvements in the UAE economy. This would mean that the charges for 2017, when trying to normalise the numbers, would be Dh71 m, leaving a normalised profit of Dh3m.

When a company’s revenues drop 32 per cent, and its bottom line is driven first and foremost by changes in provisioning, then the actual underlying core business is not actually driving profit generation. This is why I encourage followers of companies to closely read the financials, which are audited, rather than press releases and management presentations, which are understandably conflicted in terms of investors.

A couple of other points about Shuaa’s accounts caught my eye. Fee and commission income increased by Dh5.2m, or about 10 per cent. That’s pretty good, right? Except that Dh4.6m of that is from associates and related parties, as you can discover when reading the detailed notes to the accounts. Always keep an eye on how much business is generated from with the group, versus from real independent customers.

One positive point that’s worth noting about Shuaa is that it has managed a lot of its excess cash far better than FAB, as analysed previously, by moving the much of the cash into the fixed income category.

Shuaa’s bottom line ultimately looks quite good, with the company making some smart management decisions with regards to employee compensation and cash management. Digging deeper, however, there are some issues that need further clarification. First and foremost, changes in provisions charges of Dh170m are not part of normal business. This needs to be normalised in looking at profitability.

A much smaller issue, but one that should be understood and noted nonetheless, is fee income from associates that accounts for a majority of increase in Shuaa’s fee income.

This article was originally published in The National.