Moody’s negative on UK water after price review, politics

Ratings agency Moody’s has shifted its outlook on four UK water companies to negative following concerns about regulator Ofwat’s pricing review, as well as political pressures on the sector.

Affinity Water, Anglian Water, Thames Water and Wessex Water have all seen their outlooks changed to negative, with Moody’s concerned by the impact of Ofwat’s ongoing pricing review, dubbed PR19, the details of which were first revealed last year.

Ofwat has ordered companies to lower their cost of capital to 2.4 percent RPI [retail price index], a new record low amid a promise by chief executive Cathryn Ross that the sector “will need to be more efficient and innovative than ever before”. The change on the quartet’s outlooks ensures that 60 percent of the sector’s companies rated by Moody’s now have a negative outlook.

“PR19 is going to be a lot tighter financially for the companies than has been the case in the past,” Stefanie Voelz, vice president, senior credit officer at Moody’s, told Infrastructure Investor. “Normally, for price reviews we would look at the companies’ business plans as well as the regulator’s determinations and see whether these result in changes to credit quality that would require a rating adjustment. This time, we’ve been acting a lot earlier because the allowed returns will be quite tight, which will squeeze quite a lot of companies. There’s also a lot of uncertainty and possibly more risk to the downside as to how Ofwat thinks about efficiency targets and performance requirements. The negative outlooks are also a signal companies may need to do a bit more to be able to protect their credit quality this time.

“There’s now quite a lot of restrictions around capital structure,” Voelz said. “This is a departure from Ofwat’s stance that capital structures are for companies to decide.”

Moody’s also pointed to recent political pressures affecting the outlook, with UK environment secretary Michael Gove criticising the sector several times in recent months, over high dividends, tax havens and “concerning” operational performance. The comments come amid promises by Jeremy Corbyn, leader of the UK’s opposition Labour Party, to nationalise the sector, although Moody’s says this did not have an explicit effect on its outlook.

“To some extent the nationalisation risk is driving the political attention and the regulator’s response to it,” Voelz explained. “If and when it happens we would need to react to that, but we think the political and regulatory attention is in response to the nationalisation threat.”

The ratings agency, however, did downgrade the UK water sector regulatory regime to Aa from Aaa, citing “the heightened risk of future political interference in the design of the regulatory framework” that led to a reassessment of the sector’s stability and predictability.
Voelz added that reducing leverage might help lift the outlook, with highly geared companies most at risk due to less financial flexibility and Ofwat’s drive to reduce debt in the sector.