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UK Water: Financial Resilience Update
Andrew Moulder – Senior Analyst - European Utilities
Bozhidar Dinkov – Analyst - European Utilities
EXECUTIVE SUMMARY
- Last week Ofwat released its annual ‘Monitoring Financial Resilience Report’ for the UK water companies, with data evaluated for the financial year ending 31 March 2023. Once again both Thames and Southern Water are judged to be higher priority for engagement and monitoring.
- While Thames and Southern continue to be higher priority, Severn Trent, United Utilities, Anglian and South West are all within the standard category, with no specific concerns. Yorkshire Water has taken action to support financial resilience during 2022/23 and has been removed from higher priority, down to ‘elevated concern.’
- Overall, in the 2022-23 year key credit metrics have slightly worsened. Average gearing across the sector rose to 68.2% compared with 66.2% for the previous year, FFO/net debt deteriorated and adjusted cash interest cover was generally weaker. Much of this was to do with higher inflation and rising costs.
- For 2022-23 RoRE ranged from 12.14% for Severn Trent, down to a -10.07% for Southern Water, but only seven companies, out of 17, reported a RoRE above their base return. Average RoRE across the sector was 3.6%, against an average allowed base return of 4.1%. We note that in their PR24 business plan submissions many companies highlighted what they perceived to be a downward skew in the incentive framework for the next regulatory period. Returns in the current period do seem to bear this out.
- Thames recently managed to demonstrate market access with a £300 mn 16.5 year bond, although it did have to pay up. The bond priced at a yield of 8.3% with an 8.25% coupon. We regard it as positive that Thames was able to come to the market, but everything has a price, and a regulated ring fence entity issuing senior debt at 8.3% demonstrates the uncertainty around the name.
- Thames issuing new debt at 8.3% certainly adds weight to the argument that the cost of new debt is higher than the Ofwat early view of a nominal cost of 5.34%. Ofwat will update its cost of debt depending on market conditions at the date of the final determination in December 2024.
RELATIVE VALUE
We do not yet have published views on the UK water companies, but from the graph above the widest names are Thames and Southern, while the tighter names are UU, Severn Trent and Welsh Water. In our view that reflects the relative risks and uncertainties around the various companies.
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