UK Water: Love, Actually? 

• The Final Determination on 19 December 2024 was, in our view, a big step in the right direction for most of the UK water companies. The allowed return was raised, the Totex spend was increased and the ODI regime was softened. The equity market liked it, with UU flat, Pennon (South West Water) up 0.34% and Severn Trent up 0.94%, in the context of a 1.14% fall in the FTSE.
• But it was not love all around. While Thames and Southern saw positive movement between the DD and FD, the Thames Totex is still 16% below the company ask and Southern’s is 11% lower. Thames’ bill will be allowed to rise by 35%, not the 53% the company wanted and Southern bills will increase by 53%, not the 84% requested by the company.
• While the WACC and the cost of equity have increased, the cost of equity, at a real 5.1%, still looks low to us, especially for Thames and Southern, where debt is current trading at 10% nominal yields, and where both need significant equity. Ofwat said on the call that Thames’ finances were a matter for the company, and that the FD gave clarity to the sector – but not for Thames and Southern.
• For most of the sector this looks like a good outcome, and we expect most companies will accept the FD. For Thames and Southern, at least, we are not so sure.
• Whether or not Southern challenges the FD, the other key question is if Ofwat has conceded enough to keep Macquarie onside, and enough for Macquarie to continue to adhere to its proposed equity timetable. Of course the ball is in Macquarie’s court, and we await any official response from Macquarie. It is not beyond the bounds of possibility that Macquarie chooses to address Southern’s capital structure at some stage. Whether this FD is sufficiently bad to be a trigger for Macquarie to take umbrage is TBD.

Financial Metrics

Ofwat released its long anticipated and potential contentious final determination (FD) for PR24 on 19 December, and on the whole, it was positive for the UK water sector. Ofwat has listened to the post draft determination comments and has softened the starting point on ODIs as well as bringing in an in period outturn adjustment mechanism. It has allowed bills to rise more significantly, it has increased Totex and the WACC is above 4%, albeit only just. The equity market likes it, and, at the end of the day UU closed flat, Pennon (South West Water) was up 0.34% and Severn Trent rose 0.94%, in the context of a 1.14% decline in the FTSE.

Severn Trent has already issued a statement saying that it “welcomes” the publication of the final determination, that it is “pleased to have seen movement on the five key topics we represented on in August, following constructive collaboration with Ofwat in recent months,” and that it expects to deliver RCV growth of 45% over AMP8. Severn Trent states that it will “carefully consider the Final Determination in full over the coming weeks and provide a further market update early in 2025.” The company will be holding a brief investor presentation at 8am UK time on 20 December, and for those that miss this a recording will be made available after the event on the Severn Trent website.