Moody’s drops its outlook for the whole sector to negative

Moody’s last week said its 12-18 month outlook for the UK water sector had tumbled from stable – where it has sat since 2004 – to negative, on the back of Ofwat’s PR19 headline return cut of a third.

The ratings agency observed the cut – the regulator’s indicative wholesale rate is 2.3% from 2020, down from 3.6% currently – will “weigh heavily on the credit metrics of many firms and underpins the negative outlook”. It noted too that “the proposed (partial) change of inflation indices will benefit companies' cash flows but at the expense of future growth of the regulatory capital value”.

Moody’s said that while highly geared firms with expensive, long-dated and/or small debt portfolios remain most at risk, the whole sector will come under pressure. According to vice president – senior credit officer at Moody’s Stefanie Voelz (pictured): “While UK water companies will review their financial and dividend policies in light of the probable cut in returns, some may ultimately be unwilling or unable to maintain their current credit quality.”

Other factors cited by Moody’s as contributing to the negative outlook included:

  • While companies' borrowing costs will reduce over the period as they refinance at lower rates, most will likely underperform the future cost of debt allowances, creating pressure on interest coverage metrics.

  • Lower returns and more volatile cash flows from enhanced incentives may require adjustments to capital structures and balance sheet strengthening if credit quality is to be maintained.

  • Growing competition on upstream as well as downstream activities will increase the sector's business risk in the medium to long