Moody’s last week changed to negative the outlook on the ratings of Thames Water, Anglian Water, Wessex Water and Affinity Water as it published a new paper, the title of which summarised its sentiment: Regulator’s proposals undermine the stability and predictability of the regime.
The ratings agency said Ofwat’s moves to exert greater influence over companies’ capital structure and dividends and to claw back the benefit of higher gearing “represent significant departures from past regulatory practice. They evidence a modest deterioration in the stability and predictability of the regulatory regime and companies will need to demonstrate stronger financial metrics if they are to maintain credit quality.”
The paper commented specifically on Ofwat’s April proposal to claw back outperformance from highly geared firms – now defined as those with debt in excess of 60%. Moody’s commented: “This would reduce already lower allowed returns further and curb earnings for more highly leveraged companies.”
The two factors – increasing regulatory risk and the potential earnings impact – were cited as the the main drivers for the outlook change on the four companies (ratings were affirmed). Moody's also pointed to its revised and slightly more demanding financial ratio guidance for the sector, which has been recalibrated to reflect the rating agency's perception of increased regulatory risk. “Specifically, the negative outlooks reflect Moody's expectation that a reduction in allowed returns from 2020 will weigh on companies' financial metrics and, absent measures to strengthen companies' balance sheets and/or significant outperformance, there is an increased risk of key ratios falling below Moody's guidance for current rating categories.”
The agency added PR19 is likely to be credit negative for most companies. “We now hold negative outlooks on 60% of the rated water companies and the sector as a whole, signifying the risk that lower returns and increasing cash flow volatility will weigh on credit quality, unless shareholders are willing to support degearing. Holding companies with debt outside of highly-covenanted operating company financing arrangements are particularly exposed to the proposed curtailment of distributions.”