Moody’s has warned utilities would be hit should the UK ditch RPI in favour of a lower measure like CPI or CPIH (including housing costs). This is in response to the inquiry launched by the Economic Affairs Committee into the use of the Retail Price Index (RPI) as a measure of inflation.
Moody’s highlighted the main risk for utilities as:
Slower revenue and dividend growth
“As companies are mainly financed with fixed-rate debt, a reduction in future revenue would lead to weaker interest coverage ratios, a credit negative. Similarly, lower RAV growth could require an adjustment to dividends to keep gearing constant, potentially causing problems for any holding company debt.”
Potential mismatch between the growth in RAV and debt
“Index-linked debt has historically allowed companies to efficiently align assets and liabilities and may mitigate some of the negative effect of a lower RPI on financial ratios. However, index-linked bonds typically have clauses that protect bondholders from adverse changes to an index, which if invoked could lead to adjustments being made to protect their value. Revenues and RAV would then be inflated using the new, lower RPI while debt would use a higher, modified value, leading to a mismatch. This would result in a weakening of some financial ratios, a credit negative.”
Early redemption of bonds would present a liquidity challenge. “If companies were unable to issue index-linked debt, they could be forced to refinance with fixed-coupon debt, weakening their interest coverage ratios. However, this is a low risk as bondholders could be sympathetic to the plight of an affected company and may seek to negotiate for the bonds to continue.”
Ofwat has already announced it intends to use CPIH at PR19, while WICS will press on with its use of CPI at SRC21.