Lower returns and regulatory risk add to negative outlook for water warns Moody’s

Moody’s has reaffirmed that its outlook for regulated water in 2019 is negative, on the back of regulatory, political and public pressure.

The ratings agency’s latest research, 2019 outlook negative as companies steer through troubled waters, issued last week, identified the following points.

Ofwat is expected to cut allowed cash returns from 3.6% currently for the wholesale activities to around 2.9% on average over 2020-25. Companies with gearing in excess of 70% will see their returns cut further. A number of companies are reducing their gearing before the start of the next regulatory period.

Company business plans have pledged a combination of a significant decline in real terms average bills and more investment.

These plans incorporate 10% efficiency savings on totex, but remain subject to regulatory challenge. Moody’s said: “Ofwat may require additional cost reductions. Lower allowed returns and more demanding efficiency targets could significantly weaken future credit metrics.”

Cash flow could also be weakened by performance penalties, competitive pressure and legacy adjustments. According to the agency: “Increasing rewards and penalties under outcome delivery incentives, volume risk exposure on processing sewage sludge and different remuneration rules for new water resources could increase cash flow volatility from April 2020. Most companies will also see a cut to their regulatory capital value (RCV) at the start of the new period, reducing future return potential.”