Fitch moots ODI moderation and higher WACC for draft determinations

Fitch Ratings has pointed to “possible moderation” of Outcome Delivery Incentive (ODI) benchmarks by Ofwat when it issues its draft determinations (DDs) on 11 July.

In a new publication, UK water – relative credit analysis, the ratings agency said it expected Ofwat to “opt for a more measured stance” in setting ODI benchmarks, against which water companies are measured to determine rewards or penalties for performance. It considered: “The regulator may indicate that the targeted standards might exceed what is reasonably achievable for water and wastewater networks if a significant portion of the industry experience net penalties, given their operational realities.”

In other positive news for water firms, Fitch said it expected material increases in risk free rates and iBoxx indices since September 2022 (Ofwat used 30 September 2022 as the cut off date in its final methodology) to lead to a higher weighted average cost of capital (WACC) in the DDs.

Further, Fitch said it expected water firms to provide early guidance on their capital structure expectations after Ofwat’s publication on 11 July, even though “equity injections in the sector will be largely contingent on Ofwat’s final determination”. It explained: “While shareholders are in principle committed to support their respective companies, the risk-return balance will be a key consideration for their investment committees”. It shared that “issuers with low rating headroom, especially compared with Ofwat’s updated licence requirements (minimum rating of ‘BBB’/Negative from April 2025) will have to inject equity into the regulated licensed operating companies, in order to remain consistent with the target rating”.

The agency divided companies into three performance categories against four highlight factors, as shown in the table. On totex, it explained its sector-wide ‘average’ rating despite overspend is because the overspend is largely due to higher investments rather than inefficiency, including transition investment brought forward into AMP7 from AMP8.