Macroeconomic pressures cause Moody’s to shift water outlook to negative

Moody’s UK water outlook has turned negative, reflecting macro economic pressures.

In a new note, Stefanie Voelz, VP-Sr Credit Officer at Moody’s, listed reasons contributing to the negative outlook

Inflationary cost pressures that may not be fully offset by revenue adjustments.

She explained: “Sustained high inflation is typically credit positive for UK water companies. However, they are exposed to any mismatch between the headline inflation rate and their rising costs. Inflationary increases to revenue and Regulatory Capital Value (RCV) are also subject to a lag, resulting in volatile metrics.”

Inflation will increase companies' RCV, lowering gearing to the extent that debt does not grow.

However, more than 50% of the sector's debt at March 2022 was inflation-linked, reducing the potential benefit for most companies. Higher inflation will also increase periodic accretion payments under inflation-linked derivatives.”

Rising interest rates will affect interest coverage metrics – especially for companies with large funding needs.

Penalties for under-performance would further weaken cashflow – notably in light of the high profile of pollution incidents and ongoing wastewater investigations.

Ofwat’s higher early PR24 view on allowed return of 3.29% will improve credit metrics, and – paired with significant investment requirements – lead to substantial increases in bills.

This will exacerbate affordability concerns, particularly in light of weaker macroeconomic conditions and may also increase companies’ exposure to growing bad debt.”