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Rating agency downgrades South East Water debt outlook as inflation pressure grows

by Trevor Loveday

Ratings agency, S&P Global, has revised its outlook for South East Water’s issued debt to negative from stable. The revision is based on the impact of high inflation on the water-only company’s inflation-linked debt which, at 55% of its total debt, is in line with the sector average said S&P.

The agency said the negative outlook “reflects our view that SEW's credit metrics, particularly its adjusted ratio of funds from operations (FFO)-to-debt, are at risk of not recovering to levels we view as commensurate with the rating by the end of the current regulatory period.”


S&P added: “despite our expectations of a gradual normalisation of inflation levels in the next 12 to 24 months. We now think FFO to debt might not be above 5% and debt to EBITDA below 10x, by the end of the AMP7.” S&P went on to project that the company's FFO to debt “will average 3.0% through to March 2025, approaching our 5% target only in the final year of AMP7.”

It highlighted the pace of energy price inflation and noted that SEW was “fully hedged on wholesale energy costs for 2023 and well advanced for fiscal 2024,” but remained “largely unhedged for fiscal 2025.


S&P went on to predict that “water companies are unlikely to recover all cost increases via bills during AMP7. The actual increase in some input costs may be greater than the increase in allowed revenue.” It went on to point to the U.K. cost-of-living crisis and its potential to “create political and regulatory pressure that would make it difficult for water companies to pass on inflation of more than 10% to consumers via bills.”


The agency said current inflation was at at level that overrode the benefits inflation can bring to a water company through inflation-linked increases in regulated revenue. It said short-term impacts on financing and operating costs of the current high in inflation were having “a substantial, negative, short-term effect on the sector's credit metrics,” amplified by the sector’s exposure to inflation linked debt.


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