S&P Global has reduced its credit rating for Northumbrian Water and its parent group in the face of rising operating and financing costs arising largely from “a heavier-than-anticipated capital expenditure programme.”
S&P said the downgrade was predicated also on inflation and escalating unhedged energy costs but added: “Even after stripping out the effects of inflation, Northumbrian Water’s and Northumbrian Water Group’s metrics would remain below our existing target, on the back of the group's heavy capex programme and projected distributions.”
The ratings agency said in a research note it lowered its rating for Northumbrian Water and its parent, to BBB from BBB+ with a stable outlook for the duration the current AMP period to 2025. The new rating remains above the investment grade threshold.
S&P said the downgrade “stems from the much tougher current operating conditions compared with the previous regulatory period.” It projected the retail price index to average 12.6% during the current financial year and 4.5% during the following one. And the the spike in energy prices in the last quarter of 2021 exacerbated by the Russia-Ukraine conflict has, according to S&P left Northumbrian with some 20% of its power demand unhedged for financial year 2023 and 50% for 2024. Meanwhile S&P anticipates that the company’s bills for wages and chemicals will increase over the last two years of AMP7.
S&P said NWL's use of inflation-linked financing instruments for about 40% of its total debt, inflation will “significantly push up financing costs in financial year 2023 and 2024”. This, the agency said, was due to large non-cash [asset and liability-linked] inflation accruals”.
It said its stable outlook indicated its expectation that the group's adjusted ratio of funds from operations
to debt will remain within 6-9% and its debt will stay at 8-10 times earnings before interest, taxes, depreciation, and amortisation throughout the rest of AMP7.
S&P noted that the company was “relatively less exposed to rising financing costs due to inflation than its peers whose inflation-linked financing accounts for about 50%.
The agency highlighted the potential financial threats from a “greater focus on environmental issues and the growing reputational and financial risks for water and sewerage companies.”
It pointed to the Ofwat’s probe, opened in March 2022, into five water and wastewater companies, including NWL, for alleged licence breaches at their wastewater treatment works. S&P warned that any fines that might result from from any proven license breach would be against a backdrop of “increased public scrutiny on environmental issues for the sector.”
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