Southern seeks £550m of new equity as Fitch downgrades its ratings

Southern Water confirmed it is looking to shareholders to inject £550m of equity into the group by October, £375m of which will be in the regulated business to maintain prudent gearing, as it published its annual report on Friday and Fitch downgraded its ratings.

Fitch moved Southern from BBB+ with negative outlook to BBB with negative outlook. It explained: “The downgrade reflects increased pressure on SWS's credit profile, as key credit ratios are not commensurate with the previous rating. In particular, gearing headroom is not sufficient to offset AMP7 weak average cash and nominal post-maintenance interest cover ratios (PMICR).” It noted the case assumed £169m of output penalties in 2023-25, relating to wastewater asset health, pollution incidents, internal sewer flooding and CMeX.

The Fitch action produced a credit rating downgrade trigger event, blocking dividends. Southern said it also expected a financial ratio ‘trigger event’ under its own financing arrangements. The company confirmed: “As such, dividends will be suspended until these trigger events have been resolved.” Note though that shareholders have not received a dividend anyway since 2017, and no dividends are anticipated for the rest of this AMP.

Fitch said Southern would be able to maintain sufficient liquidity to fulfil its totex and financing requirements during the trigger event. Southern pointed out that it maintains three investment-grade credit ratings of BBB+ (S&P), Baa3 (Moody’s), and BBB (Fitch). Fitch further noted that it expects Southern to trigger a rating cash-lock up in April 2025 under the new Ofwat licence condition to maintain a minimum credit rating above BBB or equivalent with negative outlook, absent any exemption.

Commenting on its annual report, Southern Water pointed out that it had been grappling with above inflation cost increases and higher funding costs. Net financing costs increased by £82.4m to £278.6m, largely driven by higher indexation on inflation-linked debt.

Despite these struggles, it said it was making “good initial progress” on its turnaround plan. “For instance, we fully expect to be awarded two-star Environmental Performance Assessment rating by the Environment Agency for 2022, which compares to one-star for 2021. We recognise we have further to go, and the Turnaround Plan sets out our ambition to reach a three-star EPA rating in 2025.”

A £1.1bn equity injection by the then new majority shareholder Macquarie Asset Management in September 2021 enabled a £2bn capital investment programme to 2025 to support the turnaround. Southern said its ambition was now to go further to invest £3bn by 2025.

Southern Water reported loss before interest and tax of £11.9m for the year to 31 March 2023 – down from a profit of £17.6m in the previous year.

Volatility in the company’s financials with net financial costs up year-on-year 42% to £279m and a fair value gain on derivatives at £659m for the current report period after a loss of £669m in the previous year gave a profit before tax at £369m compared to a £669m pre tax loss in the previous 12 months.

The hike financial costs was driven by the impact of inflation on the company’s £93.3m index linked debt. The driver for the volatility in financial instruments was fluctuation in gilts.

Revenue for the reporting period was down 4% to £824m due largely to £64m in outcome delivery incentive penalties.