Wessex slips out of Moody’s Baa1 rating after CMA decision

(by Karma Loveday)

Moody’s has downgraded Wessex Water from Baa1 with negative outlook to Baa2 with stable outlook.

The ratings agency said, in its view, Wessex would be unable to maintain credit ratios consistent with the previous Baa1 rating in light of the final Competition and Markets Authority (CMA) settlement: “Assuming that Wessex Water performs in line with the CMA's redetermination, we forecast that the company will achieve an adjusted interest coverage ratio (AICR) of around 1.4-1.5x on average over AMP8 and maintain average gearing, measured as net debt to regulatory capital value (RCV), around 70%.” These ratios fall outside its Baa1 ratio guidance of a minimum average AICR of 1.6x and maximum gearing not exceeding 68%, but remain in line with minimum requirements for a Baa2 rating.

Wessex secured a £271m cost allowance uplift from the CMA, comprising enhancement allowances up £277m (to £2.4bn – primarily for nutrient removal) and base allowances down £6m (to £2.2bn). Moody’s said there remains a £542m cost gap compared with Wessex’s requests in response to Ofwat’s draft determination. This poses a risk of cost overruns, albeit Wessex has a strong track record of efficient cost performance and may manage to remain within the revised cost allowances. The CMA's 4.20% CPIH-deflated return is above Ofwat's 4.03% allowed appointee return and provides an additional small cash flow benefit.

Moody’s did not expect Wessex to pay dividends during AMP8, to support its investment plan and maintain gearing at around 70%. As such, no additional shareholder equity was envisaged. The company has sufficient liquidity over the next 12-15 months.

The wider water sector risk landscape, as noted in Moody’s rating action on Northumbrian Water last week, was a broader consideration in the assessment.

Moody’s explained the stable outlook reflected its expectation that Wessex will be able to perform broadly in line with the CMA final redetermination, thereby supporting financial metrics that meet the requirements for a Baa2 rating.

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Comment

(by Verity Mitchell)

Ofwat, in its final determinations, assumed that all companies would need to issue equity in order to continue to pay dividends. The calculation was based on Ofwat's assumptions of certain credit metrics based on a notional capital structure. In Ofwat's calculations, Wessex had the second lowest FFO/net debt ratio of any of the larger water and wastewater companies (only Hafren Dyfrdwy was lower).

It is therefore not surprising that Moody’s has downgraded Wessex a notch even though it assumes Wessex will neither raise equity nor pay a dividend; and even though the company has benefited from the CMA redetermination.

Will the owners of Wessex be content with a lower rating and no dividends? An equity injection would create some headroom, ease the pressure to remain within revised cost allowances and allow dividend distributions during AMP8. For many of its peers, new equity has provided the cushion to achieve all of these objectives.