Financing doubts cast over water company business plans

Financing the £96 billion business plans proposed by water companies for 2025-30 will need all earnings to be retained to maintain gearing levels, an analyst has forecast.

Luis Correia da Silva, partner at Oxera Consulting, raised concerns water company plans for 2025-30 are reliant on huge sums of equity being put forward by investors at a time when returns are squeezed and the sector is under myriad performance challenges.

Spending ambitions for PR24 are dependant around £5.3 billion of novel equity in AMP8 and £11.7 billion through to AMP12.

However, Da Silva warned this was an underestimate and pointed to asset renewal costs that will add significant amounts to spending requirements.

His analysis of PR24 plans submitted to the regulator at the start of October was presented at the Moody’s UK Water Under Pressure conference.

The plans of several water companies accused regulator Ofwat of putting investors off with its methodology for setting the cost of equity that will not provide sufficient returns to attract adequate new money to the sector.

Da Silva suggested five-year periods were not long enough to consider dividend returns risk and reward, and said “much longer-term” thinking was needed to align a sustainable dividend policy over time.

“We need a fundamental rethink and take much longer term view of this than five-year building blocks,” Da Silva said, describing current AMP lengths as a means to an end, not an end in themselves.

Stefanie Voel, vice president infrastructure and project finance at Moody’s calculated that PR24 enhancement spending of £38 billion more than the £96 billion outlined. This additional spend on projects funded through direct procurement for customers (DPC) or other financing models would mean significant uncertainty in long term investment needs, Voel said.

Panelist at the same event, Mike Osbourne of Infrared Capital, acknowledged the incentives to put money into the water industry were not enticing. He said returns of 0.7% above the cost of debt were reliant on hitting all performance targets.

He added: “If we can get back to a point that the sector is set up to achieve and get appropriate level of return and risk against equity and debt, then it can look attractive again.”

Last week, credit ratings agency Fitch said new equity injections from shareholders would be key to the next investment period – and for water companies to maintain investment grade ratings. Much of this, Fitch highlighted, was as yet unsecured. Its analysis of submitted PR24 plans indicated a need for £7.5 billion of new equity.

Ofwat was accused by several water companies of putting investors off with its methodology for setting the cost of equity that will not provide sufficient returns to attract adequate new money to the sector.

The gap between equity and debt reducing would be less desirable to investors with the weighted average cost of capital expected to be calculated at 3.29%