Highly leveraged water firms could seek ‘fresh equity’

Highly leveraged water companies could be forced to seek “fresh equity” because of increased regulatory pressure including possible licence changes, according to Moody’s Investors Service (Moody’s).

The credit rating agency, has published a water sector comment today (7 March), following Ofwat’s chairman Jonson Cox having set out a sweeping programme of reform for water companies last week.

Speaking at Water UK’s annual City Conference for investors in London on 1 March, Cox challenged companies to improve their financial resilience and adjust dividend policies.

Moody’s said Ofwat’s “call for change” may force companies to cut debt.

Stefanie Voelz, vice president-senior credit officer at Moody’s, said:“While such balance sheet strengthening would be credit positive, the imposition of explicit restrictions on companies’ capital structures would represent a divergence from past regulatory practice.”

In his speech, Cox referred to recent criticism and challenges to the legitimacy of the sector. He focused on “aggressive financial structures” and questioned the financial resilience of highly leveraged companies with gearing in excess of 70 per cent.

Moody’s listed companies with highly leveraged financing structures including Anglian Water, Southern Water, Thames Water, Yorkshire Water, Affinity Water and South East Water.

Voelz added: “In expectation of a tough price review in 2019 and lower allowed returns, many of the more highly geared companies have started increasing financial headroom by reducing debt to below 80 per cent of their regulatory capital value (RCV).

“This has been achieved by the retention of earnings, but to bring gearing down further, for example towards 70 per cent, before 2020 would almost certainly require equity injections.”

Moody’s highlighted shareholders could choose to raise additional debt above the regulated operating company to fund this, but it noted Cox implied companies should raise “unencumbered equity”.

Voelz said: “The prices at which stakes in the private equity-owned highly leveraged water companies have recently changed hands suggests that they continue to be seen as attractive investments.”

But Moody’s warned shareholders may be “reluctant” to inject additional cash considering estimated lower returns from 2020 onwards.

Environment secretary Michael Gove, who also gave a speech at the City Conference, reiterated his recent pledge to back Ofwat.

He said he would give the regulator “whatever powers are necessary” to get all water companies “to up their game and further lower consumer bills.”

With the 3 September deadline looming for water companies to submit their business plans to the regulator, Moody’s suggest they have “little time” to plan and potentially implement “significant changes” to their capital structures.