Ofwat flags financial concerns with half of water companies

Ofwat has concerns about the financial resilience of half of all water companies in England and Wales.

The regulator raised concerns about eight firms in its annual financial resilience report, despite concluding that the sector has improved overall during the past year largely thanks to £4.6 billion of new money committed by shareholders.

Thames, Southern and SES were classified as requiring urgent action to improve financial resilience for the second year running and were joined by South East in the list of companies which Ofwat is most concerned about.

Yorkshire and Portsmouth each moved out of the higher concern caetegory but their progress will continue to be monitored by the regulator. Both organisations received a boost of equity – £150 million for Portsmouth for Havant Thicket reservoir, and £940 million to Yorkshire to bolster resilience. Ofwat praised the actions taken to improve and called on others to follow the trend.

They now sit alongside Affinity and Northumbrian in Ofwat’s ‘elevated concern’ category.

The regulator said there were no specific concerns or actions required relating to Anglian, Hafren Dyfrdwy, Severn Trent, South Staffs, South West, United Utilities, Welsh and Wessex.

“We’ve been calling for the water sector to be strengthened by further investment that is why we welcome the £4.6 billion of additional equity,” said David Black, chief executive of Ofwat.

“Where we have seen cause for concern, we have also seen some companies responding to the challenge and we expect them to continue to work on improving their financial resilience.”

Financial resilience has come under sharper focus following intervention by Ofwat, which introduced licence modifications earlier this year that allow it to intervene where conditions are not met and the power to block dividends.

During the year, the regulator said companies had done better at articulating and being transparent over dividend policies.

Ofwat said it will publish a full assessment of company policies in due course, but in the interim said some companies are not meeting expectations and called for more improvements. It added that dividend yields should reflect individual company circumstances and financing needs, not based on the base yield of 4% that Ofwat set as reasonable for well-performing companies.

It said payments should reflect outcome delivery incentive (ODI) rewards or penalties and explain decisions accordingly.

“We have been clear that we expect benefits accruing to equity that are not linked to performance delivery for customers and the environment, such as the consequences of high inflation on fixed rate debt and gearing, should be retained or reinvested and not distributed as outperformance,” Ofwat said.

It added that declaring dividends to meet obligations of parent or holding companies was not justifiable without considering performance of the main company.

Ofwat noted that high inflation has contributed to the regulatory capital value and revenue allowances of companies, which equity investors benefit from when the equity portion of the RCV rises faster than the amount of RCV that is financed by debt. In 2022-23 compound average annual growth rate of the RCV was 7%.

The flipside of rising inflation and interest rates has been higher operating costs as well as capital investment and financing costs that add to company cash pressures during the year.

These factors, Ofwat said, highlight the need for companies to keep adequate headroom and financial flexibility to manage turbulent times.

With spending proposed by the sector for 2025-30 to be more than double the current investment period at £96 billion, companies will need access to both equity and debt to deliver on their plans without risking their financial resilience.

During the year, work to bolster resilience across the industry included:

• Thames – £500 million equity to support investment in AMP7 and a further £750 million agreed by 2025.
• Southern – new owners Macquarie pumped £550 million into the business for its turnaround plan on top of £1.1 billion injected in September 2021.
• Yorkshire – called back intercompany loans totalling c£940 million, due March 2027, with £400 million already repaid.
• Portsmouth – shareholders injected £20 million and committed to a further £150 million to support the business while building Havant Thicket reservoir.
• SES – £22 million has been agreed to by shareholders by March 2024 to strengthen financial resilience, of which £7 million has been received and indication of further if required. Owners are reviewing the business and a decision is expected in December that may result in a sale.
• Severn Trent – Ahead of its PR24 plan being published, the company sought to raise £1 billion of new equity to fund its enhancement programme for 2025-30.