Water sector rating revised down to ‘negative’ following PR14 overhaul

Fitch Ratings has revised the UK water sector’s rating outlook to negative from stable, following the publication by Ofwat of new guidance on risks and rewards.

According the ratings agency, Ofwat’s more flexible approach to setting price controls, together with its guidance of a 3.85 per cent vanilla weighted average cost of capital (WACC) will not allow some UK water companies to maintain credit metrics commensurate with existing ratings.

In December fellow agency Moody’s also warned that the sector’s outlook could be downgraded to negative following Ofwat’s initial suggestion that water companies had not gone far enough on cutting investor returns.

During an investor conference call PwC, acting as advisors to Ofwat, clarified that credit ratings were not the “be all and end all” in terms of setting price limits.

Keith Mason, senior director of finance and networks at Ofwat, highlighted that it was for management teams to put in place a suitable financing structure that will allow companies to maintain an investment-grade rating.

Fitch is concerned that Ofwat’s ‘hands-off approach’ for the 2014 price review does not consist of specific rating targets for the sector.

This is a change from PR09 when Ofwat assessed water companies’ financial profiles against target financial ratios that were consistent with an ‘A-’ rating. If one particular did not meet the required thresholds, Ofwat ensured that the respective companies met the criteria for a strong ‘BBB+’ credit rating as a minimum.

The ratings agency said in a statement: “At this stage there is little visibility as to whether Ofwat’s benchmarking will allow for headroom in any expenditure items, which could give some companies room for manoeuvring.

“Fitch may tighten its credit ratio guidelines if the overall package of the tariff settlement leads to an increase in business risk, which at this stage is a real prospect.”

The agency also confirmed it would review the ratings of highly leveraged transactions in the sector over the next six to eight weeks.