Certainty around allowed returns and cost allowances for the 2020-25 regulatory period has brought stability back to regulated water companies but coronavirus will continue to create obstacles.
This is the view of credit ratings agency Moody’s, which noted the significantly weakened interest cover ratios across England and Wales because of the cut to allowed returns set by Ofwat in its PR19 final determinations.
Report author and senior credit officer Stefanie Voelz anticipated credit ratios would stabilise at a weaker level due to the cuts Ofwat made to allowed returns for AMP7.
The report noted the latest word from the Competition and Markets Authority (CMA) may result in the four appellant companies being allowed a return 30 basis points below its initial redetermination, yet still above Ofwat’s. The CMA is currently consulting on its revised approach to redeterminations for Anglian, Bristol, Northumbrian and Yorkshire, which are due in mid-February.
It noted the pandemic could bring more operational and performance instability, making it more difficult to meet regulatory targets.
Voelz explained Moody’s previously estimated the sector could incur performance penalties of £150 million to £350 million, equivalent to 0.1 per cent annually, however ongoing restrictions that delay upgrade works could push penalties closer to the top of that range.
“Given increased potency of performance incentives following Ofwat’s 2019 price review, companies are placing added focus on meeting outcome delivery incentive targets, with many reporting good progress in the first half of the current financial year to March 2021, despite Covid-19,” Voelz said.
“However, companies may also suffer penalties because of increased household consumption due to working from home requirements during a warm spring and summer.”
Per capita consumption targets were challenged last year with many households stuck at home during the warm dry spell in the early summer.
Revenues to non-household customers have fallen as businesses have closed through lockdown and consumed less water as well as facing financial difficulties.
The report noted the recovered revenue from such customers later in the AMP cycle would buffer the wholesalers but likely be exceeded by penalties for not meeting targets.
Voelz said credit quality is assessed in light of average forecast metrics not single-year performance. “We anticipate that most companies will exhibit relatively weak metrics for the current financial year ending March 2021, largely driven by lower revenues but potentially also reflecting higher costs, although with a significant portion recoverable at a later stage.”
The majority of companies were rated stable, with three listed as negative.
Those companies appealing Ofwat’s final determination for 2020-25 all have a negative outlook as uncertainty over their business plans continues.
Longer term risks including climate change, Brexit and further economic challenges stemming form the pandemic could all cause the outlook to deteriorate from stable to negative.