The Ofwat director in charge of assessing water company business plans has reassured the sector that the next price control (PR24) will be “more generous to investors than PR19”.
The issue of whether the regulator’s tight leash on returns is alienating investors from the water sector came to a head on Friday (28 March) with the announcement that Thames Water shareholders have withdrawn a promised £500 million cash injection because of Ofwat’s feedback on the company’s business plan for 2025-2030.
However, Chris Walters insisted to Utility Week that the regulator would “err on the side of investibility” when it comes to assessing the plans and that the concerns of private equity investors had come through loud and clear.
Thames’ chief financial officer Alastair Cochran publicly called on Ofwat to reassess its position on returns as he faced questions on his shareholders’ conclusion that at the moment the company’s business plan is “uninvestible”.
“The regulator has a financing duty to ensure companies can carry out their statutory functions by providing reasonable returns on capital,” he said. Cochran admitted that Thames and Ofwat “clearly have a difference of opinion” on acceptable weighted average cost of capital (WACC) for AMP8 with the company’s business plan proposing a WACC of 4.25% in October, which Cochran said would be equivalent to 6.3% now.
In its ‘early view’ of the the cost of equity and debt in December 2022 Ofwat set a rate of 4.14% and 2.6% respectively. Based on a notional gearing level of 55%, which the regulator is planning to reduce from the current level of 60%, these rates would translate to a weighted average cost of capital of 3.29%.
Cochran said the WACC in Ofwat’s final methodology is “considerably lower”, but he added this is one of several factors in the plans that contribute to the overall return that an equity investor could expect to receive from investing more money in the company.
“If you look at the cost of equity in Ofwat’s WACC, it’s less than our current cost of debt when we finance the business, so you have to ask yourself why an equity holder who is taking on more risk would take a lower return than buying a bond in the market,” Cochran added.
Despite Cochran’s concerns, Ofwat’s director of the price control Walters, speaking before the announcement had been made, told Utility Week the next price control would be more generous to investors than PR19.
“We are not blind and deaf to the fact that the financial world has moved since we first offered an early view on what the rate of return might look like,” Walters said. “It’s moved in a way that’s going to make returns more generous.”
Through ongoing engagement with investor communities, Walters said the private equity voices have been the most critical.
Among the polarity of views, Walters underlined that not all investors’ perceptions of the sector are negative.
“The message is that the sector must remain investable,” he stressed. “I have done a lot of engagement with investor communities and it’s true there are a variety of views out there, perhaps the most critical voices are private equity voices. Other investors have been less critical.”
On Thames specifically, Walters said that the challenges facing the firm are the same as the rest of the sector, albeit to a different degree.
“Thames is a challenged company,” Walters said. “But its challenges are a difference of degree, not a difference of type.
“Those are related to the challenges the sector as a whole faces and we need a PR24 that meets those challenges.”
Thames, which has attracted special administration regime (SAR) speculation since last summer, remains debt-laden to the tune of £14 billion.
However, as a regulated company it has a guaranteed income of £2 billion annually from serving a quarter of the population with water and sewerage services.
Speaking shortly after the shareholder announcement, Thames chief executive Chris Weston played down fears that the firm could be put into special administration.
The full interview with Chris Walters will be published in an upcoming Digital Weekly issue of Utility Week.