Severn Trent (SVT) is expected to remain stable over the next regulatory period thanks in part to its strong performance in the current cycle.
That is according to a forecast from ratings agency S&P, which predicts the company will generate lower cash flows in AMP7 but will maintain its current credit ratings.
S&P said it expects the next regulatory period to be tough but continues to assess SVT as one of the most efficient companies in the sector.
The reduced cash flow, mainly due to a reduction in allowed return on capital, will lead to a tightening of credit metrics.
The agency affirmed the water company’s long-term credit issuer rating of BBB and the BBB- issue rating on debt issued.
S&P said the stable outlook reflects its expectations that SVT will demonstrate solid operating performance and maintain funds from operations to debt about 9 per cent and debt to EBITDA of less than 9x.
Strong past performance – including earning £132 million in outcome delivery incentive (ODI) rewards during the current regulatory period – will assist the company to maintain its credit metrics. It achieved favourable cost of debt at 3.7 per cent and will recover around £30 million in rewards in each of the first three years of the next regulatory period beginning in April.
Reflecting on performance in AMP6, S&P noted SVT achieved a cumulative return on regulatory equity (RoRE) of 9.1 per cent through a combination of ODI rewards, low financing costs, and £460 million of total expenditure outperformance.
SVT was the first company to accept Ofwat’s final determination for its 2020-25 business plan.
The fast-tracked company committed to reducing customer bills by 9 per cent; 15 per cent leakage cuts; a 43 per cent drop in water supply interruptions; a 29 per cent reduction in pollution incidents and to lower PCC by 4 per cent.
These incentive related targets will result in what S&P expects to be a RoRE of between -2.83 per cent and +1.90 per cent.
S&P said: “We believe that SVT is well positioned to continue demonstrating solid operational performance, and potentially benefit from rewards and efficiencies on its allowances. The group’s relatively strong operational performance in the current regulatory period, with £132 million of net rewards, supports our view.”
Overall SVT’s credit metrics will weaken despite its positive performance. Gearing will increase in the next AMP to 65 per cent and the company’s dividend policy will be in line with consumer price index (CPIH) inflation.
S&P believes a rating upgrade is unlikely for SVT but it could lower the rating if the funds from operations (FFO) to debt ratio weakens to below 9 per cent or if the company incurs operation penalties for not delivering on its business plan.
In Ofwat’s final determination, SVT’s bills will have to fall by 8.9 per cent; total allowed revenues will be £7.77 billion; totex allowance will be £6.2 billion and the company will be allowed £864 million for improvements to service, resilience and the environment.