UK water plc faces a lower cost of capital

The water industry regulator has published new guidance on the cost of capital it sees as acceptable for the water companies. Its report gives guidance on a number of financial parameters and sets out what it believes is reasonable to ensure the water companies make a ‘fair’ return that rewards their investors but also protects customers.

Ofwat are saying that the weighted average cost of capital (WACC) should be in the range 3.5% to 4% rather than about 1% on average in the water companies business plans. The highly leveraged water companies (Thames, Anglian, Southern and Yorkshire) may as a consequence struggle to protect their credit ratings. Fitch the credit ratings agency said last week that this move could lead to a down grading of their ratings.  

It is a double whammy in that Ofwat is also questioning the high gearing of some companies suggesting that gearing should be around 62% - its currently in the range 60-70%.

It is part of the on going battle between those who feel that water bills are too high and still rising at an unacceptable rate. The Ofwat Chairman Jonson Cox has been quoted as saying: “the last few years have been very kind to the owners of water companies, at a time when life is very challenging for customers”.

This signals that the water industry is likely to be entering a new era of much harsher financial constraints which will inhibit there room for manoeuvre. It also comes at a time when some of those in the water sector need to strengthen their balance sheets to support future growth in their asset base.

The outlook is likely to get more challenging. Its clear that the current problems with flooding are spreading too other parts of the country and are likely to get worse given the weather outlook. Contamination of flood water with raw sewage is one of the major problems and a significant risk to those exposed to flooding. Concerns over the state of the sewerage network are bound to significantly increase as the lessons start to be drawn from the current flooding problems.