US ratings agency Moody’s has downgraded its outlook for the UK’s water industry due to an uncertain macroeconomic environment and increasing scrutiny from regulators over poor performance.
In an investment note, Moody’s downgraded its outlook for the sector from ‘stable’ to ‘negative’.
“Ongoing regulatory and affordability pressure as well as a volatile macroeconomic environment continue to weigh against a positive outlook,” Moody’s said.
The ratings agency expects inflationary cost pressures across the industry to not be fully offset by revenue adjustments, and for underperformance in the sector to further weaken cash flow.
Sustained high inflation is typically credit positive for UK water companies, however, Moody’s considers water companies to be exposed to the mismatch between the headline inflation rate and their rising operational costs.
In particular, rising interest rates will hit companies with large funding needs as allowed returns, intended to cover companies’ cost of debt and equity capital, are fixed during each five year regulatory period Ofwat establishes under pricing reviews.
Water companies have also faced an intense public backlash over numerous leaks and pollution incidents, sparking calls to prosecute board members of companies that have breach regulations.
Moody’s highlighted that these pollution incidents continue to receive heightened attention from regulators.
This has increased the risk of future fines, it said, with Ofwat and the Environmental Agency both investigating suppliers accused of discharging untreated sewage in breach of regulations.
In an update last summer, Ofwat confirmed that it had opened enforcement cases against six companies including Anglian Water, Northumbrian Water, South West Water, Thames Water, Wessex Water and Yorkshire Water.
Moody’s said it does not expect these investigations to conclude over the next 12-18 months, adding further uncertainty, while the potential additional legal action is also becoming an increasing possibility.
The ratings agency said, however, it “could change the outlook back to stable” if the regulatory environment became more supportive of growth and economic conditions improved.
Ofwat has been approached for comment.