RPT-Fitch Affirms Southern Water's Senior Secured Debt at 'A-'/'BBB'
Sept 20 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has affirmed Southern Water (Finance) Limited's (SWSF) senior secured ratings for its class A debt (wrapped and unwrapped) at 'A-' and its class B debt at 'BBB'. The Outlooks for both classes of debt are Stable.
SWSF is the debt-raising vehicle of Southern Water Services Limited (Southern Water), the regulated, monopoly provider of water and wastewater services for parts of Sussex, Kent, Hampshire and the Isle of Wight, UK.
The affirmation reflects Southern Water's rankings for regulatory and operational performance in the lower half of the peer group, improving cash flow generation supported by management action and higher k-factors as well as the covenanted and secured financing structure, including early warning signals based on financial and non-financial parameters (defined as trigger events in the documentation).
Ofwat, the economic regulator for the UK water sector, will modify the tariff-setting methodology for the price control period from April 2015 to March 2020 to focus more on customer service and sustainability. To date there has been little guidance as to how these changes will be implemented. Therefore, Fitch cannot judge the impact of the upcoming tariff settlement on the credit quality of the sector at this stage.
However, given i) under-recoveries in the order of GBP150m to be returned to the company under the revenue correction mechanism, ii) that Southern Water is rated one notch lower than peers with a comparable financing structure, and iii) lower levels of working capital requirements over the next price control period following significant progress with the metering programme, Fitch does not expect any negative rating pressure for Southern Water going into the next price control period.
KEY RATING DRIVERS
Adequate Financial Metrics
Fitch estimates FYE13 leverage to be 67.2% for class A and 83.0% for class B. For the remainder of the price control gearing is expected to range around 72% and 82% for the respective tranches. Post-maintenance and post-tax interest cover (PMICR) at FYE13 was 2.17x for class A and 1.73x for class B before considering under-recoveries. When removing swaps with pay-down provisions the ratio reduces to 1.47x for class A and 1.25x for class B. Over the remainder of the price control period Fitch expects interest cover to be slightly weaker, which is driven by higher cash tax and pension deficit repair.
Improved Cash Flow Generation
Management scrutiny of operating practices and focus on regulatory targets over the past two years have yielded results, including better cash collection, working capital management and implementation of efficiency measures. Coupled with higher allowed real price increases in percentage terms (also called k-factors) in FY13 and FY14 of the price control cash flow generation has improved visibly. Also, restriction of dividends and continued high retail price inflation have led to a reduction in gearing/created some financial flexibility at the given rating level.
Regulatory Performance Needs Improvement
Southern Water reported in FY13 marginal asset serviceability for wastewater non-infrastructure relating to a number of iron failures at its wastewater treatment works. The company has applied for iron consents to be revised at a number of its wastewater treatment works which should allow compliance to be improved. Also, the company needs to catch up with peers in terms of customer service as measured by the service incentive mechanism and reduce incidences of internal sewer flooding. Overall, Fitch continues to rank Southern Water in the lower half of the industry for operating and regulatory performance.
As of March 2013 the group had unrestricted cash and cash equivalents of GBP92.1m and GBP200m of committed, undrawn revolving credit facilities with a June 2015 maturity. This liquidity position is sufficient to cover maturities, operating and capital requirements as well as incremental dividends to the holding company until March 2015.
We note that a maturity in March 2014 of GBP250m class B debt has already been pre-funded and the related deposits are not included in the cash balance quoted above.
Positive: Future developments that could lead to a positive rating action include:
- If the group maintains pension-adjusted net debt / RAV comfortably below 73% (class A) and 83% (class B) during the next price control and improves its position in Ofwat's league tables at least to sector average, Fitch will consider positive rating action.
Negative: Future developments that could lead to negative rating action include: Given improved cash flow generation and incremental financial flexibility at the current rating level negative rating action appears to be a remote prospect at this point in time.
- If cash flow generation were to deteriorate in a way that gearing had to increase in order to procure funds for operating and capital expenditure requirements/keep operations running, then negative rating action should be expected.
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