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Nov 05 -
Summary analysis -- United Utilities PLC -------------------------- 05-Nov-2012
CREDIT RATING: BBB-/Stable/A-3 Country: United Kingdom
Primary SIC: Water Supply
Mult. CUSIP6: 91311Q
Credit Rating History:
Local currency Foreign currency
28-Jan-2010 BBB-/A-3 BBB-/A-3
29-Nov-2007 A-/A-2 A-/A-2
Rating Rating Date
US$400 mil 6.875% nts due 08/01/2028 BBB- 28-Jan-2010
EUR 7 bil med-term note Prog 10/13/1998: sr
unsecd BBB- 28-Jan-2010
US$250 mil 4.55% nts due 06/19/2018 BBB- 28-Jan-2010
EURO CP prog auth amt EUR2 bil A-3 02-Feb-2010
The ratings on U.K.-based regulated water utility United Utilities Water PLC (UUW; BBB+/Stable/A-2), and its parent, United Utilities PLC (UU; BBB-/Stable/A-3), reflect our assessment of the consolidated group's "excellent" business risk profile and "significant" financial risk profile. The ratings are supported by Standard & Poor's Ratings Services' view of the group's almost exclusive focus on the water sector, a sector that we consider as having low operating risks. Further support for the ratings comes from the stable and predictable cash flows generated by the broadly credit-supportive regulatory framework over five-year periods; relatively low balance sheet gearing compared to peers; and a "strong" liquidity position with significant pre-funding of capital expenditures (capex).
These rating strengths are in part offset by a weakening in cash flow-based credit measures following the start of the current five-year regulatory period on April 1, 2010, which illustrates the issue of regulatory reset risk. Additional constraints on the ratings include an operational track record that has been below average historically; and a large capex program that, when combined with dividend payments, we think will result in negative discretionary cash flows during the current regulatory period (2010-2015).
Although we rate the company on a consolidated basis, the long-term rating on the holding company (UU) is two notches lower than that on the operating subsidiary (UUW) because UUW benefits from regulatory protection. In our view, debtholders at the holding company level are more exposed to nonpayment risk because they have only secondary access, through dividends, to regulated operating cash flows (for more information, see "U.K. Regulatory Ring-Fencing Risk For Utility Holding Companies: Standard & Poor's Approach," published July 8, 2003, on RatingsDirect on the Global Credit Portal).
S&P base-case operating scenario
In our base-case operating scenario, we anticipate that UU will continue to report a stable operating performance to the end of the current regulatory period, which ends in March 2015. In our forecast, we anticipate that revenues and underlying operating profit will steadily rise, supported by the increasingly supportive profile of approved real tariff increases, RPI inflation of 2%-3%, and stable controllable costs. We further anticipate that UU's EBITDA margin will remain above the peer group average, and that it will continue to be supported by the disposal of most remaining nonregulated businesses in 2010, which has resulted in over 98% of operating profit being derived from the relatively high-margin water business.
UU's rankings of operational performance, as assessed by the regulator Ofwat, are showing signs of improvement after being at the low end of the peer group in recent years. In the new Service Incentive Mechanism (SIM) for 2011/2012, UU showed the joint greatest degree of improvement of all the water companies in terms of total points, moving from last position (21st), to 16th. The company believes it is making further progress in 2012/2013, and it aims to rank at least in the middle of the pack for the three-year period to 2013/2014, which will avoid it receiving a revenue penalty in the next price control. Apart from the SIM, UU no longer shows any areas of material weakness, in our view.
S&P base-case cash flow and capital-structure scenario
For the remaining years of the current regulatory period ending in March 2015, we anticipate that UU's S&P-adjusted FFO-to-debt metric will maintain a good degree of headroom at the current rating level. In our forecast, we anticipate that adjusted FFO will steadily increase, supported by rising operating profits and a moderation in debt indexation, which we subtract from FFO, but that adjusted debt will also rise, as a result of negative discretionary cash flows.
We anticipate that UU's adjusted FFO interest cover and debt-to-RCV ratios will remain strong for the rating. The group's gearing is benefitting from inflation, which increases its RCV. UU expects to achieve financing outperformance in 2010-2015 of more than GBP300 million, due to relatively high inflation and a low cost of debt. The company has not changed its stated dividend policy of targeting a real growth rate of RPI + 2% per year until at least 2015.
The short-term rating on UUW is 'A-2', and that on UU is 'A-3'. We assess UU's liquidity as "strong" under our criteria and calculate that liquidity sources should exceed liquidity needs by about 1.3x over the next 12 months.
As of March 31, 2012, we estimate liquidity sources of about GBP1.33 billion. These include:
-- Unrestricted cash and equivalents of about GBP321 million.
-- An available GBP420 million in undrawn committed bank facilities with expiry dates beyond 12 months.
-- FFO of at least the amount in 2011/2012, which we calculate (before our adjustments) was GBP590 million.
We estimate UU's liquidity needs over the next 12 months to be about GBP1.05 billion, comprising:
-- Short-term debt of GBP127 million.
-- Capex of about GBP700 million.
-- Dividend payments of about GBP220 million.
The stable outlook reflects our view of the relatively predictable performance of UU's low-risk, regulated U.K. water and wastewater operations. We anticipate that UU is likely to continue to manage its business efficiently; maintain a stable financial profile throughout the 2010-2015 regulatory period; and continue to improve its operational performance, which Ofwat has assessed as below average historically.
In our opinion, UU is developing more rating headroom in the current regulatory period, supported by financial outperformance on regulatory assumptions, and the profiling of regulated tariffs and infrastructure renewals expenditure. We would consider an upgrade if we believed that UU could sustainably achieve an adjusted FFO-to-debt ratio of more than 12%, while maintaining adjusted FFO interest coverage of more than 3x and an adjusted debt-to-RCV ratio of less than 65%. Furthermore, if we assess UU as having improved its operational performance to at least the peer average, we would consider reducing the threshold for adjusted FFO to debt to 11% to reflect our view of reduced business risk. This assumes that we see no increase in business risk in other areas, for example, as a result of regulatory reform or competition in the sector.
We consider downward rating pressure as less likely, based on current information. However, a downgrade could occur if UU was unable to maintain an adjusted FFO-to-debt ratio of about 9%-10%, assuming an unchanged business risk profile.