Dec 17 -
-- The credit metrics of U.K.-based water utility United Utilities PLC are showing an increasing degree of headroom, supported by financial outperformance in the 2010-2015 regulatory period to date.
-- Regulatory measures of operational performance are showing a steady improvement, and United Utilities remains committed to its almost exclusive focus on the low-risk, regulated water sector.
-- We are therefore revising the outlook on United Utilities, and its operating company United Utilities Water PLC, to positive from stable. We are also affirming the ‘BBB-’ and ‘BBB+’ long-term corporate credit ratings on United Utilities and United Utilities Water, respectively.
-- The positive outlook reflects the possibility that we could upgrade the companies in the current regulatory period if the current trends continue.
On Dec. 17, 2012, Standard & Poor’s Ratings Services revised the outlooks on U.K.-based water utility United Utilities PLC (UU) and its subsidiary United Utilities Water PLC (UUW) to positive from stable. At the same time, we affirmed our ‘BBB-’ long-term and ‘A-3’ short-term corporate credit rating on UU, and our ‘BBB+’ long-term and ‘A-2’ short-term corporate credit ratings on UUW.
The outlook revision reflects our opinion of steadily increasing headroom in UU’s Standard & Poor‘s-adjusted credit metrics in the current 2010-2015 regulatory period, and the possibility that we may upgrade the companies in the current regulatory period if the current trend of financial outperformance continues. The positive outlook is further supported by our view of UU’s strong focus on improving its regulatory measures of operational performance and its almost exclusive focus on the low-risk, regulated U.K. water sector.
In the 12 months to March 31, 2012, UU’s adjusted funds from operations (FFO) to debt improved to 12.1% from 11.6% in the previous financial year, supported by the continuing trend of inflation being above the regulator’s expectations. Inflation benefits regulated utilities because their revenues and regulated capital value (RCV) are inflation-linked. In addition, in March 2012, UU benefited from a one-time tax benefit related to the decrease in U.K. corporation tax to 24% from 26%, effective April 1, 2012, which resulted in a significant deferred tax credit. We anticipate that there will be a further tax credit in March 2013. UU is also benefitting from an increasingly favorable profile of real tariff increases and the front-ended nature of infrastructure renewals expenditure, which is highest at the beginning of the regulatory period and then declines gradually.
We currently anticipate that UU’s adjusted FFO-to-debt ratio will hover at about 12% for the rest of the 2010-2015 regulatory period. We will consider upgrading UU if we believe that its adjusted FFO-to-debt ratio can sustainably stay above 12%, assuming an unchanged business risk profile. In this regard, we will closely monitor developments on regulatory reforms that the regulator and U.K. government are considering. In our opinion, UU’s other credit metrics, including adjusted debt to RCV and adjusted FFO interest coverage, remained strong on March 31, 2012, at 59% and 2.8x, respectively.
We will consider lowering our adjusted FFO-to-debt guidance to more than 11% if we consider that UU’s regulatory measures of operational performance have improved to at least the peer group average. We do not yet view UU as being at, or above, the peer average, although we observe that UU ranked relatively well in the regulator’s key performance indicators in 2011/2012. We also see that the company is steadily improving in other measures that we monitor, such as the Service Incentive Mechanism (SIM). This said, we believe that UU still needs to improve its published SIM ranking from 16th of 21 companies in the last combined score for 2011/2012.
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 was GBP590 million before our adjustments. 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 positive outlook reflects our opinion that UU is developing increased ratings headroom, with adjusted ratios benefiting in the current regulatory period from financial outperformance as a result of relatively high inflation, real tariff increases, and the front-ended nature of infrastructure renewals expenditure. In addition, we consider that UU’s regulatory measures of operating performance are steadily improving as result of management’s strong focus on this area.
We would consider an upgrade if we believe that UU can 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%. This assumes an unchanged business risk profile. In this regard, we will closely monitor developments on regulatory reforms that the regulator and U.K. government are considering.
If we assess UU as having improved its operational performance to at least the peer group average, we would consider lowering the threshold for adjusted FFO to debt to 11% to reflect our view of reduced business risk, again assuming an unchanged business risk profile.
Under our methodology for rating holding companies of U.K. regulated utilities, if we were to upgrade the regulated operating company, UUW, by one notch to ‘A-', we would likely upgrade the holding company, UU, by two notches to ‘BBB+'. This is because our methodology for rating holding companies of U.K. regulated ring-fenced utilities--which applies when the regulated operating company is in the ‘BBB’ rating category--would no longer apply. (For further 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.)
Related Criteria And Research
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ratings Affirmed; CreditWatch/Outlook Action
United Utilities PLC
Corporate Credit Rating BBB-/Positive/A-3 BBB-/Stable/A-3
Senior Unsecured Debt BBB- BBB-
Commercial Paper A-3 A-3
United Utilities Water PLC
Corporate Credit Rating BBB+/Positive/A-2 BBB+/Stable/A-2
Senior Unsecured Debt BBB+ BBB+
Commercial Paper A-3 A-3