Fitch Ratings has affirmed UK-regulated water and wastewater company, Wessex Water Services Limited's (WWSL) Long-term Issuer Default Rating (IDR) at 'BBB+', senior unsecured rating at 'A-' and Short-term IDR at 'F2'.

Fitch said the affirmation reflects its expectation of adequate financial metrics to support the ratings given the company's track record of outperforming the regulator's cost targets, despite the greater efficiency challenge embedded in the final determination of tariffs for the period April 2015 to March 2020 (AMP6). “The ratings also reflect WWSL's robust financial and regulatory performance and continued market-leading position in the UK water sector,” Fitch said.

Wessex Water Ltd (WWL) is rated 'BBB', one notch below the operating company, which reflects the subordination of creditors at holding company level and Fitch's expectation that WWL will not raise any material external debt.

Commenting on key rating drivers, Fitch said WWSL's strong operational performance, a high level of transparency in terms of expected revenues and likely levels of capital expenditure are offset by increasingly tough regulatory performance targets and lower returns on capital in AMP6. The water company’s strong business profile is also offset by higher levels of leverage compared with similarly rated issuers across the corporate spectrum.

WWSL is seen as a leading performer in the UK water sector and Fitch expects the company to maintain its position.

Quality likely to improve

Fitch expects the company to outperform AMP6 quality targets and retain its upper-quartile performance, backed by its strong operational track record and the implementation of new processes and cost efficiencies. Fitch is also expecting further benefits from improvements in catchment management, in-sourcing of the design elements of the capital investment programme, and the restructuring of its workforce. The integrated water supply grid, which the company expects to be completed in 2018, will significantly reduce reliance on single water sources. This will improve the resilience of water supplies and enable WWSL to reduce abstraction volumes and quickly offset any deterioration in raw water quality.

Combined totex outperformance of £165 million expected over AMP6

The company met all of its regulatory outputs for AMP5, and achieved capital expenditure outperformance of around £150 million or 15%, compared with regulatory allowances. Operational expenditure outperformance was around £66 million or 8%, including exceptionals and leakage costs, and excluding pension deficit repair payments. Achieved opex efficiencies are in addition to operational costs absorbed by the company related to the adoption of private sewers, carbon reduction commitment and bad debt costs. The ratings agency forecasts include a combined totex outperformance of £165 million over the five-year period.

Increased business risk in the sector

The ratings agency also highlighted what it regards as increased business in the sector, commenting:

“We believe that business risk in the water sector has increased for AMP6, and is now more closely aligned with regulated UK gas and electricity network businesses. In addition to a significant reduction in the cost of capital, total expenditure will be benchmarked to the top quartile by 2020, representing a more demanding target for capital expenditure. “