Southern Water has warned that a future downgrade to a sub-investment grade credit rating would result in a breach of the company’s licence and borrowing covenants and “represents a material uncertainty on the company’s ability to continue as a going concern.”

The warning comes in the company’s Interim Financial Information and Report for the six months ended 30 September 2024 published this week which saw Southern Water fall to a record annual operating loss of £72 million.

The loss from continuing operations after tax was £63.1 million (period to 30 September 2023: profit of £41.1 million).

The company is also required to refinance a £350 million bond that is due for repayment in March 2026 and requires additional funding (debt or equity) before March 2026.

“Given recent downgrades and market sentiment, there is no guarantee the company will be able to successfully refinance or raise this additional equity. The directors anticipate being able to refinance the debt, based on a history of successful fundraising in the past and following discussions with advisors, but this is not included in the base case because it is not yet committed,” Southern Water warns in the report.

The utility says the credit ratings agencies recognise that the company has strong liquidity through to March 2026, having secured a total of £1.5 billion of new debt financing over the past 12 months, including a £300 million bond issue completed earlier in November.

However, the report says the agencies have changed their assessment of the stability and predictability of the regulatory environment for the UK water sector, resulting in downgrades to Southern Water credit ratings.

“A future downgrade to a sub-investment grade credit rating would result in a breach of the company’s licence and borrowing covenants and given the recent downgardes and market sentiment, debt refinancing or equity raising required before March 2026 represents a material uncertainty on the company’s ability to continue as a going concern,” the report warns.

Revenue for the period increased to £496.2 million (period to 30 September 2023: £441.0

million). Operating costs increased by 9.6% to £493.4 million (period to 30 September 2023: £450.3 million). Southern Water said the increase was largely driven by an increase in operating expenditure - over the period to September 2024 the principal drivers of additional operating costs were as follows:

Inflation which increased prices for all operational costs by £15.2 million. The main increases were in power and contractor and employee related costs

Increased software related costs of £1.4 million primarily related to incident management and other support software.

Increased tankering costs to deal with the continued high levels of groundwater in April

and May following the exceptional wet weather last winter were offset

Employee costs were up by £3.2 million excluding inflation due to increased resource

numbers this year

Improvements to site security and access control of £1.4 million

Further increases to the proactive maintenance programme on wastewater assets to reduce the number of incidents, pollutions and improve compliance £4.6 million

Increased leakage identification and repair activity £2.6 million

.

There was an increase to the value of the company’s longterm borrowings which grew by £511.4 million, from £4,903.3 million at 31 March 2024 to £5,414.7 million at 30 September 2024 comprising £150.0 million of new bonds, a £350.0 million drawdown on the revolving credit facility this year and a reclassification of £13.0 million of short-term lending at March 24 to long term as at September 2024.

The report draws attention to Ofwat’s review of industry performance for 2023–24 published in October highlighted that, based on the company’s 2023–24 results, its performance had improved on 9 out of 12 measures over AMP7. However, Southern is still lagging behind on its Ofwat performance commitment targets and is currently forecasting penalties for a number of areas including pollutions, treatment works compliance, internal flooding and leakage.

According to the report, the directors consider that the PR24 plan submitted to Ofwat in respect of AMP8 is financeable, but it does assume additional debt funding of £4 billion and equity funding of £650 million will be received over the 5-year term of AMP8, which is not committed at the date of the report.

“With uncertainty surrounding Ofwat’s Final Determination due in December, and significant

challenges in the sector’s investment profile, the next few months will be highly important in setting the future direction for the company and the water sector more generally”, the report says.