Fitch Ratings agency says today’s ‘A’ rating for Dwr Cymru Welsh Water reflects the company’s sound regulatory and operational performance for the financial year ending March 2014, together with the material reduction of earnings expected for the upcoming AMP6 regulatory period.

Dwr Financing is the debt-raising vehicle of Dwr Cymru Cyfyngedig (Welsh Water). Dwr Cymru is one of the ten appointed water and sewerage companies in England and Wales.

Commenting on material reduction of earnings in the sector in its affirmation, Fitch said that Ofwat’s guidance towards a cost of capital of 3.85% for the regulated companies was lower than it had expected. Fitch said that taking into account draft determinations published to date, while it appeared that efficiency targets for total expenditure in the wholesale price controls may leave some room for outperformance, allowances for the retail price controls are challenging and may offset some or all of the savings from the wholesale business.

In terms of outcome delivery incentives, Fitch described the financial rewards and penalties in the draft determination for Welsh Water as “skewed towards the downside.”

Fitch has assumed for purposes of the rating forecast that the company will earn the cost of capital of 3.85% and no premium or penalty, before factoring in negative £52.1m of revenue adjustments relating to the previous price control period (ie service incentive mechanism (SIM), capital incentive scheme (CIS) and revenue correction mechanism).

In addition, financial flexibility in terms of gearing for Welsh Water would compensate for the low interest cover – which took into consideration the cash flow dynamics of the group, ie that the company will be free cash flow neutral before potential customer rebates or additional capital projects for the benefit of customers.

Sound regulatory performance

Fitch said that in FY14 Dwr Cymru met leakage targets, improved pollution incident performance and maintained a SIM score of 84 and reported stable asset serviceability for all asset categories. However, as part of the draft determination, Ofwat assessed water infrastructure to be marginal for the whole price control, given that the company revised its data for the DG3 measure (less than 12 hours supply interruption) as part of their business plan submission. Overall, Dwr Cymru had delivered sound regulatory performance and Fitch perceives it as a middle ranking company in the industry.