Fitch Ratings agency is warning that the UK water sector remains under pressure – factors that continue to weigh on the ratings include uncertainty around the Competition and Markets Authority appeals, operational delivery on total expenditure (totex) and outcome delivery incentives (ODIs) and pandemic-related bad debts.

Recent downgrades in the UK water sector reflected return, cost and performance pressures stemming from the new AMP7 price control, Fitch Ratings says. However, the water companies still have limited financial headroom even at the new, lower rating levels, and this may be “insufficient to fully insulate them” from the possible long-standing consequences of the pandemic.

According to the ratings agency, Ofwat’s tough PR19 price control and the impacts of the coronavirus pandemic undoubtedly affected companies’ performance and financial markets after the Final Determination in December 2019 – and are further eroding the UK water companies' financial headroom.

In a special report outlining its latest assessment of the sector, Fitch says:

“The coronavirus pandemic, coinciding with the most challenging price control since privatisation, presents an enormous challenge to the sector.”

“Companies’ credit profiles are already stretched against their financial covenants and negative rating sensitivities, so they have limited headroom to withstand further shocks.

“Some companies could hit their trigger events in the financial year to end-March 2021 (FY21) in the event of a second national lockdown or extended local lockdowns.”

Although three quarters of the ratings have Stable Outlooks, the factors could individually or collectively lead to negative rating actions, Fitch warns. Most of the companies have a limited range of mitigating measures as they have already cut dividends to minimum acceptable levels and

launched major cost-transformation programmes. Any further reduction would represent a threat to operational service delivery or debt serviceability at the holding company level.

The pandemic has resulted in lower net water consumption volumes, slightly higher bad debts and lower inflation expectations. Fitch is expecting the reduction in volumes to affect revenues and cash flows only temporarily, but growing bad debts and low inflation could have a more incremental and lasting effect.

The ratings agency said:

“Should low inflation persist over the longer term due to another national lockdown and a sluggish economic recovery, companies would experience a prolonged negative impact on their gearing and nominal post-maintenance coverage ratios, adding to rating pressure.”

Click here for further information about the special report What Investors Want to Know: UK Water in AMP7