Moody’s Investor Service is forcasting a stable outlook for UK water companies over the next 12 to 18 months.

The risk assessment firm’s outlook reflects Moody’s view that regulatory certainty balances environmental and social risks in the UK water sector.

The 2022 outlook reflects fixed allowed returns to March 2025, which should underpin relatively stable financial metrics. However, Moody’s cautions that this is offset by the risk of higher interest rates, which would increase debt service costs for companies with large refinancing needs, while political and regulatory scrutiny of the sector remains high.

The analysis says that allowed returns are fixed until March 2025, resulting in relatively stable financial metrics. However, COVID-19 and company performance will cause some volatility, with the effects of the pandemic on volumes and rewards or penalties for operational performance resulting in some year-on-year volatility.

Commenting on inflation, Moody’s says market expectations for near-term inflation have increased significantly in recent months. However, while in Moody’s view higher inflation will increase companies' revenue and boost RCV growth, a large portion of inflation-linked debt means companies' debt and debt service would also grow. On average, the sector holds around 50% of inflation-linked debt, which will also grow with inflation.

The analyst is warning that while the evolution of interest rates over the next 12 to 18 months is uncertain, short- to medium-term interest rate evolution and material changes will particularly affect interest coverage metrics for companies with large refinancing needs.

Moody’s is also highlighting the fact that untreated wastewater discharges affecting rivers, beaches and bathing waters are attracting more public and political attention, with pollution incidents carrying an increasing risk of fines.

The analysis flags up the launch of investigations into wastewater treatment works in November 2021 by the Environment Agency and water regulator Ofwat, with companies “more at risk of greater penalties than in the past.”

Moody’s says it could change the outlook to negative if it appears likely that the credit fundamentals for the sector will deteriorate or greater affordability constraints prevent the water companies from being able to fund necessary investments to improve or enhance performance.

“Ongoing regulatory pressure continues to weigh against a positive outlook,” the analysis says.

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