S&P Global Ratings has revised its outlook for South East Water (Finance) Ltd.’s debt to negative from stable, as high inflation weights on the company’s credit metrics.

South East Water’s exposure to inflation-linked debt is roughly 55%, in line with the sector average. However, in the ratings agency’s view, as inflation continues to climb, financing costs are likely to be higher in 2022, 2023 and 2024.

Significantly higher-than-expected inflation levels are causing both operating and financing costs to rise significantly.

According to S&P, extreme weather has also weighed on the group's operational performance this year, with demand for water surging because of the hot weather while in February 2022, Storm Eunice caused the loss of power across the water company’s network and severely affected operations, causing water supply interruptions and water discoloration. The ratings agency said it understands that ” the representations South East Water made to Ofwat to remove the effect of Storm Eunice on its performance commitments were unsuccessful.”

In terms of energy price increases, SEW is fully hedged on wholesale energy costs for fiscal 2023 and well advanced for fiscal 2024, which helps to mitigate any significant energy cost effects on margins.

However,the ratings agency is warning that the company remains largely unhedged for fiscal 2025, leaving the company “in an open position subject to higher energy prices.” South East Water has also seen significant increases in inputs costs, such as chemicals.

S&P said it could lower the rating further if the company is unable to mitigate the negative effects of the current high inflation environment by the end of AMP7, or if operational performance deteriorated significantly.

Looking at the water sector as a whole, S&P takes the view that the water companies are unlikely to recover all cost increases via bills during AMP7, with the actual increase in some input costs possibly greater than the increase in allowed revenue.

The ratings agency commented:

“We…consider it unlikely that water companies will be able to recover the totality of increased costs via higher bills over AMP7.”

“At the same time, the U.K. cost-of-living crisis might create political and regulatory pressure that would make it difficult for water companies to pass on inflation of more than 10% to consumers via bills.”