Fitch Revises Anglian Water Outlooks to Stable; Affirms Ratings
OREANDA-NEWS. Fitch Ratings has affirmed Anglian Water Services Financing Plc's (AWF) senior secured ratings for its class A debt (both wrapped and unwrapped) at 'A' and its class B debt at 'BBB+'. At the same time, Fitch has revised the Outlooks on the Class A and Class B debt to Stable from Negative.
The revision of Outlook to Stable from Negative for the Class A debt and Class B debt reflects our expectation that the company will meet our net debt/regulatory asset value (RAV) guidelines for the rating given that the board has approved the company's business plan to reduce gearing to 80% by 2020.
The rating affirmation reflects the efficiency challenge embedded in the final determination of tariffs for the period April 2015 to March 2020 (AMP6), neutral revenue adjustments related to the 2010-15 period, adequate interest cover and Fitch's expectation of leverage being reduced to around 80% net (class A and class B) debt/RAV by 2020.
The ratings also take into account Anglian Water's market leading operational and regulatory performance. Also, the secured nature of the group's financing structure benefits from structural enhancements, including trigger mechanisms (such as dividend lock-up provisions tied to financial, positive and negative covenants) and debt service reserve liquidity.
AWF is the debt-raising vehicle of Anglian Water. Anglian Water is one of 10 appointed water and sewerage companies (WaSC) in England and Wales.
KEY RATING DRIVERS
Expected Deleveraging, Adequate Interest Cover
Fitch expects the company to reduce gearing to below 70% net debt/RAV for its class A debt and 80% for its class B debt over AMP6, which is commensurate with guidelines for the current ratings. Our expectations are based on the board-approved business plan of the company to reduce leverage over AMP6. We expect the company to achieve this through reduced dividends up-streamed to the Holdco and the use of some of the efficiencies generated over the course of AMP6. This is in contrast with the trend over AMP5 of Fitch-calculated leverage increasing to 72% for class A debt and 83% for class B debt by year-end 31 March 2015.
Fitch forecast post-tax and post-maintenance interest cover (PMICR) for class A debt, and for senior debt for AMP6 being comfortable within our guidelines of 1.5-1.6x for class A and of 1.2-1.3x for senior debt.
Operational Outperformance Expected
Fitch expects the company to outperform capex and opex targets over AMP6 given its track record, new processes and the implementation of identified efficiencies for this period.
Following the conclusion of the first year of the price control management has more clarity and confidence in achieving the operational efficiencies identified prior to the start of the price control. Fitch forecasts include combined totex outperformance and Outcome Delivery Incentive for leakage outperformance of GBP168m, in nominal terms over the five-year period.
Strong Regulatory Performance
Over the last price control, AMP5, the company has consolidated its position as top quartile performer in the industry by steadily improving its regulatory and operational performance while meeting all of its regulatory outputs. As a result of this, we believe that the company is well positioned to confront the challenges of AMP6. For financial year ended 31 March 2015 (FY15), Anglian Water reported stable asset serviceability in all four areas for its networks, and met most of its regulatory targets including leakage. Over AMP5, the company also improved its Service Incentive Mechanism score, which reflects customer satisfaction, from 79 to 85.
RCV Reduction in March 2020
Ofwat will make a one-off midnight adjustment to UK water companies' regulated capital values (RCVs) at March 2020 as a result of the price review 2014 (PR14) rulebook reconciliation.
The adjustment will not affect the companies' cash flows over AMP6 as they will retain the run-off revenues and the return earned through AMP6. However, it will result in a reduction in RCV of around 2% for water companies, although the reduction for each company will depend on its capex. For Anglian Water, the RCV will be reduced by GBP116m (in 2013 prices). This represents an increase in leverage of around 1.6% based on Fitch's forecast RCV for 2020.
In our view, the RCV reduction could put pressure on companies' credit metrics for AMP7, especially those with high gearing. The increase in gearing following the RCV adjustment could decrease financial flexibility as a result of reduced liquidity and increased refinancing risk as it may limit the ability of some companies to take on more debt. However, we believe they have sufficient time to adapt their strategies over AMP6 to protect ratings either by reducing dividends or through equity injections.
Anglian Water has a portfolio of index-linked swaps with a notional amount of GBP325m embedded in its capital structure with five year pay-down provisions. The company is currently in the process of removing the mandatory breaks related to GBP175m notional of the total swaps.
Fitch's key assumptions within our rating case for the issuer include:
- Regulated revenues in line with the final determination of tariffs for April 2015 to March 2020, ie assuming no material over- or under- recoveries
- Combined totex outperformance and Outcome Delivery Incentive leakage outperformance of GBP168m in nominal terms over the five-year period
- Slight underperformance in retail costs
- Non-appointed EBITDA of around GBP7.7m per annum
- Retail price inflation of 1.3% for FY16, 2% for FY17 and 2.5% thereafter
Positive: Positive rating action is unlikely for both classes of debt, given the highly geared capital structure.
Negative: Future developments that may, individually or collectively, lead to a downgrade:
- For class A debt forecast gearing sustainably above 70% or PMICR below 1.5x;
- For class B debt forecast gearing sustainably above 80% or PMICR below 1.2x;
- A meaningful decline in operational or regulatory performance;
- Regulatory decisions such as moving additional parts of the value chain away from RAV-based regulation or swapping RPI indexation for CPI indexation.
As of 30 September 2015, the group had available GBP556m in unrestricted cash and cash equivalents and GB500m of undrawn committed revolving credit facilities maturing in 2021 and GBP100m of undrawn committed bilateral bank facilities maturing in 2019. This will provide sufficient liquidity for scheduled debt maturities, capital expenditure, operating requirements and dividends well into 2017.
In addition, debt service reserve liquidity of GBP279m and operating and maintenance reserve liquidity of GBP96m are in place in accordance with the group's secured and covenanted financing documentation. However, this back-up liquidity is only available during financial distress.