Utility Week

18 | 18TH - 24TH JANUARY 2019 | UTILITY WEEK Finance & Investment Looking to the future As utility firms walk the tightrope between a tighter financial environment and the need to improve performance and mod- ernise, CFOs will be at the heart of tough decision-making. Going forward, CFOs and finance direc- tors will have to make difficult choices about investment, and in particular whether to prioritise the upgrading of ageing infra- structure, new capital projects and the shi to digital and low-carbon technology. And where and how to get the best returns when it comes to investing in customer engage- ment and reducing bad debt, as Anglian Water's treasurer Jane Pilcher points out. "You have to work with quite a lot of differ- ent technologies to find the few that give you those added benefits," she says. WPD's Ian Williams says cyber-security is a further important factor that sits alongside other competing investment requirements. PA Consulting water specialist Richard Khaldi also points to the difficult choices: "Operational leaders in water business will be looking for increased investment to main- tain and improve networks, while treasury colleagues will be seeking further efficien- cies to manage shareholder expectations. "In our view it will be the quality of deci- sion-making that is the difference between success and failure. With more reliance than ever before on the operational side of busi- nesses generating returns, investment deci- sions will take on a new criticality and the CFO must have confidence in the processes that support those decisions." One of the major issues facing CFOs and finance directors working in the energy Credit ratings are the City's verdict on financial strength The financial repercussions of regulators' activity don't stop at rate of returns. How well organisations perform against their tar- gets can impact credit ratings, which in turn affects the cost of borrowing, shareholder confidence and investment. With a negative cashflow, a benign borrowing environment is particularly crucial for water. So perfor- mance across a range of measures, like water leakage, also needs to be on the CFO's radar. Anglian Water treasurer Jane Pilcher says: "Some of the rating agencies have the water industry on a negative outlook, and with the political and public scrutiny we are under, we are all expecting a very challeng- ing review. "All this public and political scrutiny is putting regulated utilities under more pres- sure than they have ever been before. We are focusing on doing the right thing for our cus- tomers, the environment and putting public interest at the heart of everything we do." In July 2017 S&P Global Ratings down- graded Thames Water's credit rating. The firm's rating on Class A debt and Class B debt was lowered to BBB+ and BBB- respectively. "Our downgrade of Thames Water was the result of poor water management, compared with peers, and related to leak- age from below-ground water assets that resulted in finan- cial penalties," explained Beth Burks, environment, social and governance analyst at S&P Global Ratings. Ofwat requires water companies, as part of the licensing provisions, to maintain an investment grade rating (AAA and BBB- cat- egories). Most licences include a cash lock- up mechanism if the ratings are lowered to a level below investment grade (from BB+ to D- or speculative grade). Once the cash lock up is triggered, the company cannot pay dividends, the mechanism acting as a tool to protect it from further deterioration. Fitch Ratings also downgraded its ratings for UK water holding companies in July, cit- ing concerns over business risk in the water sector. Osprey Acquisitions (Anglian Water), Kelda Finance (Yorkshire Water) and Green- sands UK (Southern Water) were all down- graded from stable to negative. At the time, Fitch said the rating action reflected its reas- sessment of the industry business risk ahead of the upcoming regulatory price control (PR19) in the sector and its revision of nega- tive rating sensitivities for companies. S&P Global Ratings' lead analyst on UK utilities, Matan Benjamin, says many bonds stipulate that companies must maintain an investment grade credit rating. "Overall, water is a strong sector and all the operators are all in the investment grade category," he says. "And the regulatory framework in the UK is very supportive. "Having said that, there are a number of elements in the framework that we consider to be challenging over the next few years. The more inefficient and highly leveraged operators will be in a weaker position to adapt to the changes. The regulator is mak- ing it more and more challenging, introduc- ing mechanisms that limit the capacity to pay dividends. "Our rating is an indication of the likeli- hood of default," he adds. "Investors use this information as one input from a vari- ety of market factors to price bonds. If we lower a rating of a company, it indicates the probability of default is increasing, and there- fore the return that inves- tors demand will likely be higher." S&P is predicting that climate change-related fac- tors including increasing water-related risks such as freshwater scarcity, flood- ing and drought, will play a significant role in the analysis by ratings. A report from the organisation published in November points out that water-intensive industries – includ- ing utilities and power – are, unsurprisingly, the most exposed to water factors. "As climate change continues to fuel volatility in other weather systems and the hydrological cycle, we could see more rat- ing actions caused by water-related events," said Beth Burks, environment, social and governance analyst at S&P Global Ratings. But while water risks can have widely negative credit implications for utilities, they can also fuel growth for some businesses. "As markets and issuers absorb the impacts of droughts, floods, and declining water quality, there are opportunities as well as challenges," said Burks. Businesses that offer water solutions, such as water treatment technologies, have experienced positive influences on credit. Ofwat requires water companies, as part of the licensing provisions, to maintain an investment grade rating CFO Insight report

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