Utility Week

UTILITY WEEK | NOVEMBER 2022 | 11 Finance In 2021/22, Thames reported a £230 mil- lion increase in the RPI accretion on its bor- rowings – a period when inflation had barely taken off. This year's figure seems set to be appreciably higher. A‚er all, Thames has a sizeable portfolio of inflation-linked bonds, whose financing costs will presumably have risen sharply of late. While Thames' finances are complex, especially with regard to the various swaps and hedging arrangements, it seems clear that materially higher interest rates will lower its returns: Thames' financial expenses in 2021/22, increased by the RPI accretion, were £384 million (net). In its 2021/22 annual report, Thames confirmed that: "If we are unable to adapt our cost base to rising inflation or interest rates, this could result in a re-prioritisation of investment and reduced service levels, impacting customer services and operational performance." Not a message that politicians, Ofwat and Thames' customers want to hear. Floating debt United Utilities, whose shares have plunged by 18% over the past month, is also exposed to materially higher interest costs, due partly to its disproportionate reliance on floating debt, which accounts for almost 60% of its total net debt. The company recently confirmed it had bonds of £4.3 billion, which are linked either to movements in the RPI or the CPI. Its recent pre-close statement acknowledged that there was an adverse impact from this exposure. The UK's top gas player, Centrica (now a shadow of its former self), has suffered many setbacks in recent years: its shares are now worth just £4.2 billion, which is less than one-fi‚h of their 2013 value. And while there are no certainties in today's utility world, it can be safely assumed that Centrica will not be acquired by Russia's Gazprom, which was widely mooted some years ago. In fact, on the debt front, Centrica is now very well positioned, with a net cash balance of £316 million at June 2022. Over the past two decades, private equity has unquestionably figured very prominently in the UK market: rising interest rates will not be conducive to the continuation of this trend. While it is premature to sound the death knell of private equity, some recent deals, such as the acquisition of the Morri- sons grocery business, have attracted strong criticism. In fact, many privatised utilities are owned by private equity consortia, who may well be faced with markedly lower financial returns and, in some cases, with demands for further equity injections: Thames is believed to be seeking substantial additional funds from private sources. As such, fewer highly geared private equity bids are likely, because projected returns may fall while raising the necessary finance to complete such deals may become progressively harder. Challenging times indeed for all utilities – watery or otherwise. As the legendary singer, Billy Ocean, concluded – when the going gets tough, the tough get going. Nigel Hawkins is the utilities analyst at Hardman and Co, which undertakes investment research UK INTEREST RATES UK 10-YEAR GILTS UK INFLATION, CPI, 12-MONTH RATE 10% 8% 6% 4% 2% 0% 4% 3% 2% 1% 0% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% Jan 1992 Feb 19989 Mar 2004 May 2010 Jun 2016 Sep 2022 2.5% 3.4% 9.1% Source: Bank of England Source: Bank of England Source: Office for National Statistics A TALE OF THREE GRAPHS 2016 2017 2018 2019 2020 2021 2022 1982 1992 2002 2012 2022

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