UK results show return to stability

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The second year of the current pricing regime saw a modicum of stability return to the UK water and sewerage companies. Full regulatory disclosures next month will reveal the true extent of the bad debt situation.

An 80% increase in bad debt provisions at Thames Water – the largest of the UK water and sewerage companies – cast a shadow over a generally improved full-year results season for the 2011/12 financial year across the sector.

Thames reported that its bad debt charge had risen to £70.2 million (3.5% of annual revenues) from £38.4 million the previous year due to “collection difficulties and customers’ ability to pay as a result of the economic recession”. The company nevertheless announced a £43.7 million increase in operating profit on the back of a modest 0.4% increase in tariffs – although the figure of £643.9 million was still £27.2 million short of that for 2009/10.

The dramatic hike in bad debts at Thames led some industry observers to question why other companies had not reported similar trends. Independent sector analyst Robert Miller-Bakewell observed: “What’s happening at Thames is exactly what you’d expect in a recession.”

Miller-Bakewell said that while Thames is likely to be the worst affected, given the size and make-up of its customer base, it is surprising that others have not also noticeably increased their provisions. He said that United Utilities, in particular, is masking the full impact of bad debts in its figures through the IFRS accounting standard that allows it not to include debts that it believes it has no hope of recovering in its revenues.

UU reported a marginal increase in bad debts from 2.1% to 2.2% of revenues, but will have to disclose all outstanding bad debt in the regulatory accounts it submits to industry regulator Ofwat next month. “I think you’ll find on that basis that their figure is similar to Thames,” said Miller- Bakewell.

The two other remaining quoted UK water groups, meanwhile, reported slight improvements in their bad debt positions. Pennon said its provisions had fallen marginally to 1.8% of revenues, while at Severn Trent the figure was down from £33.9 million to £31.8 million (also 1.8% of revenues).

Otherwise, the results for 2011/12 were characterised by modest improvements in revenues and profits, as most of the companies benefitted from more favourable tariff adjustments than they were allowed in the first year of the present pricing regime.

South West Water was actually a bigger driver of profit growth at Pennon than the group’s Viridor waste arm for a change, as the 3.4% allowed increase in the water company’s K factor added a further £36.4 million to revenues and boosted its operating profit for the 12 months by 7.9% to £14.9 million (while Viridor’s declined by £6.2 million). This helped Pennon to achieve an overall improvement in operating profit for the year of 3%.

United Utilities also managed a 2% gain on the previous year, although its K factor was actually reduced by 0.2% during 2011/12. This was, however, a much less savage cut than the 4.3% reduction it had to absorb in 2010/11, and enabled the company to increase its operating profit by £8.6 million.

Severn Trent was the only one of the three to see its operating profit fall – by 2.9% – as it declared a special dividend to return £150 million to its shareholders. The company did, however, have ample financial headroom to make this gesture to mollify growing investor dissatisfaction at dividend levels over the past 18 months, and the move had no impact on its credit standing.

Both Moody’s and Standard & Poor’s immediately affirmed their ratings on the company (Baa1 and BBB+, respectively), reflecting the fact that even if the group chose to fund the payout at the level of the Severn Trent Water business (rather than at the holding company level), the ratio of the latter’s net debt to its regulated asset value (RAV) would remain relatively low, at 61%. “Although it is returning money to shareholders, its metrics remain comfortable for the rating,” said Andrew Moulder, sector analyst at international research firm CreditSights.

The same trends were largely evident at the other non-listed water and sewerage companies which had reported their figures for 2011/12 by mid-June, with gains from tariff adjustments partially offset by cost increases and more customers moving to metered supplies.

Anglian’s 10% increase in reported operating profit, for example, was almost entirely down to a £41.3 million exceptional gain arising from changes to the company’s pension scheme. The increase in underlying profit was about 1%, as it was allowed a flat K factor for the year after a 0.7% decrease in 2010/11.

Yorkshire, meanwhile, saw its operating profit decline for the second year running, as it incurred an additional £5.1 million of costs associated with the transfer of private sewers.

The bad debt issue apart, the results from the quoted and unquoted WASCs (and the subsequent climb in the share prices of the former) reflect a return to stability across the sector, as concerns over the impact of the current pricing regime and proposed regulatory changes – particularly the introduction of competition – have abated.

“In our view there may be changes, but the credit impact on the sector is likely to be minimal,” concluded Moulder at CreditSights.