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Pennon May Outperform in U.K. Water on Debt Structure, UBS Says

Pennon Group Plc may outperform other U.K. water companies because of an attractive debt structure and profit growth in its waste business, UBS AG said.

About 56 percent of Pennon’s debt could be swapped into fixed debt at advantageous rates if low inflation were to persist, UBS analyst Ajay Patel wrote in a report today. This would offset the impact of subdued inflation on water prices.

UBS started Pennon coverage today with a “buy” rating.

Inflation is one element used by industry regulator Ofwat in setting prices for customers. Prices for the five years from April 2010 will be set by Ofwat in a so-called final determination later this year.

Ofwat also sets a cost of capital for the sector. If companies borrow at below that level they can make a profit.

“Pennon doesn’t have as much fixed debt” as the other companies, Patel said by phone. “So if you’re in a deflationary environment it’s not as exposed to the cost of capital as the other companies.”

Severn Trent Plc and Northumbrian Water Group Plc have a higher proportion of fixed debt, offering less protection in a deflationary environment, the report said. It has a “neutral” rating on both companies.

It initiated United Utilities Group Plc, the U.K.’s largest water company by market value, with a “sell” rating. It is exposed to higher numbers of customers unable to pay their bills and a pension deficit, UBS said.

To contact the reporter on this story: Rachel Graham in London at rgraham13@bloomberg.net

To contact the editor responsible for this story: Stephen Voss at sev@bloomberg.net

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