The debt mountain at U.K. water companies is their best defense against politicians seeking to cut the cost of living.
The Labour opposition, which has pledged to freeze gas and electricity prices for 20 months if it wins the 2015 general election, may be wary of imposing a similar cap on highly leveraged water businesses, according to Lakis Athanasiou, a utilities analyst at Agency Partners LLP. Water companies have debt-to-equity ratios as high as 80 percent and rely on borrowings to keep infrastructure intact.
“I really can’t see them going after the water industry,” Athanasiou said in a phone interview. “Because they are highly leveraged structures, they need masses of debt, not just for expansion but for replacement of existing debt.”
United Utilities Group Plc, the biggest publicly traded U.K. water company, has net debt to earnings almost twice that of SSE Plc, one of the Big Six power companies, data compiled by Bloomberg show. The extra yield investors demand to own its bonds maturing in 2028 instead of similar maturity government debt has fallen 26 basis points this month to 325 basis points. The spread on Severn Trent Plc (SVT) 2026 bonds has dropped 8 basis points to 103.
Polls give Ed Miliband’s Labour Party a lead of about 5 percentage points over David Cameron’s Conservatives, which plan to curb gas and electricity bills by simplifying tariffs. Standard & Poor’s and Moody’s Investors Service say a price freeze could push up financing costs for energy companies.
“The U.K.’s water companies are significantly more vulnerable to shocks -- of the Miliband variety or anything else,” said Andrew Lyddon, a Schroder Investment Management Ltd. fund manager. “At these high levels of leverage, a business will have little ability to withstand any kind of shock.”
In the past six years a series of debt-funded acquisitions of water companies by financial institutions seeking stable, regulated returns has driven up borrowings at the utilities.
Equity in companies has slumped from 42.5 percent of their funding in 2006 to 30 percent today, with several as low as 20 percent, raising questions about their sustainability, Jonson Cox, chairman of regulator Ofwat, said in March.
Net debt at United Utilities was 6.31 times earnings before interest, tax, depreciation and amortization in the year ended March and the second-largest publicly traded U.K. water company, Severn Trent, was about 5.62 times, according to figures compiled by Bloomberg. SSE’s ratio was 3.20 times. Centrica Plc, the biggest energy supplier to households, had debt 1.1 times earnings in 2012, the latest available annual period.
Severn Trent and United Utilities declined to comment on their debt or political intervention when contacted by phone. Thames Water Utilities Ltd., a unit of Kemble Water Holdings Ltd., had a net debt to regulated-assets value of 79 percent in March 2012 compared with 72.7 percent in March 2009, according to Moody’s. At Kelda Group Ltd., the parent of Yorkshire Water Services, the ratio has risen to 81.7 percent in March last year from 66.2 percent in March 2009.
“They have so much debt because these businesses are very capital-intensive and they’ve had to fund a lot of investments; debt is a lot cheaper than equity,” Andrew Moulder, a senior utilities analyst at Creditsights Inc., said by phone. “I wouldn’t expect that you would get a government intervening to try to cut water bills.”
This borrowing is set to continue after Ofwat raised assumed debt levels in a price review, according to Impax Asset Management Group Plc investment manager Simon Gottelier.
“It is prepared to let the utilities take on even more debt given its view that interest rates will remain low for a prolonged period,” he said. “High levels of ‘allowed’ debt within the industry-wide tariff and cost of capital calculation suggest that debt-funding to the industry is here to stay.”
With water and sewage costing households 388 pounds ($629) on average this year compared with 1,279 pounds for gas and power in 2012, according to Department of Energy and Climate Change data, the water industry has escaped political scrutiny as the squeeze on living standards emerges as a key election battleground.
Thames Water’s plan to raise bills for 14 million clients in the London area by about 8 percent a year was rejected by Ofwat two days ago as too high.
The industry needs to borrow for investment at a rate of more than 20 billion pounds ($32 billion) every five years, Ofwat says.
“Spending on water is a necessity -- it isn’t a feel-good spend like renewables,” Athanasiou said. The U.K. “doesn’t want to end up paying for it. Government, Ofwat and political parties understand fully that they can’t upset debt holders.”
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