EMEA: UK utility may lack income to cover debt costs

02 March 2018 - 12:00 am UTC

Rising inflation means Wales & West Utilities’ Finance (WWU) earnings will soon not be sufficient to cover interest payments for the regulated part of the business, Moody’s has warned.

The ratings agency said last week that the adjusted interest coverage ratio (AICR) for the company, the finance arm of the UK gas distribution services company, will fall to 0.9 times for the year ending March 2018 from 1.5 times the previous year. 

AICR is earnings before interest and tax divided by interested payments.

Moody’s said WWU’s cost of debt is high relative to peers and rising due to inflation increases. The principal of its debt rises in line with inflation.

It also noted that WWU’s inflation-linked swaps have a negative mark-to-market value of GBP 977m. The next payment for the swaps is due in March 2019. 

WWU operates the gas distribution network for Wales and southwest England, which was sold by National Grid along with three other regional gas distribution networks in 2005. WWU is owned by CKI (30%), Power Assets Holdings (30%), Cheung Kong (Holdings) (30%) and Li Ka Shing Foundation (10%).

Moody’s has an investment grade Baa1 rating and a stable outlook on WWU. The stable outlook reflects the expectation that declining leverage, as measured by WWU’s net debt to regulated asset value, will mitigate pressure on interest coverage, said Moody’s, which expects AICR to move back above 1 in 2019.

Moody’s said it is unlikely to upgrade WWU’s Baa1 rating given the interest coverage situation, but that it could downgrade the rating if the situation deteriorates or if WWU is affected by unfavourable market conditions, such as reduced gas demand. Moody’s notes that gas consumption in Great Britain fell by 13% between 2005 and 2016. 

However, it also notes that WWU has performed well in cost efficiency, achieving savings of GBP 46m in 2017/18.

WWU reported operating profit of GBP 183.4m for the year ended 31 March 2017 on turnover of GBP 433.9m. However, interest payments and swap movements pushed it into a pretax loss of GBP 176.1m.

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