Water regulators are set to confirm price cuts next week, cheering consumers but ignoring pleas from companies who may need to cut dividends and raise hundreds of millions of pounds from shareholders as a result. Skip related content
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In a draft five-year plan published in July, Ofwat surprised water providers such as United Utilities, Severn Trent, Pennon and Northumbrian Water by calling on them to cut bills, rather than permitting increases.
"There could be some scope for Ofwat's proposals to improve ... although we see a dramatic change in the outcome as unlikely," said Deutsche Bank analyst James Brand.
July's draft also said the water companies would only be able to make a return on capital of 4.5 percent, calling into question their status as reliable dividend stocks and sparking a sell-off in the sector.
The move prompted ratings agency Standard & Poor's to place Severn Trent and United Utilities, along with unlisted Sutton and East Surrey, on credit watch with negative implications.
The agency said their current ratings could be vulnerable unless the companies resorted to measures such as reducing shareholder payouts, thereby sidestepping the risk of downgrades that would raise borrowing costs and further erode returns.
Fitch meanwhile said the draft contained "more sticks than carrots." It believes downgrades are unlikely but the sector's financial flexibility would be constrained.
United Utilities, which supplies 7 million people across northwest England, has subsequently raised cash by selling stakes in two assets for about $216 million (131 million pounds).
Shares in the sector have failed to keep pace with a rising market since the draft too. Pennon and United Utilities have underperformed the British bluechip index by 16 percent, Northumbrian by 13 pct and Severn Trent by 11 percent.
PROLONGED UNCERTAINTY
In what one analyst has dubbed "the big water week," the stage for Ofwat's November 26 ruling will be set by first half results from Northumbrian on Monday, Severn Trent on Tuesday and United Utilities on Wednesday.
The figures are expected to lend some support to Ofwat's belief that water companies can afford to return some of the benefits of low borrowing costs to customers.
Despite falling water demand from recession-hit businesses, Deutsche Bank's Brand expects Severn Trent to post a 20 percent jump in adjusted pretax profit to 186 million pounds, helped by price rises and lower interest charges.
He expects United Utilities to report a more modest 4 percent rise in pretax profit to 263 million pounds as price rises of 6 percent and lower interest offset the impact of weaker sales and higher power costs.
Brand predicted United's earnings per share would fall about 20 percent next year as a result of Ofwat's plans, but said it could avoid a dividend cut thanks to disposals.
Based on the current plans Severn is expected to cut its dividend by about 10 percent.
Morgan Stanley analysts believe the final ruling will take a lead from the 1999 review, which was tough and got tougher.
They say there is potential for a small equity raising of about 143 million pounds at Severn Trent and a dividend cut, while United Utilities could need to raise 500 million pounds through disposals or a rights issue.
Analyst Benita Barretto at Credit Suisse does not expect changes to the proposed cap on return on capital but said limits on price rises might be slightly less draconian.
She said the so-called K-factor, a figure set for individual companies to calculate water bill increases, may go up marginally with United Utilities the most obvious candidate.
However she does not see any immediate end to the uncertainty over dividends.
Analysts Merrill Lynch believe Thames Water at least will turn to the Competition Commission to challenge Ofwat's decision while Deutsche Bank's Brand said uncertainty over dividends and capital increases would diminish in the coming weeks and months.
(Additional reporting by Ben Deighton; editing by Paul Hoskins and Jon Loades-Carter)
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