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UK water: investment plans for 2010-15
– approximately GBP24bn of investment
and GBP6bn of refinancing is required;
the cost of debt has increased
Will competition proposals increase the
risk profile and cost further, and will the
sector lose its defensive status?
We prefer credit to equity: we are overweight
bonds issued as part of whole
business securitisations, such as Anglian,
and we like Wessex and Yorkshire; in
equities we prefer Pennon (Neutral, TP
660p), United Utilities (Neutral, TP 740p)
The credit crisis has led to a rise in UK water companies’ cost of
debt. Will the need to raise much new debt weaken its defensive
status? Will Ofwat reflect this in its 2010-15 cost of capital
assumptions? We think the real cost of debt is now at the 3.3-
4.4% levels set by Ofwat in 2005, including index-linked debt.
In setting a cost of capital for 2010-15 Ofwat cannot afford to
disregard the impact of the introduction of competition on the
risk perception of investors. Structural change will increase
uncertainty among debt investors, especially those holding
long-term debt.
We believe UK water bond yields, at c6.2%, already reflect the
higher risk profile of the sector versus UK water equity yields
of c4.4%. There may be a narrowing of the differential between
the two short term, which may persist until there is more clarity
on the cost of capital from Ofwat. In credit, we prefer bonds
issued as part of whole business securitisations, which benefit
from a comprehensive covenants package: we have Overweight
recommendations on Anglian Water (cash and CDS). We also
like Wessex and Yorkshire. We apply a higher cost of debt to
our equity valuations: we cut our NWG target price to 300p
from 350p and downgrade our rating to Underweight from
Neutral; we cut our Pennon target to 660p from 730p and
downgrade our rating to Neutral from Overweight; we cut our
Severn Trent price target to 1,320p from 1,570p and downgrade
it to Underweight from Overweight; and we cut our United
Utilities target to 740p from 820p, downgrading our rating to
Neutral from Overweight.
Investment summary
We prefer credit to equities in UK water as we believe the risks of
raising the GBP24bn new financing requirement are more
appropriately priced in bond yields
In debt, we have Overweight recommendations on Anglian Water
(cash and CDS), Wessex and Yorkshire
In equities, we downgrade NWG to Underweight from Neutral (price
target 300p), Pennon to Neutral from Overweight (target price 660p),
Severn Trent to Underweight from Overweight (price target 1,320p)
and United Utilities to Neutral from Overweight (with a 740p target)
Investment summary
The cost of debt is increasing
The cost of fixed rate debt for UK water companies
has increased dramatically in the past nine months.
UK Water: overall yield – fixed rate bonds in GBP
5%
5%
6%
6%
7%
7%
8%
Apr-00 Apr-02 Apr-04 Apr-06 Apr-08
UK Water WBS w rapped
WBS unwrapped Corp unwrapped
Source: HSBC Credit Research
Spreads over asset swaps have multiplied by five,
reaching 140bp overall. This implies an average
yield of 6.25% on our UK water sterling index –
up 40bp from a year ago. We believe that the real
cost of debt is now at levels comparable to the
3.3-4.4% range set by Ofwat in 2005. This
measure takes indexed linked debt into account.
This has proven to be a popular funding resource
in recent years. At the end of March, the sector
had GBP10bn of indexed linked debt outstanding.
However, there is uncertainty at this point on the
depth of this market given the currently very low
yields on indexed linked Gilts and the demise of
the monoline insurers.
More debt required
The UK water companies will have an investment
programme of around GBP24bn within the next
seven years, and some GBP5.6bn of refinancing
of existing debt will be required, on our estimates.
The companies are likely to remain cash flow
negative. Ofwat is currently reviewing the cost of
capital as part of the 2009 review of prices
(PR09). It is important that Ofwat incorporates the
changes in the debt market into its assumptions. If
Ofwat sets a cost of debt below the level at which
companies can access new finance, the companies
may trade at a discount to their respective
regulatory capital values (RCVs).
Will competition proposals increase the risk
profile further?
In setting a cost of capital for 2010-15 Ofwat cannot
afford to disregard the impact of the introduction of
competition on the risk perception of investors.
Structural change will increase uncertainly among
investors, especially those holding long-term debt
predicated on the continuing existence of a stable
and growing RCV of a vertically integrated
company. The sector may lose its defensive status in
light of this uncertainty.
Summary of key recommendations
We believe UK water bond yields of around
6.25% reflect the higher risk profile of UK water
compared to average UK water equity yields of
around 4.4%. We prefer credit to equities as a way
of investing in UK water. In credit we prefer the
bonds issued as part of whole business
securitisations, which benefit from a
comprehensive covenants package. We have
Overweight recommendations on Anglian Water
(cash and CDS), Wessex and Yorkshire.
In equities, the higher cost of debt reduces our
equity valuations. In addition, the companies, in
our view, will see their earnings reduce to March
2009 because of lower water volumes as a result
of the wet summer, as flagged in some of the
companies’ interim management statements.
There may also be increased bad debts and
inflationary cost pressures, which may also have a
negative effect on earnings.
We cut our target price on NWG to 300p from
350p and downgrade our rating to Underweight
from Neutral; we cut our target price on Pennon to
660p from 730p and downgrade our rating to
Neutral from Overweight; we cut our target price
on Severn Trent to 1,320p from 1,570p and
downgrade our rating to Underweight from
Overweight; we cut our target price on United
Utilities to 740p from 820p and downgrade our
rating to Neutral from Overweight. We set out our
credit recommendations and equity ratings in the
tables overleaf.
目录
Investment summary 2
Credit recommendations 4
Equity ratings 6
Financing UK water: threats to
stability 8
Company sections 21
Northumbrian Water Group 22
Pennon 33
Severn Trent 43
United Utilities 52
UK Water relative value 61
Disclosure appendix 65
Disclaimer 71
253886.pdf
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