OREANDA-NEWS. Fitch Ratings has affirmed UK-regulated water and wastewater company, Wessex Water Services Limited's (WWSL) Long-term Issuer Default Rating (IDR) at 'BBB+', senior unsecured rating at 'A-' and Short-term IDR at 'F2'. The Outlook on the Long-term IDR is Stable. A full list of rating actions is below.

The affirmation reflects Fitch's expectation of adequate financial metrics to support the ratings given the company's track record of outperforming the regulator's cost targets, despite the greater efficiency challenge embedded in the final determination of tariffs for the period April 2015 to March 2020 (AMP6). The ratings also reflect WWSL's robust financial and regulatory performance and continued market-leading position in the UK water sector.

Wessex Water Limited (WWL) is rated 'BBB', one notch below the operating company, which reflects the subordination of creditors at holding company level and Fitch's expectation that WWL will not raise any material external debt.

KEY RATING DRIVERS
Strong Business Profile
The predictable revenue characteristics of WWSL's regulated water and wastewater operations are supported by a long-established regulatory regime set by The Water Services Regulation Authority (OFWAT). WWSL's strong operational performance, a high level of transparency in terms of expected revenues and likely levels of capital expenditure are offset by increasingly tough regulatory performance targets and lower returns on capital in AMP6. The strong business profile is offset by higher levels of leverage compared with similarly rated issuers across the corporate spectrum.

Increased Business Risk in the Sector
We believe that business risk in the water sector has increased for AMP6, and is now more closely aligned with regulated UK gas and electricity network businesses. In addition to a significant reduction in the cost of capital, total expenditure will be benchmarked to the top quartile by 2020, representing a more demanding target for capital expenditure. Ofwat is pursuing progressive targets for the retail price controls, eliminating protection from inflation (on a small component of revenues) and implementing catch-up efficiency targets using an average cost to serve, which does not fully reflect each company's operating cost base.

Market-Leading Regulatory Performance
WWSL is a leading performer in the UK water sector and Fitch expects the company to maintain its position. Preliminary data for FY15 places the company as top performer in terms of customer services amongst its peers, achieving a Service Incentive Mechanism (SIM) score of 87 for overall customer satisfaction. The company met leakage targets and maintained stable asset serviceability for all asset categories. It also reduced the number of repeat flooding incidents and serious pollution incidents compared with FY14 although the latter is still higher than the five-year average but management continues to work to improve performance in this area.

Stable Financial Metrics
Fitch forecasts pension-adjusted net debt/regulatory asset value (RAV) slightly above 70%, the maximum guideline for the current rating and post-maintenance and post-tax interest cover (PMICR) at around 1.9x (five-year average), comfortably above the minimum guideline of 1.5x.

We forecast leverage to be slightly above rating guidelines partially due to the increase in the company's pension deficit as of 31 March 2015 (FY15) to GBP141.1m from GBP91.8m in FY14. However, we expect the company to manage its dividend policy in order to maintain debt to RAV at or below 70%, in line with the company's target capital structure. WWSL's PMICR is strong in comparison with its peers and supported by its low average interest rate of about 3%.

Quality Likely to Improve
Fitch expects the company to outperform AMP6 quality targets and retain its upper-quartile performance, backed by its strong operational track record and the implementation of new processes and cost efficiencies. Fitch also expects further benefits from improvements in catchment management, in-sourcing of the design elements of the capital investment programme, and the restructuring of its workforce. The integrated water supply grid, which the company expects to be completed in 2018, will significantly reduce reliance on single water sources. This will improve the resilience of water supplies and enable WWSL to reduce abstraction volumes and quickly offset any deterioration in raw water quality.

Financial Outperformance Expected
The company met all of its regulatory outputs for AMP5, and achieved capital expenditure outperformance of around GBP150m or 15%, compared with regulatory allowances. Operational expenditure outperformance was around GBP66m or 8%, including exceptionals and leakage costs, and excluding pension deficit repair payments. Achieved opex efficiencies are in addition to operational costs absorbed by the company related to the adoption of private sewers, carbon reduction commitment and bad debt costs. Our forecasts include combined totex outperformance of GBP165m, in nominal terms over the five-year period.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Wessex Water Services Limited include:
- Regulated revenues in line with the final determination of tariffs for April 2015 to March 2020, i.e. assuming no material over- or under-recoveries
- Totex outperformance of around GBP165m in nominal terms over the five-year period
- Neutral performance in retail costs
- Retail price inflation of 0.75% for FY15, 1% for FY16, 2% for FY17 and 2.5% thereafter
- No impact on cash flow generation from outcome delivery incentives, given that financial rewards and penalties will all be taken into account as part of the next price review

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating action include:
- A sustainable reduction in target leverage to below 65% and PMICR remaining above 1.8x.

Negative: Future developments that could lead to negative rating action include:
- A marked deterioration in operating and regulatory performance or financial policies leading to PMICR below 1.5x and regulatory leverage well above 70% on a sustained basis.

LIQUIDITY
WWSL's liquidity is good, with adequate funding to cover expected operating requirements, debt maturities and dividends for the next 24 months. At 30 August 2015 the company had GBP78m of cash and cash equivalents and GBP150m of undrawn committed bank facilities maturing in 2020 and GBP50m of committed undrawn capacity under the EIB loan. WWSL's next significant maturity is GBP140m due in December 2018.

FULL LIST OF RATING ACTIONS
Wessex Water Services Limited
-- Long-term IDR: affirmed at 'BBB+'; Stable Outlook
-- Senior unsecured debt rating: affirmed at 'A-'
-- Short-term IDR: affirmed at 'F2'

Wessex Water Limited
-- Long-term IDR: affirmed at 'BBB'; Stable Outlook
-- Short-term IDR: affirmed at 'F3'

Bonds issued by Wessex Water Services Finance Plc (WWSF): affirmed at 'A-'.
The bonds are guaranteed by WWSL, and thus benefit from WWSL's senior unsecured rating of 'A-'.