Water companies need to get more leeway in their price regimes for the next five years to persuade investors to back the sector for the infrastructure investments required, says UBS.
OFWAT's draft determination (for the price review covering April 2025-March 2030) still has a gap to what UBS believes is required to attract necessary equity capital to fund investments.
“We believe a c5% cash dividend yield is required from the sector at a c10-11% RAB [regulatory asset base] premium, given the risk profile and the fact growth is not being valued.
“In order to reach this level, the allowed return needs to be increased by c35bps.
“RAB run-off rates were also sharply reduced for Pennon and Severn Trent [SVT] and need to rise by around 40bps (0.4%), in our view to improve operating cash flow generation.
“This would provide around £600m extra cash flow to SVT (+4.3% on revenues) and £260m to Pennon (+4.7%)."
UBS adds that with four months to go until the final decision, it assumes cash flows to investors can improve to justify a c10-11% RAB premium.
Much depends on rates and asset multiples in September and to a degree October, but on its assumptions, it favours (the cheapest) Pennon (PT 890p, Buy) where a dividend cut is priced in.
Severn Trent is a sell (PT 2,340p) on valuation while United Utilities gets an upgrade to Buy (from Neutral) with a PT 1,150p (from 1,180p) on a much lower premium priced in compared with SVT, and an allowed return uplift will make it financeable.