Thames Water: the big financial plug is needed to break the balance sheet

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If water is life, then life has been pretty good for those keeping Britain’s taps running. No one has done a better job of Thatcherite liberalization than the private owners of water utilities, including UK pension funds. Cash has leaked into Thames Water. The sudden departure of chief executive Sarah Bentley sparked talk of renationalisation on Wednesday.

Previous owner Macquarie, which helped amass Thames Water’s massive debt pile, deserves blame. The combination of natural monopolies, cheap credit and lax regulation made water utilities look for low-risk, attractive returns. Thames Water, the largest, is now on the brink due to rising interest rates and £14 billion in debt.

Water companies must swim against the current. Inflation increases operating expenses and financing costs. Among peers Thames is most exposed to the latter, particularly when additional debt on holding company Kemble Water is involved. The Thames ranks joint-worst in the country for water treatment, sewage pollution and leakage.

Although it spends a higher share of revenue on new investments than competitors, higher interest charges will hold it back. It needs wholesale restructuring of its bloated balance sheet.

Its net debt to EBITDA ratio at operating company Thames as of September 2022 was 14 times. For Kemble the figure was 22 times. Operating leverage was not equal to interest cost, with interest cover at 0.6x and 0.3x, respectively. The high share of index-linked loans leads to losses, while indexed water rates lag behind interest payments.

It is difficult to measure whether Thames gives extreme returns or not. According to S&P data, cash transferred from the operating company to investors through interest payments and dividends has amounted to around £4.1bn over the past decade. Pearce United Utilities and Severn Trent have paid similar amounts. The difference at Thames is that three-quarters of that cash flow went to debtors in the form of non-taxable interest payments.

This is a volatile model. Shareholders invested an additional £500mn last year alone. An additional £1 billion has been promised. Achieving a leverage ratio in line with the sector average would require a reduction in debt equivalent of £3.6 billion by a quarter. Much will depend on when inflationary pressures finally subside.

Thames needs a financial plug. But a government supporting privatization should again not attempt to socialize any cost through taxpayers.