Investing.com -- Moody's (NYSE: MCO ) Ratings has downgraded the long-term Corporate Family Rating (CFR) and senior secured debt ratings of Dwr Cymru Cyfyngedig (Welsh Water). The ratings have been lowered to Baa1 from A3. The outlook for the company remains stable. This action was taken as Moody's believes Welsh Water will be unable to maintain an average Net Debt to RCV of 60% or less, which was consistent with the previous A3 rating.

On December 19, 2024, the regulator Ofwat published its final determinations of tariffs, costs allowance and returns for the regulatory period running from April 1, 2025, to March 31, 2030. Welsh Water was the first company to formally accept the determination on January 22, 2025.

The final determination for Welsh Water was significantly improved from the draft determination published in July 2024. Ofwat granted expenditure allowances of £5,997 million over five years against the company's revised request of £6,021 million. This was a reduction of 0.4%, compared to 12.2% at the draft stage.

The Outcome Delivery Incentives (ODIs) package also improved, with less demanding performance targets and greater use of maximum penalty caps by Ofwat. In particular, Welsh Water will accrue £62 million of ODI rewards if it delivers its performance forecast, compared to a £112 million penalty for the same level of performance at the draft determination stage.

Despite these improvements, challenges remain. Ofwat rejected Welsh Water's request for a bespoke harm-based storm overflows ODI, instead mandating a spills-based measure. This measure could lead to a £16 million penalty for Welsh Water, which could increase to a maximum of £60 million if performance does not improve from 2023-24 levels.

Additionally, Welsh Water's expected performance under the mains bursts ODI has deteriorated since the draft determination. The company now expects to complete more work to achieve its leakage performance, which could result in a penalty of around £25 million.

Moody's expects Welsh Water's Net Debt to RCV to increase to 62-64% in March 2025, up from 60.4% as of March 2024. These levels are above the 60% guidance for the A3 rating level, as revised in November 2024. If Welsh Water significantly overspends or incurs net ODI penalties, this gearing will increase further.

Despite the downgrade, Welsh Water's rating continues to be supported by its position as a monopoly provider of essential water and sewerage services, its low levels of gearing relative to the sector, and the not-for-dividend status of its ultimate parent company, Glas Cymru Holdings Cyfyngedig. However, the rating is constrained by challenges in certain areas of the final determination and high cash interest costs as a result of inflation-linked derivatives.

The stable outlook reflects Moody's expectation that Welsh Water will perform in line with its final determination and achieve key ratios consistent with the current rating levels. The ratings could be upgraded or downgraded based on Welsh Water's performance and changes in business risk for the sector.

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