Fitch Ratings agency has said it expects Southern Water to achieve capex and operating expenditure outperformance of around £63 million over AMP6 with its affirmation of the firm’s debt-raising vehicle Southern Water (Finance) Ltd's senior secured ratings for its class A debt at 'A-' and its class B debt at 'BBB', with the Outlooks for both as Stable.

The affirmations reflect Fitch's expectation of adequate financial metrics to support the current ratings, despite Southern Water's position in the lower half of the peer group in terms of regulatory and operational performance. The rating action also takes into account the efficiency challenge embedded in Ofwat’s final determination of tariffs for the AMP6 period April 2015 to March 2020.

The ratings also reflect improved cash flow generation derived from the revenue correction mechanism allowing the collection of AMP5 revenue under-recoveries of around £215m through AMP6 regulated revenues. Fitch said the implementation of new operating practices and efficiency measures with a greater focus on regulatory targets is also contributing to the water company’s improved cash flow.

Fitch’s expectation is for Southern Water to continue improving its performance during AMP6 as a result of the additional investment that it incurred in AMP5, a greater focus on regulatory targets by management, and the innovative efficiencies and new processes implemented to date and due to be implemented in the future.

Operational outperformance expected

Fitch expects the company to achieve capex and operating expenditure outperformance over AMP6 as a result of "notable changes" to its procurement and delivery model including pain/gain sharing mechanisms with contractors, which were not employed in AMP6, and in-sourcing of a number of processes. The ratings agency forecasts include combined total expenditure (totex) outperformance of around £63 million over the five-year period.

Fitch identified improvement of the group's position in Ofwat's league tables to at least sector average as one of a number of developments that could lead to a positive rating action.

Negative ratings actions "remote prospect" at present

Fitch said that given improved cash flow generation and incremental financial flexibility at the current rating level, negative rating actions are a remote prospect at present.

However, deterioration in cash flow generation leading to increases in gearing to procure funds for operating and capital expenditure requirements or a decline in operational or regulatory performance were factors which could impact on ratings.