Potential Changes to RPI Could Hit UK Utility Equity Investors

Fitch Ratings is warning that UK utilities’ dividend payment capacity could be reduced by a new methodology that is coming in to calculate the retail price index (RPI), not to mention the UK government’s recent announcement that it intends to force energy firms in the country to offer customers its lowest tariffs. 

The credit ratings agency (CRA) does, however, add that the potential methodology changes to the calculation of RPI are unlikely to affect the ratings of regulated utilities in the UK, due to existing headroom compared with ratio guidelines or regulatory mechanisms that take into account price pressures faced by the companies relative to RPI. 

The UK Office for National Statistics launched a consultation on 8 October 2012 that considers changes to the calculation of RPI. These include statistical methods employed for averaging changes in prices as well as options to improve the measurement of the cost of private housing rents. While RPI has historically mostly been recorded in the range of 0.50% to 1.00% above the consumer price index (CPI), proposed changes would likely narrow this gap, and effectively lead to a lower out-turn RPI, compared to the current method of compiling the data.

Part of the UK’s sovereign debt interest is linked to RPI, as well as benefit accruals of many pension schemes, tariff increases of regulated utilities and other goods, services or benefits. Therefore, the outcome of the consultation could have a noticeable impact on wealth distribution across the UK economy.

Fitch has considered the potential consequences for the ratings of regulated network utilities. The agency believes there may be a small negative impact on earnings before interest, taxes, depreciation and amortisation (EBITDA) margins. However, more importantly, financial flexibility/headroom that is created each year through indexation of the regulatory asset value (RAV) will reduce and allow for a lower dividend stream to equity, assuming a constant gearing in terms of net debt/RAV. 

Generally, for issuers that are comfortably placed at their rating level, the resulting impact on financials should not affect their ratings, added Fitch. However, for issuers that are weakly placed, proposed changes to the calculation of RPI could lead to negative rating action in the future.

 

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