From The Editor | January 15, 2016

The 2016 Financial Guide To Utilities

Peter Chawaga - editor

By Peter Chawaga

The floors of a treatment plant seem like a far cry from Wall Street. Whether it speaks to the ubiquity of water services or the pervasiveness of investment dollars, the two are actually more closely linked than they seem.

Water and sewer utilities are businesses like any other and investors are more than interested in having a hand in their operations. As such, financiers are referring to their crystal balls as they contemplate what the year might have in store for the industry.

A Solid Investment

Credit rating agency Moody’s Investors Services issued a 12 to 18 month outlook for business conditions of municipal water and sewer utilities in December, calling the sector “stable.”

This is primarily based on a unique aspect of the field: the independent power that utilities have to set rates. Moody’s found that utilities are willing to raise rates when needs arise and from an investor’s standpoint, this is a huge asset.

This gets the financial sector excited because it indicates sound debt service coverage, a metric used to measure the ability to produce enough cash to cover its interest, principal, and lease payments. Investors are comfortable knowing that utilities have the ability to absorb unexpected costs while meeting their operating expenses. Moody’s estimates that utilities’ median annual debt service coverage level will be roughly twice the maximum level of future payments in 2016.

The other investor-pleasing aspect of rate control is that it makes utilities’ cash reserves particularly liquid and easily accessible. This also protects against unforeseen expenses and allows business to continue as usual in the face of crisis. The report projects that this year, water and combined system utilities will have liquidity, or unrestricted cash on hand, to pay for over 300 days’ worth of operating costs. Sewer systems will have liquidity to cover over 500 days, per the report.

Moody’s expects that consumers will be able to handle the utility rate increases that might come their way this year, based on the projection that the country’s economy will grow 2 to 3 percent in 2016 while inflation remains low.

The agency declined to elaborate on this financial strength or to advise a utility on how it might capitalize, citing the objectivity of its credit ratings.

Stormy Outlook

The report makes some projections that go beyond the financial. Moody’s predicts that while climate change will continue to pose a challenge for utilities, the results will be manageable.

“These events pose ongoing capital and operating challenges,” the report reads, “but have not led to material sector-wide effects on financial metrics.”

Utilities’ bottom lines are protected by access to cash reserves and extensive federal aid in the event of weather-related crisis.

While Western states endure record-setting drought with no relief in sight, Moody’s believes that conservation efforts and increased water rates will manage demand and maintain supply. Areas along the East Coast and in the South that experienced flooding last year suffered significant repair and upgrade costs. However, according to the report, increased emergency preparedness and the right capital investments have balanced these burdens and the fiscal outlook, at least, remains sunny.

Missed Opportunity

In a prediction that may not surprise many in the industry, Moody’s does not foresee any significant improvement to the country’s fading infrastructure in 2016.

The report puts the onus on utilities, claiming that because they are not reinvesting aggressively enough in plants and equipment, depreciation will only continue. The agency has found that long-term spending is typically funneled towards ongoing capital needs, not issues that are five to 10 years away, even though the utilities are financially healthy enough to fund capital investments.

Moody’s warns that this capital under-investment can be a big risk for utilities. Broken down infrastructure often leads to operating inefficiencies and unreliable service. As infrastructure continues to age, systems may begin to violate U.S. EPA regulations and find themselves slapped with costly consent decrees.

Nobody can say how these predictions will play out but many investors have made a fortune with shakier information. If this outlook can be believed, we are in for a stable 2016.