Southern Water - initiation

All,

Please find our analysis of Southern Water here.

The company is highly indebted, has had its permitted revenue cut by Ofwat in December and has been subjected to a substantial fine as well. Cash production appears to be turning negative, which should raise leverage. 

Such rise in leverage could either directly trigger a dividend freeze (via covenant) or result in a downgrade from IG status and thus trigger such a freeze indirectly. The downgrade could come more quickly if agencies take into account the £1.4bn of swap liabilities at those entities. Either way, upstream bonds are outside the ring fenced perimeter of the regulated entity and thus subordinated. To the Class A debt within the regulated perimeter.

As regards public bonds, the opportunity seems to us to short the unwrapped bonds at spreads currently no wider than 1-1.5% and position for a re-rateing to HY status.

Wolfgang