Market Outlook: Water Utility Market to Remain Stable in 2014

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Market Outlook

By Doug Scott

American families weren't alone in facing setbacks from the recession. For water utility managers, the recession, and years since have been full of trials and tough decisions. While the challenge was formidable, water utilities - for the most part - were up for it. Sound decision-making and prudent planning have set the industry back on track. What does the future hold? So far, signs look positive.

Facing Challenges

During the recession, water utilities saw demand for their services fall almost annually, making it difficult to accurately budget revenues. At the same time, costs for essentials such as electricity and chemicals saw periods of sharp increases, and operating costs have since moderated, applying less pressure to utility budgets. On the revenue front, usage has stabilized, translating into more consistent money flows, but demand remains either flat or slightly down from pre-recession norms, forcing utilities to charge customers more for the same amount of total income.

In spite of these economic challenges, utilities have fared better than most sectors, managing to post favorable financial and debt profiles given their essential service nature, which have preserved a baseline level of demand. Utilities also enjoy a monopoly within their service territories, which has allowed them to push forward with some measure of rate adjustments without excessive fear of pressures from competitors.

Today's View

Fitch's 2014 medians point to very strong debt service coverage, which dropped only to 1.8x in 2012 and has improved slightly each year since. Available cash balances have remained ample and rose to over 400 days of operating expenses this year. At the same time, utility debt levels have fallen as managers took a wait-and-see approach toward major capital projects, relying on recurring utility revenues to make repairs.

While wait-and-see policies have contributed to financial stability, the need to reinvest in the business to assure production quality over the long-term continues to be front and center. Water utility managers will need to contend with balancing these reinvestment needs with the cost pressures it places on customers to ensure buy-in from public officials.

Over the Longer Term

Looking into 2014 and beyond, Fitch believes that water and sewer utilities will continue to exhibit overall stability. Sector fundamentals are unchanged, debt levels are manageable, and the steady economic national picture should allow utilities to make incremental financial improvements and begin investing more money back into their businesses.

The external issues that could disrupt this progression are four-fold: a resumption of economic weakness; a failure by the governance structure to implement timely and necessary rates to protect infrastructure and assure product quality; a substantial shift in the state and federal regulatory environment; and continued stress on local governments that carry over to their utilities.

While these potential pressures are real, Fitch expects that the order of magnitude required to derail the sector would need to rise to near-catastrophic levels given the performance of the sector through the recession. More likely, any external challenges would serve more as a limiting factor on future sector improvement as opposed to a material threat.

About the Author: Doug Scott is a managing director in Fitch Ratings' U.S. Public Finance group, based in Austin, Texas. As analytical head for the U.S. water & sewer and municipal bond fund sectors, Doug oversees a team of analysts responsible for the ratings and research of municipal credits across the country.

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