I've heard of capex, opex and capmanex,,, but first time I've heard of totex.. some of you may find this interesting. best regards, Jonathan

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UK water sector's move to totex cannot address potential financeability concerns

Global Credit Research - 16 May 2013
www.moodys.com/research/Moodys-UK-water-...potential--PR_273275

UK water sector regulator Ofwat's proposal to introduce total expenditure (totex) benchmarking, performance incentives and cost recovery mechanisms of water companies' cost submissions is not designed to address potential financeability concerns, says Moody's Investors Service in a report on the sector published today.

The new report, entitled "UK Water Sector: Speed of Money Cannot Address Potential Financeability Concerns", is now available on www.moodys.com. Moody's subscribers can access this report via the link provided at the end of this press release.

Ofwat published its draft methodology on the framework and approach for setting price limits for the next five-year regulatory period commencing 1 April 2015 (AMP6). The regulator is proposing to use a totex approach in place of conducting a separate analysis of operating expenditure (opex) and capital expenditure (capex). For further details on the draft methodology, please refer to 'UK Water Sector: Ofwat's Methodology for PR14 Likely to be Credit Neutral', published in February 2013.

Moody's notes that companies or the regulator could seek to modify the speed of cost recovery under the totex approach in a manner that may offset the negative cash flow impact of lower returns following a likely reduction in the allowed weighted average cost of capital (WACC) -- in itself a result of the decline in interest rates and required return on equity since the last price review in 2009.

"Whilst any resulting increase in a company's cash flows could reduce external funding pressures, which would be credit positive from a liquidity perspective, that company may also use the resulting financial flexibility to enhance shareholder distributions at the expense of the economic value of the regulated business and future cash flow generation," says Stefanie Voelz, an Assistant Vice President - Analyst in Moody's Infrastructure Finance Group and author of the report. "If that was the case, that company's leverage could increase, notwithstanding the appearance of healthy cash flow-based credit metrics, and this development could have negative credit implications, if sustained over a period of time," Ms Voelz continues.

The adoption of totex will increase the potential misalignment between cost incurrence as reported in a company's financial statements and cost recovery as allowed under the regulatory model. Moody's believes that a faster pace of expenditure recovery may not necessarily correspond to a fundamental improvement in financial strength. The rating agency will reflect this view in its evaluation of the credit metrics it uses to assess companies' financial performance.

As a result of Ofwat's adoption of the more sophisticated but also more complex totex methodology additional disclosure by the companies and/or the regulator will be needed to enable the reconciliation of the accounting and regulatory perspectives on the treatment of expenditure for the purpose of determining whether a regulated business is out-performing or under-performing its expenditure allowances as set by Ofwat.

Details on how the totex approach for UK water companies will be implemented are still unclear, and hence its overall impact remains uncertain. However, Moody's expects more clarity in further publications over the coming 12 to 18 months, including (1) the regulator's final methodology for setting AMP6 price limits in summer 2013; (2) companies business plans in December 2013; and (3) Ofwat's draft price determination in summer 2014.