The potential collapse of Thames Water and a mooted move into public ownership amid spiralling debts has put the spotlight on the contingent of water utility firms on the UK stock market.

Saddled with their own significant borrowings and with investment required to fix the UK’s ageing water infrastructure, questions are being asked about their ability to continue to pay generous dividends to shareholders.

As Morningstar observes: ‘The problems facing Thames Water are not unique as the entire water utility sector in the UK is suffering from rising inflationary pressures and higher interest rates, especially as currently more than half of the sector’s debt costs on average are linked to the prevailing rate of inflation.’

The London-listed trio, United Utilities (UU.), Pennon (PNN) and Severn Trent (SVT) have all seen their share prices come under pressure since the news Thames Water was in talks over a temporary nationalisation in the event it is unable to service its net debt of £13.8 billion.

Utilities tend to have high levels of debt because their earnings are determined by the regulator and are therefore predictable. This means lenders can have a decent degree of confidence in their earnings and are happy to lend to them.

The rapid increase in interest rates over the last 18 months means the costs of servicing these borrowings is going up. Many utilities also have a significant proportion of inflation-linked debt too. According to its latest full-year results Pennon’s index-linked debt represented 30.1% of total borrowings – the aim is to reduce this to between 20% and 25% by 2025.

Pennon, Severn Trent and United Utilities have all pledged to increase their dividends in line with inflation. For now, at least in the case of Severn Trent and Pennon, their balance sheets are taking the strain with dividends funded from debt.

The table shows the net debt to earnings before interest, tax, depreciation and amortisation for the listed water utilities. On another measure, their regulatory gearing levels are materially below the 80%-plus seen at Thames Water. At the last count Pennon’s, at 60.8%, is just above Ofwat’s notional target of 60%, United Utilities’ is just below at 58% and Severn Trent’s comes in exactly at 60%.

Regardless, funding their pay-outs from debt will not be sustainable in the long term and Ofwat introduced more stringent rules in March 2023 preventing water companies from paying dividends if their credit rating slips to BBB (the last rung of investment grade debt) with a negative outlook.

On the flipside, if the companies stop paying such generous dividends it will be hard to find investors who are willing to continue backing them.

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