Scalper1 News
Executives Darren Jameson – IR Steve Mogford – CEO Russ Houlden – CFO Analysts James Brand – Deutsche Bank Deepa Venkateswaran – Bernstein Iain Turner – Exane Lakis Athanasiou – Agency Partners Dominic Nash – Macquarie Edmund Reid – Lazarus Verity Mitchell – HSBC United Utilities Group PLC ( OTCPK:UUGRY ) Q2 2015 Results Earnings Conference Call November 25, 2015 4:00 AM ET Darren Jameson Good morning everybody and welcome to United Utilities Half Year Results Presentation. Thank you for attending and nice to see many familiar faces here in the room. For those of you who don’t know me, I am Darren Jameson and look after Investor Relations at UU. I just need to run through the usual housekeeping duties as usual. A test of the fire alarm is not planned for this morning, so if it’s for real and the alarm goes off, please could you make your way out of the auditorium by the exits in the corner of the room. Could we also please turn off BlackBerrys and mobile phones et cetera please. And as always, today’s presentation should be considered in the context of the cautionary statement towards the back of your presentation packs. So, with no further ado, I’d now like to pass over to our Chief Executive. Steve Mogford Thanks very much, Darren. Good morning, ladies and gentlemen. Welcome to our half year results presentation covering the first six months of the 2015 to 2020 period, AMP6. We made a good start to AMP6, building on the momentum established in AMP5 which saw us climb from a low base five years ago to becoming one of the two leading water and waste water companies, as measured by Ofwat’s key performance indicators. We are capitalizing on the transitional investment we made in AMP5 to give us a rapid start to our major investments for this five-year period. Given our strong focus on customer satisfaction, we were disappointed that customers in part of Lancashire were inconvenienced by the water quality incident last August. We were absolutely focused on restoring water quality for customers as quickly as possible, and this was achieved by the beginning of September. Disappointing as it was, the Lancashire incident isn’t reflective of our underlying performance as our results today demonstrate. Our annual business planning round is currently underway and this process will deliver our refreshed plans for the period 2016 to 2020. We are still at a relatively early stage but we remain of the view that our AMP6 final determination remains tough but within reach. Our plans will build on our first-year experience in setting our AMP6 outperformance targets, which we expect to share with you at our full year results next May. This is the agenda this morning. I’ll provide you with an overview of our operational performance in the first half of the year, and Russ will then update you on the financials. I’ll finish with a summary and outlook for the Group. Our achievements in AMP5 give us a good platform for the next five years. We reduced customer complaints by around 75% over the AMP; and we achieved joint top place in Ofwat’s assessment of water and wastewater company performance. And we were delighted to again be assessed as a first quartile sector performer by the Environment Agency. So, we’re off to a good start for AMP6. The transitional investment we made at the end of AMP5 has given us a smooth transition into AMP6 and we expect to invest around £800 million this year. We have a strong balance sheet and good credit ratings, with gearing stable at around 59%. We have locked in a low cost of debt for 2015 to 2020. We are rolling out systems thinking across our group, bringing together technology, asset information and processes to deliver further improvement across our wholesale business. We are well advanced in the competitive business retail market. And we continue to win customers in Scotland and now have annualized revenue of around £18 million. This learning is supporting preparation for full opening of the English business retail market in 2017. We plan to invest over £100 million across the next five years to mitigate energy pricing and availability risk. And all this supports our dividend policy of a growth target of at least RPI inflation for the period 2015 to 2020. This chart shows our joint top ranking Ofwat’s key customer operation and environmental performance indicators. We’re ranked alongside Wessex, in which we both scored only one amber with all other scores green. And that’s a very satisfying conclusion to AMP5 and a great place to start for AMP6. I’d like to take just a few moments to touch upon the incident we experienced last August. Our regular sampling program discovered that our water networks supplying parts of Lancashire had been contaminated by low levels of the parasite cryptosporidium. As a consequence, we issued a precautionary boil water notice to over 300,000 properties, representing approximately 10% of our customer base, whilst we set about restoring supply of wholesome water to customers. We took an innovative approach of installing ultra violet treatment at service reservoirs serving the affected area. And this was a complex engineering program which our teams completed with unprecedented speed. This along with re-zoning from other supply networks facilitated a progressive lift by postcode of the boil water notice. And full service was restored by early September. The test of any team is hot it responds to challenge and I am very proud of the way in which the UU team handled the situation along with our many subcontract partners. We’re also very appreciative of the advice, support and assistance we received from our regulators and local and central government as well as the patience and understanding of our customers. We paid compensation progressively to customers as we lifted their boil water notice. And associated costs amounted to £25 million, of which compensation was the main element. There has also been some impact on SIM, and I’ll touch on this shortly, although we don’t expect the incident to have a material impact on our ODIs. We have undertaken a lot of work to understand the root cause of the incident and continue to work closely with the Drinking Water Inspectorate, which is the water quality regulator who will issue their report on the incident in due course. As you’d expect, we can’t comment any further until that report is published. So moving onto customer satisfaction. We were the most improved company on SIM during AMP5, with customer complaints down by approximately 75% across the five years. And we’re making early investment in new systems to improve customer satisfaction further. You will recall the SIM combines quantitative and qualitative measures. And as I mentioned previously, Ofwat has change the SIM methodology for AMP6. As expected, SIM survey results are more volatile than they were for AMP5 and it is therefore more difficult to see trends in the data collected to-date. Our underlying performance has seen us averaging at mid-pack over the trial period last year and we started the 2015 to 2016 year well, achieving an improved qualitative SIM score for quarter one and also achieving a further reduction in complaints. Ofwat survey qualitative data four times per annum and the second wave for this year was conducted during our water quality incident. Unsurprisingly our water scores deteriorated significantly for quarter two, although our scores on the waste water component were good. Despite this incident, our first half qualitative SIM score only fell slightly compared with last year’s average. However, we will only understand the extent of post incident SIM recovery once the quarter three scores are available. Customer complaints in the first half of this year remain at a similar level to the corresponding period last year, and we remain on track to hit our own internal quantitative target for the year. However, it is difficult to assess our ranking from a sector perspective as not all companies have agreed to data share. Looking more broadly, our North West customer survey has consistently placed us third behind John Lewis, and Marks and Spencer on a range of perception measures. We’ve recently received our results from the October survey, which is the first since the water quality incident, and although, as you’d expect, our scores dipped amongst those surveyed in the affected area, our rating overall remained stable and we are still in third position. And those of you who attended Ofwat’s recent Water 2020 event will also have seen that UU was rated as the most improved water and waste water utilities, as measured by the Institute of Customer Service. So, the range of measures we use to monitor customer satisfaction continue to indicate improvement, building on our year on year improvement during AMP5. As I’ve mentioned, we intend to set outperformance targets next May, but good early progress is reinforcing our confidence that the totex targets we have accepted are tough but within reach. I’ll cover the CapEx component of totex and Russ will later discuss OpEx. We spent £39 million of transition investment in the last 18 months of AMP5 to give us a good head start to AMP6. Our new engineering and capital delivery partners are working constructively to help us plan and organize our investment program and contracts worth approximately £700 million have already been awarded. We are also seeing the benefit of our new arrangements in the innovation being brought to the table by our new partners. As planned, we are accelerating our investment program to secure early delivery of customer and environmental benefit. We are clearly focused on work which underpins performance against AMP6 Outcome Delivery Incentives. Regulatory capital investment in the first half of 2015-2016, including £76 million of infrastructure renewals expenditure, was £358 million, giving us the platform to increase this to around £800 million for the full year. This is ahead of our business plan and represents a much better start than the first year of AMP5, when we invested just £608 million. For AMP5, we created our internal measure of effective capital delivery with our Time Cost and Quality index, TCQi. And over the period, we drove improvement from around 50% to consistently over 90% against this measure, a significant achievement given the scale and complexity of our investment program. Our £3.5 billion regulatory capital investment program for AMP6 is similarly complex and we have toughened the TCQi measurement mechanism to drive further improvements in our performance. Reflecting the efficiency challenges accepted through our final determination, our TCQi mechanism now gives a greater weighting in the cost element to our biggest capital projects and measures cost in terms of totex. It also extends coverage to relevant non-regulatory commitments. Despite this tougher approach, our projected TCQi score for this year remains high at around 90%, representing a very good performance and is towards the upper end of our target range of 73% to 98%. Moving on to outcome delivery incentives or ODIs, which are a new feature of this 2015-20 regulatory period. As outlined at our results last May, we have 18 wholesale ODIs with financial rewards or penalties. Most of the ODIs include a deadband associated with target performance, for which there will be no reward or penalty if actual performance sits within the deadband. Performance on each ODI will be assessed annually with individual ODI rewards or penalties determined each year. The annual performance on each ODI then accumulates to form a five-year total. And for UU, performance adjustments will be made at the next price review and impact the 2020-25 period rather than the next five years. Rewards will result in an uplift to regulatory capital value or RCV and penalties feed into a revenue reduction. As previously advised, risk is skewed to the downside, with nine ODIs potentially attracting a penalty only. Our sewer flooding ODI, for example, becomes progressively very challenging and is sensitive to weather conditions. However, we’ve made a good early progress in a number areas, and in particular, the full pollution performance has been good to-date. Half way through the year, we believe it’s unlikely we can achieve a reward for 2015-16 but we need to get through the winter before we are able to refine our view of the overall result for the year. We intend to provide a more detailed update at our full year results in May 2016, including five-year targets. I talked to you in detail last May about how our ‘systems thinking’ approach to running business will help drive customer service and operational efficiency improvements. Today, I will just provide a brief overview of the progress we are continuing to make. This chart outlines some of the things we are doing, shown in blue at the top of the slide, and some of the key benefits shown in red, towards the bottom of the slide. We have now fully implemented our innovative production line model across the wholesale business. And our production leadership is supported by embedded multi-disciplinary teams, including project management and engineering resource. These teams are focused on optimizing performance of our assets including enhancements to meet new water quality or environmental requirements. We are investing in a new digital network to provide a communications backbone for the increasing volumes of data we now use to monitor and control our assets and we have extended the use of sensors in our networks. Over 80% of our assets are already connected to that new network. We are in the final stages of implementation of our new asset management system which, in conjunction with our new field force scheduling capability, will improve efficiency of our planned and reactive maintenance work. Our new Integrated Control Centre, or ICC, is up and running providing continuous monitoring of our assets. And our ‘systems thinking’ is being implemented through waves of new capability rolled out across the business with the ICC acting as the main control hub in which performance is planned and monitored. This will enable us to model and better predict events before they occur and impact customers. And the ICC is a critical enabler to our continued improvement in efficiency, performance and customer satisfaction. We are also increasing our energy self-generation capability, something I will discuss later. And I intend to provide you with updates on ‘systems thinking’ progress at future presentations. Now moving on to business retail. Our early preparation and progress means we are well positioned for full market opening. We have established a strong presence in the Scottish market for business customers, having secured over 250 customers covering over 3,000 sites and representing annualized revenue of around £18 million. The Scottish market has become highly competitive as more companies use it to gain experience ahead of the English market opening in April 2017. We therefore continue to bid selectively, pursuing business at attractive margins, rather than solely growing market share. And value added propositions continue to be a competitive differentiator. Cost to serve will be critical to success in a competitive market and we were an early mover in implementing a new customer account management system at the end of AMP5. We are now engaged in tweaks to our systems to provide compatibility with the recently issued Market Architecture Plan for the English business retail market. Preparation is also well advanced in our wholesale business in preparing for market opening. We played a leading role in the establishment of the English Market Operator, MOSL, and this is now up and running as a separate legal entity overseen by an independent board and with its systems provider selected and on contract. Moving onto energy self-generation. Power is a significant cost for us, at around £60 million per annum, and so it makes sense to look at economically viable options to use our sites to increase our self-generation capability, reducing our exposure to future energy prices. We already generate a significant amount of energy from sludge — electricity from sludge and this is currently the main source of our renewable energy, which was equivalent to around 18% of our total electricity consumption last year. At our largest site, Davyhulme in Manchester, we are exploiting the increased gas generation from our new advanced digestion facility, SBAP, that I have mentioned in previous presentations, by building a plant to clean up and inject that gas into the national grid network. We are continuing to develop more combined heat and power assets and to optimize the performance of those we already have, but to supplement this we are also growing our non-regulated energy business taking advantage of the company’s significant land and asset base. We have looked closely at wind generation opportunities and have planning approval for a small number of sites but our principal focus is on solar power, which currently has the most attractive returns. We have a program for rolling out solar installations across our sites using our extensive roof areas and redundant land for solar farms. We recently announced the go ahead for installation of what will be Europe’s largest floating solar array system on Godley reservoir, just outside Manchester. Whilst floating solar has been deployed elsewhere around the world, most notably in Japan, it’s a relatively new technology in the UK. The installation at Godley is expected to consist of around 12,000 panels, covering around 45,000 square meters which is equivalent to the size of around seven football pitches. This should contribute to keeping our energy costs down and benefit water bills, so good for both shareholders and customers. Overall, we plan to invest over £100 million across the next five years in our non-regulated energy business, mainly in solar facilities. And subject to good projected returns, we are aiming to double our energy self-generation to around 35% by 2020. And finally, operating in a responsible manner is fundamental to the way in which we run our business and there is growing evidence of a link between ESG and shareholder value. I believe that we struck the right balance between customers and shareholders in sharing AMP5 outperformance through £280 million of reinvestment. We’re investing in our apprentice and graduate programs to attract and develop high caliber people. As our jobs become ever more demanding, we recognize the fundamental role that training plays in equipping our people for their roles and we recently invested in our new technical training centre just outside Bolton. This leading edge facility uses sector leading tools and technology to educate our people from entry at apprentice level and beyond. In addition, I place particular emphasis on recruiting high caliber individuals from outside the water sector to bring their learning to bear on the business. We’ve always placed significant emphasis on governance and we’re pleased to see that our strong ESG performance continues to receive external recognition, as outlined on the slide. And we were particularly pleased to retain our World Class rating in the Dow Jones Sustainability Index for the eighth consecutive year, a significant achievement given the index’s increasingly challenging standards. So, we believe that our responsible approach to business is delivering for all our stakeholders. Now, over to Russ. Russ Houlden Thank you, Steve. Good morning. So, now moving onto financial performance for the first half, which is the first period under the new regulatory price controls. This is a good set of results, in light of these new tough regulated price controls. Underlying operating profit at £309 million was £35 million lower than the first half of last year impacted by these new controls, along with an increase in operating expenses that I’ll discuss shortly. Underlying profit before tax was £205 million, £17 million lower, benefiting from a decrease in underlying net finance expense. Underlying EPS was down by 1.9p, or 7%. We’ve declared an interim dividend of 12.81p per share, up 2%, reflecting the increase in RPI for the year to November 2014, which is the rate included within our price controls for 2015-16. We’ve maintained our responsible financing policies, with RCV gearing at 59% which is in the middle of our target range of 55% to 65%. This supports our robust capital structure and we have solid credit ratings of A3 with Moody’s and BBB plus with Standard & Poor’s. And it is worth noting that Standard & Poor’s recently uplifted its view of UU to a positive outlook. And our dividend policy for AMP6, targeting growth of at least RPI each year, will keep dividends growing at a sustainable rate. As usual, we’ve made some adjustments to reported profit to get to underlying profit, which we believe gives a more representative view of underlying performance. We had a £37 million fair value gain in the first half of this year, largely due to gains on the regulatory swap portfolio, mainly resulting from the unwinding of our opening liability position in respect of derivatives hedging interest rates. This compares with a fair value loss in the first half of last year of £20 million, meaning that there was a £57 million net movement across the two periods. Underlying operating profit also strips out £25 million of costs associated with the water quality incident and £5 million in relation to preparations for business retail market reform. So, whilst the reported profit for the half year was £9 million higher, the more meaningful underlying measure was down £13 million, at £163 million. So, this is a summary of the underlying income statement after making the adjustments shown on the previous slide. Revenue was down by just £2 million at £857 million, despite the new regulated price controls, mainly because the first half of last year was impacted by the special discount we applied to customer bills. We also benefitted from slightly higher non-regulated sales in the first half of this year. Underlying operating profit at £309 million was £35 million lower than the first half of last year. This reflects the new regulated price controls, an expected increase in depreciation and other costs, partly offset by a reduction in regulatory fees and bad debts, which I’ll discuss in more detail on the next two slides. Underlying profit before tax was £205 million, down £17 million, due to the £35 million decrease in underlying operating profit, partly offset by the £18 million decrease in underlying net finance expense. This decrease in underlying finance expense was mainly due to the impact of lower RPI inflation on the portion of the Group’s index-linked debt with an eight-month lag and a lower cost of debt locked-in on the Group’s nominal debt. The underlying tax charge of £42 million was £4 million lower, due to the tax impact of lower underlying profit. It is worth noting that, on 26th of October this year, the UK government substantively enacted its intended future changes to the mainstream rate of corporation tax. As a result of this, we would expect a deferred tax credit of around £120 million to be recognized in the full year accounts. However, we will exclude this credit from the underlying profit measures. Overall, nothing in the first half changes our expectations for the full year. We have continued to maintain tight cost control, although, as is often the case, there were some special factors affecting the comparison of underlying operating expenses between the two periods. Overall, our underlying operating expenses were up £32 million. The main increases were in employment costs, £4 million, largely because of current pension service costs; hired and contractor services, £3 million, mainly due to higher network maintenance costs; property rates, £5 million, mainly because of a credit last year; other expenses, £20 million, partly because of a large legal credit last year, and partly because of legal and other provisions this year; and depreciation, £12 million, partly because of the larger asset base and partly because of accelerated depreciation on assets which have been replaced slightly earlier than anticipated. These cost increases were partly offset by cost reductions in the areas of power, £2 million; bad debt, £3 million; and regulatory fees, £11 million. Looking forward, if we were to continue to accrue future service benefits for existing contributing members in our defined benefit pension scheme, current service costs would escalate further. We have therefore, after careful consideration, started a period of consultation with our employees and trade unions with regard to transferring the 40% of our employees affected onto our defined contribution scheme. So, looking at bad debt in a bit more detail. Deprivation remains the principal driver of our higher than average bad debt. You may recall that bad debt costs increased last year to just over 3% of regulated revenue. This was partly due to a review of bad debt provisions for business customers in preparation for systems upgrades, ahead of full market opening, and a review of operational debt processes and bad debt provisions in domestic retail in preparation for the 2015-20 period. Our bad debt performance in the first half, at 2.3%, is slightly better than the 2.5% guidance that I gave you in May. So, we’ve had a good first half, but we are not changing our full year guidance of around 2.5% at this stage. Turning now to the statement of financial position. Property, plant and equipment was up £129 million in the year to £9.8 billion, reflecting expenditure on our large capital program. As at March 2015, the Group had an IAS 19 retirement benefit surplus of £79 million and this surplus has increased to £126 million at September 2015. This £47 million favorable movement mainly reflects the accounting remeasurement effect under IFRS of a small increase in corporate credit spreads. Cash and short term deposits were intentionally increased to £356 million in preparation for a £425 million bond maturity next month. We minimized the cost of carry by drawing down in June the final £150 million from our £500 million EIB loan, which we signed in September 2013, and by issuing over £100 million of notes via private placement. Derivative assets and liabilities have remained relatively stable. Gross borrowings increased by £198 million, to £6.8 billion, mainly resulting from the debt drawdown and new issuances. Retained earnings have increased by £23 million, impacted by post-tax remeasurement gains on our DB pension schemes of £27 million. Net debt was £89 million higher than the position at March, mainly reflecting expenditure on our substantial capital investment program. This chart shows our RCV and gearing level. The blue bars show the growth in our RCV, which has slowed over the last year, mainly due to lower RPI inflation. The green line shows the movement in RCV gearing over the last few years. Our gearing has remained stable at around 59%, with the growth in net debt largely offset by the growth in the RCV. Our responsible approach to financing means that gearing at 59% is in the middle of our target gearing range of 55% to 65%, supporting a solid A3 credit rating. Moving on to cash flow. Net cash generated from operating activities at £370 million was similar to the first half of last year. The impact of lower profit was offset by an improvement in working capital cash flows and a slight reduction in corporation tax paid. Cash used in investing activities was down slightly, mainly reflecting slightly lower capital investment compared with the first half of last year, as expected, as we start the new five-year regulatory period. We have achieved a smooth transition into AMP6 and our full year investment expectation of around £800 million is much higher than the £608 million we invested in the first year of AMP5, as Steve mentioned earlier. Net cash generated from financing activities was £50 million, compared with £13 million used last year, reflecting an increase in proceeds from borrowings. Now onto financing. Over the next five-year regulatory period, we have financing requirements totaling around £2.5 billion. This is to meet a combination of refinancing and incremental debt, to help fund our investment program. We are in a strong position, having already raised over £1 billion of our requirements, and this slide shows just how active we’ve been. We have raised £750 million from the EIB, our largest lender, of which £350 million was drawn down late in AMP5, £150 million has been drawn down in the first half of this year and £250 million remains to be drawn over the next six months. In addition, we have raised over £300 million from existing relationship banks, via private placements, tapping specific pockets of demand, to achieve excellent value relative to the public capital market. Some of this finance was index-linked and some was nominal, in line with our well-understood hedging policy. So, we now have financing headroom well into 2017. And finally, a brief update on our hedging. As a reminder, we leave the equity portion of the RCV exposed to RPI inflation by hedging the debt portion of the RCV for inflation through index-linked debt and the effect of our pension scheme liabilities. We are currently hedged in line with our policy. And as I mentioned, we have been raising an appropriate mix of index-linked and nominal debt to maintain this position. The average cost of our £3.2 billion, long-term, index-linked debt portfolio is 1.6% real and the more recent index-linked debt we have raised is at more attractive rates. We believe that our hedging strategy keeps us better hedged for inflation than our listed peers. Owing to the current low level of inflation, this gives us a financial benefit relative to them. We are therefore well placed in this period of low inflation and this has been reflected in a reduction in underlying finance expense in the half year, along with a smaller increase in the principal of our index-linked debt, benefitting gearing. In respect of our nominal debt, this is virtually all fixed for the 2015-20 period. This has been done at an average interest rate of around 3.75%, although, as we mentioned in May, we expected this rate to be slightly higher this year, particularly in the first half, as we await the maturity of a £425 million, 6.125% bond next month. To help manage our exposure to the various ways in which Ofwat could choose to set the cost of debt at the next price review, we are continuing with our 10-year reducing balance policy for the post 2020 period. Overall, our hedging policy puts us in a good position for financing costs in both this five-year period and the next five-year period. So, in summary, this is a good set of results in the light of the new tough price controls. We have benefitted from a reduction in underlying finance expense. We continue to maintain a strong balance sheet and solid credit ratings, with S&P having recently uplifted us to a positive outlook. We have already raised over £1 billion of our £2.5 billion financing requirements for the forthcoming five-year period. We have locked in a low cost of debt for 2015-20, with an appropriate mix of index-linked and nominal debt. And our hedging policy means we are well-placed to manage future financing costs. Now, back to Steve. Steve Mogford Thanks Russ. I’ll finish by providing a brief summary and outlook, before we move onto Q&A. We have made a good start against a tough set of AMP6 targets. Our AMP5 operational achievements and customer service improvements gave us good momentum for AMP6, and our ‘systems thinking’ approach is a key enabler to our further improvement. Transitional investment ahead of AMP6 gave us a smooth transition into our 2015-20 investment program, while our new partnering arrangements already delivering benefit. We have delivered a good performance in the first six months of this year, reinforcing our confidence that the totex targets we accepted in our final determination remain tough but within reach. We continue to maintain a strong balance sheet, good credit ratings and we have locked in low debt costs for the 2015-20 period. And we are advanced in our preparations for opening of the English business retail market to competition in 2017. Overall, we believe we have established a solid foundation to deliver further benefits to customers, shareholders and the environment, and we are targeting an annual dividend growth rate of at least RPI inflation through to 2020. Okay. That concludes our results presentation. Thanks very much for your attention. We’ll be now pleased to take questions. Question-And-Answer Session Q – James Brand It’s James Brand from Deutsche Bank. Three questions, if I may. First is just on Ofwat’s plans for 2019. They’ve said that they are looking to introduce more market forces, particularly in two areas, in water trading and in sludge. I would say you’re probably quite well-positioned in terms of water trading but I was wondering whether you could tell us how well-positioned you think you are in terms of sludge and cost versus other companies. Second question on solar, just wondering how you’re thinking about the plans and whether they’re affected at all by the cuts the government’s announced in FITs. And third question on the EIB loan that you drew down on around the middle of the year. I was wondering whether you could tell us what rate of interest you are paying on that. Steve Mogford Okay. I will pick up the first two, if I can. I think you’re right to look at sort of the public statements that we’re seeing from Ofwat in terms of thinking about what’s called Water 2020 or PR19 in old money. And I think there are probably two areas to that which are around potential introduction markets, one is, around water trading and trying to encourage water trading looking at how that could be done, particularly in the context of incremental requirements. And I think that’s recognizing that as we go forward, resilience of water supply is a particular issue particularly in the sort of South East and West of the country. So, I think that’s one area. I think the other component is around sludge, which is business — unfinished business because if you remember, there was an OFT review of sludge and the sludge market or the bio processing market. And I think there is an aspiration there just start looking at that. One of the things that we’ve been doing for some time, and it’s been linked to improving our energy self-generation, is looking at our sludge activity in the context of how do you optimize, both sludge processing and disposal but also the energy generation opportunity that you get from that. So, we’ve put a quite lot of effort in thinking about sludge separately from our waste water activity and looking at sludge really as an asset and how do you maximize the potential of the asset. So, we’ve recently appointed somebody that is responsible, not sure he was overly keen at going on and saying he was our sludge manager to friends and family. But essentially he is now responsible within the business for looking at sludge, how do we optimize bio-digestion, but also we’ve been investing in some production planning technology, which looks at how you best move sludge around. So with how do you take it optimizing transport costs against the quality of the sludge, the quality of the digestion, the energy output. So, I think sort of thinking that we’ve been doing over the last few years does give us quite a good indication as to how one might do that more broadly. And there is limited such trading goes on at the moment. For AMP5, we actually said to other companies, are they interested in, some of those dialogues are running. So, I think it is an area that does have potential for people who want to consider the bio-digestion market more broadly. On solar, clearly, I think Russ had said to you that in the last presentation what we were looking at in terms of the return on investment. I think the FITs changes have had an impact on that. They have lowered the threshold for us at which we would look at solar investment, but what we can find is that there are still a significant number of investments available to us, which will meet a revised threshold, recognizing the FITs changes are coming through. So, many of the schemes that we’re now working on, we will capture those or we’ve already got the benefit, so pre locked in. But as we go into next year, then we’ll be working on a lower threshold, but one which is still attractive. Do you want to pick up EIB? Russ Houlden Yes, sure, on the EIB point, the slide you’re talking about I think showed two EIB loans. It’s the £500 million which we signed a while ago and that’s now being fully drawn down. That one we took in floating rate form and that has been taken down in four tranches. The most recent tranche we took at LIBOR plus 51 basis points. If you look at the four tranches in total, they’ve ranged from LIBOR plus 51 to LIBOR plus 71 basis points. The other EIB loan we’ve got is undrawn which is the indexed-linked one and so obviously we have yet to determine the rate that will be on that one. Unidentified Analyst Just on the pension changes and what escalation, and the charge would you expect, if the scheme remained open; what do you think you’ll have to give in return; and do you think that the changes risk derailing the improvement program, if your employees are unhappy? Steve Mogford Do you want to do the first two, and I’ll do the last one. Russ Houlden Yes, I think the cost escalation will be quite significant; I won’t put the exact numbers on it. But with the changes in national insurance and so on that will be coming through, plus changes in longevity, the escalation in cost will be quite significant. I think in terms of the impact on employment proposition, I think we are very good employer; we continue to attract the best people in North West. Obviously it is more difficult to recruit people from the London market but most of our employees come from North West. Steve Mogford I think when you look at it, we’ve now got almost 60% of our employees in a DC scheme, which is a very good scheme when you look at it in the context of the market overall. And we’ve announced that, and looking at the pension arrangement, the DB arrangement, it’s — we consider it’s unsustainable going forward and as Russ indicated. But we’re still in very early stages of consultation. So, we’re about to start consultation with both employee and with trade union representatives, and understanding how we can make the transition from one to the other. So, very early stages yet, but obviously we’re very conscious of the fact that we’ve got a very engaged workforce that delivered tremendously over the last five years and we want to keep that arrangement. Deepa Venkateswaran Thank you. This is Deepa from Bernstein. I had a question on your TCQi index. You have said you have changed your methodology and now it’s at 90. I think in your earlier methodology, you were reaching 95%. So, could you just help us understand what you would have been rated at, say last year, under your new methodology? And secondly, in terms of the SIM score, you did mention that in the last two quarters, I mean you are number 13 out of 18, I mean that’s obviously slightly below average, what would your apart from kind of waiting for the impact of the incident to die out; is there anything else that you would do to improve your SIM scores? Steve Mogford Okay. I think on TCQi, if you look at a like for like, we are probably up 5 percentage-point shift, so it’s right. And if you are around 90%, we probably would have been in the previous score around 95%. I think the thing that we have done is that we have — we toughened it by here putting in a totex measure because clearly we’re very interested in whole life costs; it’s not just capital investment activity. What we’ve also done is, in the last program, we started very much — in the last five years, we started very looking at what we would see as being commitments that we’ve made to regulators, so the way that you would look at our commitment made to a customer. Here what we have done is that we now extended the portfolio of projects that we are measuring. So, essentially, in our speak, anything which is a commitment and a driver for our performance is now included in that metric. So it’s a much broad base of measurement and it’s a tougher base of measurement that we are putting. We also put far more emphasis on the cost component of a metric. But I think — and we are really pleased. And I’ve got a long track record in capital programs, construction programs, and I think the improvement that we’ve seen in project management and risk management over that period has been great. The man in front row there, Neil Colman has a lot of credit to that. He’s been our capital program delivery driver force, and he now runs, what we call, program services. Because we’re now injecting that program management confidence into our production teams and planning over five-year horizon, so further moves in that. On SIM, SIM is really interesting. I said last time that we expected the results to be more volatile because we — the survey now includes not only people who had their complaint addressed and therefore it was a ‘how was it for you’ question, and now it’s ‘how is it for you’ because you find — you’ve got people meet problem or meet query. And generally, you find people more dissatisfied. So, it’s quite — what you see is distinct different SIM scoring levels between the two. It is leading — there is no controlled sample, so you don’t ask fixed number of each community. And so, we are seeing for all of the companies, a high degree of volatility in scores. But I think what it’s causing to do is also realize that we were getting really, really good at reducing numbers of complaints and dealing with them, but we still had issues where we’ve got complaints that are sticky that are not being resolved sufficiently quickly. So, we are putting a lot more energy into — in the manner in which we deal with complaints, the degree of communication whilst there is an issue. And I think it’s causing us to drive further into the challenge of how do you deliver a great customer experience. And I think, as I said, our underlying performance prior to the water quality incident was actually showing an improvement, we have consistently had very good waste water scores. Water was our biggest challenge. And actually we are beginning to see improvement there. So I think we are very confident that once we get through the impact of the incident in Lancashire, we should start to see those actions bearing fruit. Iain Turner Can I ask a couple of questions? Sorry. It’s Iain Turner from Exane. Can you just give us an update on where you’re on bathing waters? I think there was report earlier in the year. The ones — I think there were a couple of yours that weren’t quite where they needed to be and how much of that is down to you and how much that is sort of donkeys and things? And then, on the pension changes, how much of the pressure to change is coming from Ofwat and whether regulatory regime works, just sort of a philosophical question. Steve Mogford Okay. On bathing waters, it’s actually been a good year. We’ve now effectively gone through the first bathing water season under a new legislation. And we’ve seen good performance on bathing waters. One of the areas we were particularly concerned about was Blackpool and we seen good performance in Blackpool. We think significant contributor to that is one of the big investments we made in the Preston area which — where the river flows out onto Blackpool beaches. I think it’s probably too early to say that that’s likely to be the trend through the period because it is very weather dependant, and we had quite a dry summer and the rain’s didn’t really hit the North West until sort September time. So, I think that we need to see how we go forward in future years. I think it’s still is an issue, very much an issue for us in the North West. We have big investment programs along particularly that Blackpool coast line during this period. We have already got — some have been — we’ve already finished and others are ongoing. So, I think bathing waters is still an area where we’ve got to pay a very close attention. But first year, good, and I think a big contribution from weather, and prior and investment. I think on pensions, it’s not being driven by Ofwat. It’s not something that Ofwat required us to do or indicated that it would be the right thing to do. I think we are just ending up where most of industry is. The DB schemes are becoming unsustainable and we need to move people to a good DC scheme and find a way of doing it. And that’s where we are going with the consultation and we have got — we really will try on this side now. Lakis Athanasiou Lakis Athanasiou with Agency Partners, just two questions on regulatory. On the 10-year reducing balance, do you have any thinking or thoughts about moving that out, extending it out to 15 years, given what happened in the ‘81, the indexation? Secondly, I think more importantly, on Water 2020, the competition issue, you went in the sludge trading and water trading and you know to all intents and purposes, we can pretty much ignore that. But are you at all concerned with Ofwat’s desire to split that out even further treatment distribution, extensively to — for excess pricing, but one’s got to worry about further movement by Ofwat in introducing competitive segments and treatment for example. Steve Mogford I think do you want to deal with reducing balance? Russ Houlden Yes, I’ll deal with the reducing balance point. The 10-year reducing balance policy we set probably about four years ago now, something like that. And we set it following extensive discussions with Ofwat to try and pin them down essentially on how they will set the cost of debt, and they refused to set the formula. And they always keep their options open. And they could look the spot cost of debt, they could look at the forward curve, they could do indexation. And that was allowed for in the 10-year reducing policy. So, the possibility of indexation was already in there when we set the reducing balance policy and that policy was set in order to minimize the variance from all of the possible options they could come up with. I think the full range of options is still there. Obviously indexation looks like it might be slightly more in than out than it was two years as an option but I don’t think it’s a slam-dunk that they’ll move to indexation because of course there will be a fear on their part that by moving to indexation, if rates rise, that might not be the best thing for customers. So, it’s still there in the balance and it doesn’t change our view f the 10-year policy. Steve Mogford I think on Water 2020, I think you were at Moody’s Conference where we were talking there. We’ve done quite a lot of work in thinking about how to do deal with excess pricing. And I think particularly when we are looking at water resources and you are looking at incremental resources because I think the general we have got in the South of England dealing with the resilience is that we do need access to greater resources; we don’t store enough water principally. And so trading contribution, storages contribution, transfer has some potential. And so, I think for us, we look at the RCV really as not necessarily being representative of the value of the particular asset. And in a sense, it is less asset related, it is essentially a lump of money that investors put into the business that requires remuneration. And I think for me, the way that Ofwat is recognized that is protected at 2015 — up to 2015 was sort of a recognition of that fact. So, I think what we have said for excess pricing is that really we ought to be looking at this on with a LRIC principle essentially and looking at what is a long run cost associated with creating a new asset and doing a direct comparison between that — between if you did it yourself or a third party came into do it. And that doesn’t involve RCV allocation in that context. And I think that’s a paper we’ve put out. We have discussed it with Ofwat. I think we will see in December when we put out the consultation where they are on that. But we certainly don’t — and I think if we are looking at it certainly from our perspective, protection of an RCV invested is really important, I think that’s important not for historic but future RCV as approved as we forward in successive waves of price review. I think getting an arrangement for excess pricing which is really looking at those long-run incremental costs, so I think we do think there is a need for change in the arrangement. We will see where Ofwat is when we see that consultation. Lakis Athanasiou On the RCV being protected in 2015 and completed in 2020, 20% is unprotected, and I’ve never managed to pin Ofwat down to what the hell that means. Do you have any concerns regarding that or is it something kind Ofwat kind of through in the air and that really themselves know what they’re talking about? Steve Mogford I think my personal view — our view is that we go through a very, very detailed process to arrive at a pricing position for each successive end. I think it would be somewhat churlish to then say that having gone through that process and satisfied ourselves whether it was necessary and not to protect as you go forward is an issue. But we’ll see where we land on that. But I think for me that’s part of the investment proposition. And I think having a way of dealing with that I think is really important. And I am hopeful that as we go forward, we might see further thought from Ofwat on those aspects. Russ Houlden Just to add to what Steve is saying on this excess pricing and RCV point is really important point. If any of you have not read our excess pricing paper, I would recommend you to do so because it does attempt to deal with the Gordian knot really of how do you enable efficient entry which must be good for customers and must be the right thing for Ofwat to try and promote whilst not enabling inefficient entry and creating unnecessary asset stranding. And in telco where I come from, the answer to that is LRIC. And sort of three or four years ago, was saying to the guys, look, so it might be LRIC but you’ve got to this RCV thing, how do you marry together LRIC with RCV? And what the paper does is essentially say that you keep the average cost and you deduct LRIC to enable access to your treatment and your network and that works therefore for water trading. That satisfies all of the adjectives that you would have. And we haven’t had any other proposal that can satisfy all the objectives. So, I think it will be really good for you to understand the proposal, and if other proposals do emerge, to compare them with that proposal. Dominic Nash This is Dominic Nash from Macquarie, couple of questions please. The first one is on this energy investment. Could you just confirm, I presume it’s outside the regulatory ring fence, but you said at your talk earlier that customers will benefit from lower prices. Is that — are you going to be striking for long-term energy contracts, so like between yourself, and how will the regulator look at that if it goes against you, and say power prices fall lower than the price that you strike? And a quick follow-up on the energy one is, are you looking at the demand side management as well as your major energy user can use or take advantage in the recent rules changes and balancing and demand side management that coming through? And I think which [indiscernible] which is at a same sort of time that the regulator is looking at shaping the industry, they’re also looking at innovation and corporate structure with potential management exits and mergers and be shuffling of assets and all those. This presentation is very much focused on, seems to me, very much focused on here and now. Are you starting to look a strategy within the water sector and where United Utilities should position itself in line with changes in corporate structure going forward? Russ Houlden Yes, first of all on the energy point, as Steve said, the removal of FITs reduces the total return available to the Group but keeps it above the cost of capital and we’re very comfortable that’s at level which investors would be happy with. In terms of the regulatory, non-regulatory, we set an arms-length price with the long-term contract and we have quite a lot of evidence that supports our arms-length price, which enables Ofwat to come along at any time and inspect, and we believe that it will pass the life test. And as to onsite and so forth, I suppose our position so far has just been to generate energy for own consumption and occasionally where it’s surplus to requirements to export it to the grid. However, we are starting to look at sort of private wire options to adjacent and industrial users and whether they might also provide an opportunity which exceeds the cost of capital. We haven’t yet done any of those; we haven’t yet even committed to any, but it’s on our radar to start look at that sort of thing as well. Steve Mogford Yes. And we’ve got something like 52,000 hectares of land that we steward. So, our primary objective has been for our own consumption because we’ve got quite a high energy build and it’s probably our second biggest cost in that sense, so… Dominic Nash As a matter of interest what is the efficiency or what’s utilization of solar penal in North West of England? Steve Mogford I think when you look at it you’d be surprised. I mean I’ve lived in London for a long time and the North West and you’d be quite surprised actually that it’s not as bad. In fact, it’s often dryer in the North West than it is in South you believe. I think on the other one which is associated with innovation and corporate structure, really interesting point. Because I think there — we’ve heard lots of statements coming from Ofwat around from Jonson Cox and Cathryn and others, which is looking at being open to M&A and looking at corporate restructuring. And I think clearly, there is a — if you look at the systemic efficiencies, there are in the sector, one might question how many companies you really need to have comparators. And there is a tremendous amount of overhead just sat there because you’ve got 18 companies with 18 of everything that you’re doing. So, there is an opportunity there. I think for us what we’ve been doing is looking at the future direction of the market and starting to say how do we look our assets and how do we optimize the value of those assets as new markets develop. And we first saw the competitive business retail area as one which we could see was going to come early. We structured our business; we created a separate team; we hired in people with that experience. And that’s led to us being one of the most successful competitors in Scotland, and probably be one of the more advanced in England for preparing for that market. Now, our attitude to that has always been what we want to do is we want to have a strong position in that market. Whether we’re the long-term owner of that business, we will see, in terms of where it goes. But, there is no point sat there letting your asset value being whittled away through competition. So, our view has been that attack is the only form of defense in that environment. I think the same is there in sludge. We still to look to the sludge area for some time, really on the basis of our own needs and whether we could optimize that, I think opening of the sludge market. Again, we’re restructuring internally; we are not creating a separate division at this point in time but what we are doing is restructurings, so essentially we can look at that market which is the broader bio-digestion market and where are the opportunities in that. And that can actually take you to a place which is you see that market as interesting or it could be that that’s something that somebody else is better doing for you. And I think if you look at all of our business, it’s beings sliced, certainly in terms of operations and lines of responsibility to focus on those areas where we see that being future changes in the market in which we are operating and how can we be strong and exploit that. So, I think here today is about to here and now in terms of what we are seeing but there is an awful lot of future thinking going on, and positioning to be able to do the best we can when those markets develop. Edmund Reid Edmund Reid from Lazarus. I was interested in what changes you are implementing to reduce your retail cost and when are you comfortable with the glide path that Ofwat set on that? Steve Mogford There is no doubt that the — notwithstanding the deprivation adjustment that we were given by Ofwat, the average cost of serve allowance or the retail cost of serve allowance for domestic retail we were given is a big challenge for us in terms of meeting it. Clearly, we were appreciative of the glide path, but you can’t do these things overnight. I think the drivers there of cost in those areas, obviously this is a base service activity and are you being as efficient as you can. And we do believe that we can be more efficient in that area. And I mentioned that we are making investment in new customer relationship management systems. We did a lot of definition work for that in AMP5. We are going through final design of the detailed design of those systems. And over the next 18 months, we will commit to and invest in, and implement new customer relationship management systems, which are designed to be able to look at the kind of experience that customers are looking for with a service provider but also able to take out cost associated with delivering that service. The other driver for us is deprivation and vulnerability. And I think that’s an area for us where from a cost of serve and looking at that in the context of a national average, the North West is more deprived. We have a higher component of customers with vulnerabilities. And the only things that will change that principally are going to be the economy and the employment levels and the general conditions. And I think what we can see is going forward we have got further challenges to roll out; we have got the benefit arrangements; changes coming through. We are already seeing the impact of some of what’s called the bedroom but essentially allowances people have for accommodation that’s already flowing through into areas. So, I think for us for some considerable period, we can see that we are still going to have deprivation because the North West tends to lag the rest of the economy in recovery. So whether that’s another conversation when it gets to 2019, I don’t know; I suspect it might well be. But we are doing a lot to drive our underlying cost, so as we get to the end of this time, we are in a much better position for the discussion with Ofwat on PR19. Verity Mitchell Verity Mitchell, HSBC. I’ve got question for Russ actually because he’s corporate treasurer by training. I just wondered, given your policy’s very much index-linked in terms of a number of incidents [ph] you have what you think about the proposed CPI RPI changes? That’s first question. The second is just going back to the water quality incident. In terms of the ODIs, we assume there will be some penalty on the water quality service index but it’s also reliable water service index, was that just about interruption just for the clarification please? Russ Houlden Okay. On CPI RPI, and I think our view is that there is actually no need to change because RPI is a very well-established index, it’s one everybody trusts, and indeed changing would potentially create an increase in bills to customers. And that’s a curious feature that perhaps you wouldn’t appreciate until we get into detail how the regulatory mechanism works. That said, if Ofwat felt obliged to change, then it’s essential that they follow through on what they have essentially set down in the documentation this summer about keeping investors whole. And so we will be looking at how they propose to do that if that’s what they propose. Steve Mogford I think the other key element for us Verity here is that there is actually a CPI linked on market; I think that’s — we actually need a broader government action on this, which is for us, unless you’ve got some reference market out there, it’s going to make it very difficult for companies to work in that area. So, I think our view is it is not something — whilst there may will be, an aspiration and a rational for moving and making some sort of transition arrangement from one to the other. Because you can understand the argument from the customer side of a telescope that says well, hang on a minute, most of my income moves by CPI, rather than RPI, which is more closely related. So to that extent; is it right for water companies to increase prices by RPI. That’s the debate you hear coming other way. And I think if you do want to make that change; there is a lot of things to do. I think firstly, as Russ says, understand the impact on customers of making the change. I think for confidence from the sector, if you were going to do it, be transparent, so that people understand how that transition’s made. It doesn’t sort of go into the smoke filled room and the whack appears at the end of the price review in the way we have seen in the previous years. I think this issue needs to be very transparent, if they want to do it. And I think the other aspect is that we need to get joined up action across government, so the treasury engaged in creating a reference market that we can then use in industry. So I think it’s quite a lot of things to do, if you want to do it. But I think doing it that way would give trust and confidence to the sector that we understand how it’s going to be done. Russ Houlden Not just joined up cross government as between if you like treasury and Ofwat and so forth but also joined cross regulators because of course you invest in and recommend investments in many regulating sectors. And it would be rather bizarre if one or two moved and the others held there was no need to. Now I think Cathryn Ross actually chairs the cross regulatory group. So, if anyone is going to pull off the cross regulatory solution, then she should be able to do that. So, we are looking with interest. We have explained Ofwat on a number of occasions. We think the conditions for a successful transition, if that’s what they want to do but equally we said we don’t think the transition is necessary. Steve Mogford You talked about water quality. Yes, you are right. The ODI impact for the incident will have — it will have small impact in those areas because of the nature of the incident. I think our water performance more generally across the year has a greater impact on those ODIs than the water quality incidents in isolation. So, I think and I say, we think on the basis of performance so far this year, it’s unlikely that we see an upside on our ODIs. And because so many of those ODIs are weather dependant, particularly in the waste water environment, we have got to get through the winter before we are confident as to where we are going to land. Russ Houlden It’s probably worth to sort of reiterating our, if you like, soft guidance or our feel on ODIs, we haven’t changed that. We have always said that the full range of ODIs is from minus 470 penalty to a 140 million reward. We have always said that that was an extremely unlikely outcome to be either end of that range because you would have to simultaneously either miss or spectacularly succeed on 18 dimensions. And therefore, we have said that we think the more likely range of outcome is in the plus 50 to minus 100 range. And there is nothing that’s happened over the last six months that makes us change our view on that. Steve Mogford Okay, any other questions? No? Thanks very much, thanks very much for coming. And really appreciate your attention and interest. Thank you. Scalper1 News
Scalper1 News