Pennon Group Plc (PNN) Earnings Call Transcript & Summary

Good morning all, and welcome to today's Pennon Half Year Results call. My name is Adam, and I'll be the operator for this call. [Operator Instructions] I will now hand over to CEO, Susan Davy to begin. So Susan, please go ahead.

Thanks very much, Adam, and hello, good morning, everybody. I'm joined here today by Paul Boote, our Group Finance Director, and I hope you've all had the opportunity to see the slide presentation first thing this morning. I thought perhaps just before we start the Q&A. We'll just give a bit of an overview of those results and then open the lines for questions. I mean, obviously, the pandemic has presented at all with an unprecedented test of our sustainability and resilience. And so I'm very pleased, we're reporting for Pennon a robust half year first half results for 2020. Obviously, this has only been possible due to our impressively dedicated colleagues and their hard work has enabled us to operate as normally as possible. And so we're very much focused on delivering for all our stakeholders in making that positive contribution. Obviously, having taken the CEO role in August this year, I'm delighted to be leading the business at this important time. So first of all, you've seen the results, talking about the reshaping of the Pennon Group with the sale of Viridor, which completed in July, this half year, as expected, has seen significant shareholder value realized. We've got the GBP 3.7 billion of net cash proceeds that we received, and you've seen the results, the GBP 1.7 billion profit on disposal. What have we been doing with those proceeds, well, we have been responsible. As most imagine, we are repaying debt at the Pennon level. And so far, we've repaid some GBP 750 million to date, we've put about GBP 6 million into the Pennon pension scheme. So we'll now focus on U.K. Water, we've got South West Water and Pennon Water Services, our business-to-business retailer. And we've just started our new regulatory delivery period for South West Water, which takes us out to 2025. So what's important about this 5-year, well, we are looking at a new deal about changing the nature of our relationship with customers, communities and people. And one aspect of that has been that our groundbreaking innovative WaterShare+ scheme, which has been giving customers a stake and a stay in the business. So we have returned GBP 20 million to customers. That's as a result of our financial outperformance in the last regulatory period. Customers had the option of either taking a GBP 20 credit on their bill or will be taking a stake in Pennon with their share. Really pleased to say one in 16 household customers have opted to take the share, more than tripling the number of Pennon shareholders and demonstrating significant customer ownership for us as a listed company. So a very changing dynamic there, the relationship we have with customers. It's not just about shares, it's not just about putting money back on the bill, but it's also about getting the basics right. And you'll see in the presentation that we have been driving operational excellence to customers in the first half of this year. Certainly, with our 5-year delivery plan in place, we have been delivering against our commitment of 80% of our ODIs already on target or in reward in some key areas that we're delivering on. So as to customers and communities, in terms of our employees, very much nurturing talent with 500 apprenticeship scheme planned over the next 5 years. And we've been an early adopter of the government's Kickstart scheme where we're bringing in individuals who are on universal credits, 16 to 24-year olds. We get them into the business. We've got offers out already. And those individuals come into our business and then hopefully move on to our pension scheme through that process. With our nearly diverse share register, that means both customers and shareholders can benefit from our sector-leading dividend policy that means benefiting from the announcements today, where we're increasing the dividend by 2% ahead of CPIH inflation, which for this half year is 2.7% overall, at 6.77p per share. So I'll just hand over to Paul now, who will just give the highlights on the financials.

Thank you, Susan, and good morning, everyone. Just to touch briefly on the financials. Clearly, the backdrop to this half year has been difficulty with COVID-19 for all businesses. But pleased to say for Pennon, we've seen a limited net financial impact from COVID. We have seen business customers reducing their demand, but that has been mostly offset by higher demand from our household residential customers through the period and also another facet of COVID is the impact on cash collections. And again, pleased to say through the period, these have held up and remained robust. And just touching on Pennon Water services there in terms of our business-to-business retailer, pleasing to see new revenue coming through as it wins large national contracts with sustainable businesses. So all that results in a continuing group profit to underlying profit before tax of GBP 86.7 million, and that underpins our underlying earnings per share of 17.9p, which, as Susan said, supports the 6.77p interim dividend for this period. Also worth noting, clearly a landmark year for the group, sale of Viridor recording profits after tax at GBP 1.7 billion, which, together with the continuing group profit brings the statutory profit after tax to nearly GBP 1.8 billion in this half year period. So in summary, it's been a strong and resilient performance across the group. We're focused on our sector-leading water and wastewater businesses, and we believe we're in a strong financial position to meet challenges and opportunities as they present. And with that, I'll turn it over back to Adam, who will start the Q&A.

[Operator Instructions] Our first question today comes from Mark Freshney of Crédit Suisse.

Mark 2 questions, if I may. Firstly, on the potential proceeds, which you put at GBP 2.7 billion. On my numbers, that would take you likely up to the high 60s in terms of RAV gearing for South West Water, if you were to return it all or deploy it all depending upon what the leverage was and what you bought. My question is that given what the sector has been through and the criticism on high leverage, in recent years, would you not think it is sensible to certainly remain below 65. And my second question is on the GBP 2.7 billion. I think, Susan, in your previous role, you indicated that there could be a capital return and a potential acquisition of a water company. I sense today that it would be either an acquisition or a complete return. Is there a change in your thinking on the division of proceeds there?

Susan here. I will probably start with the second question first, I hope you are doing well. So in terms of your question around, is our messaging changing slightly on what we're doing in terms of the proceeds after we've been paying down the debt and then putting into the pension scheme. I think the answer is no. The message isn't really changing in terms of what we said we've been doing, we've been working extensively to look at opportunities across the water sector and assets that are executable, obviously, with the water sector the reason who the companies are in that and we're looking to see if we can deliver something that gives attractive financial returns or benefits to customers. I think we've always said it's a compelling value, opportunities of favorable capital will be returned to shareholders, obviously, we haven't defined what that mix of balance may be. And obviously, that will depend on where we get to with that review. So the metric hasn't changed. And certainly, there's no nuancing that should be taken from any of the work that we've put out today. So very much as we were working through the potential for opportunities, obviously, balancing that and benchmarking it against a return of capital to shareholders, but obviously, we will update in due course when we finish that review. Paul, do you want to take the question on the gearing and the RAV?

Yes, of course. I guess probably would start by saying. So in the slide presentation, there was the slide you're referring to with a high, with the GBP 2.7 billion on. And really, that chart sets out the announced use of proceeds that we've got to date. So you'll be aware that we've consistently talked about paying down a certain amount of debt, about paying pension contributions. And also, it just shows how you get from that GBP 4.2 billion enterprise value, if you like, for Viridor down to the GBP 3.7 billion cash proceeds. And then the announced use of proceeds. Now clearly, that is the position as announced, and as Susan says, the reshaping of the group is clearly still underway, and we're in that transitional phase right now. So as we move through that and we work through opportunities and consider shareholder returns, at that point, you would expect clearly a further announcement at some point regarding those use of proceeds, which would then be factored into that GBP 2.7 billion. So I wouldn't read it quite as you've read it, that there's a definitive we're going to do something with GBP 2.7 billion, and therefore, gearing is going to increase significantly from where we are now.

Our next question comes from Jenny Ping of Citi.

3 questions from me, please. So if I look at one of your presentation slides, Slide 24, that looks at the 8% RORE in the first half. And if I specifically focused on the financing, the 2.1% with the effective interest rate of 2.5% versus the GBP 4.2 million of Ofwat, how much of that would -- the differential will you be able to keep for Pennon shareholders, i.e., what is the portion that's ultimately going to be clawed back through the netting process at the end of the regulatory review? And if you can give us an update on whether Ofwat has given any more visibility on how to deal with that, that would be great. And then the second question is just on the M&A point following Mark's questions. I just wondered whether you can give us a sense of how you're approaching it, whether you have got specific targets inside, which you are effectively negotiating or then starting conversations with the management? Or are you sort of doing the sum, so to speak? And then -- or approaching whichever companies that actually are willing to talk and then bring the sum. So which way around is, if you can give us an idea of how you're going about this. And then very last question, just in terms of ODI versus totex, you obviously talked about totex outperformance in the first half and ODI on totex negative position. One of your peers have said it's better to deliver on ODIs at a potential cost on the totex front because on ODI's there is a repeatable benefit over the 5 years rather than one off 1 year impact. How do you see that in the context of the South West Water?

So thanks for those questions. I think in terms of the first question around the financial outperformance -- or financing outperformance, sorry, around the differential between the allowed returns from Ofwat and the effective rate and where we are. I mean, obviously, we're financing, there is a share in rate per se with financing. So unlike totex and with the work that we're doing around the sharing for that, and how that consumer methodology on financing is different. And yes, it was attracting, I mean I got to that, but there is a sharing rate per se. The one thing that we have done, though, and if any of you aware of this from the last regulatory period is that we have a sharing mechanism, which is WaterShare+ where we have, as is done this time around, where we have overall net benefit in terms of financial outperformance for the regulatory period, we will share benefits back with customers. And lot of times, we did put customer fee and financing outperformance into that mechanism to share with customers, which we will do again this time to have a net overall outperformance for the business, which obviously, we're targeting to do. So there isn't a regulatory sharing mechanism for finance. So I'd say that, obviously, from our business plan and from what we've done this time around, we're very keen to share with our customers in terms of that outperformance. And then perhaps I will answer question 3 before I answer question 2 because in a way it's kind of linked around this ODIs, and is it better too that we're delivering on your ODIs rather than delivering on totex. So yes, we are very much planning to deliver on our ODIs. We've made a good start in this first half period where we are delivering 80% of our commitment either on track or on target. There are a couple where we obviously need to focus on and the specific one around pollution, so we are very much focused on delivering those ODIs. And it's not all about investment. It's also about our processes and our systems and how we organize ourselves. So we are very much focused on improving ODIs, but we also think it's really important to be as efficient as we can be, and that's why we always focus on our cost base and make sure that we are driving ourselves to be more innovative. And there are lots of examples within our business where innovation is coming to the fore. It's our treatment logos. It's our network centers that we're putting in as well to really helping driving some of that totex efficiency. So it's really important that we deliver on that totex efficiency because that lowers the bill to customers and also investors get a return from that as well in the long run. So it is about focusing on both, and we are absolutely focused on those, and we're absolutely delivering on both as well. So those are the 2 answers for 2 questions, 1 and 3. And then in terms of the M&A, I mean, obviously, lots of questions around that, I'm sure in terms of what we're doing and how we're approaching it. I mean we are being extremely disciplined in our approach. We are looking at our opportunities, and we have narrowed down in what we're assessing, but we have nothing else to kind of report or announce today from that perspective. But certainly, in going through that review, we are assessing opportunities to make sure that they are only treated, that their value creation is there, and that includes the impact on shareholder returns, income and growth as well as looking at the impact from customers as well as the stakeholders. And we are benchmarking that against the return of capital to shareholders. We know who -- in terms of our history of acquisition, with our acquisition of Bournemouth Water and the fact that obviously went very well for us and worked very well for customers as well. So we are focused on looking at those opportunities. We are narrowing down. We have been working very diligently through that over the last few months, but with nothing else to announce on that today, Jenny.

Sorry, maybe a follow-up just on the first one. It is very much the indexation element, I was interested in. So are you able to elaborate on that? How much of that differential between the 4.2% million and 2.5% will be effectively given back through the indexation process?

We've got the iBoxx trading, which is on the cost of new debt, which we will obviously be doing at trued up at PR24. But in terms of the numbers that we've reported today, I think it's a small impact, but obviously, we can come back on that one.

Yes. And the trading iBoxx obviously increases through the period. So as we're setting at the start that would be a lower impact to this initial period.

Our next question comes from Dominic Nash of Barclays.

Just a couple of questions from me, please. The first one is on ODIs. You've bought up that you're doing well on 80%, but obviously, the pollution incidence is dragging you down a little bit. There's been quite a lot of recent press reports about the environment agent and raw sewage being pumped into rivers. What Star ratings have you got for your EPA at the moment? And are you on track? Do you think to get your 4 Star target, I think, by 2024? The second question is actually on totex. It looks like your run rate in the first half is the same as the AMP6 and the question we've got there is, do you think that you can build up momentum on outperforming totex from here so that we can actually see the totex proportion outperformance increase from here? Or do you think the efficiency targets will hold you in check as we go through this current review?

Okay. Thanks for those questions, Dominic. So first of all, on the ODIs and the efficiency. I mean, yes, absolutely, we started the first half period well, 80% on track or exceeding target. Yes, pollution is a focus area for us. And if you look at our ODIs, which are split between bespoke, common, and those of common comparative. It is in the common, comparative where we've got the 3, internal sewage flooding, leakage, supply interruptions, so bespoke doing really well. And then we've got pollutions, which is creating a GBP 4.9 million negative for this half year. So we're doing a lot more work on pollutions. Obviously, it's from bespoke. In August, we've changed the management team in wastewater, we have restructured what we're doing with supply chain, and we are identifying a number of hotspots in our region that we're focused on and tasking for improvement, and that is underway. And in fact, it's early days, yes, but certainly, month-on-month, since August, we have seen a good reduction in the number of pollution incidents that we are seeing. So I'm pleased with the progress that we're making, but there is much more to do. So to your question around the EPA. So we're a 2 Star company at the moment. And yes, we are targeting to get 4 Star and absolutely our plan and our pollution incident reduction plan will get us to that 4 Star position, which we're targeting to do by the end of this regulatory peak period, and we are putting all sorts of changes and plans in place to achieve that surveillance plan with that. And then totex run rate? But in terms of the run rate, yes, very similar run rate to the one we had in AMP6. I think we've said in the presentation that we had good delivery this first half year and from the work that we're doing internally and the efficiencies that we can see locked in, we can see that run rate continuing through K7.

[Operator Instructions] Our next question comes from James Brand of Deutsche Bank.

I have 3 questions. There's quite a lot going on in the results. The first question is on ODIs, I guess, and the overall level of outperformance, and you just answered Dom's question on totex. So I guess if we're thinking about incentive outperformance, ex financing for the rest of the period. Ultimately, it sounds like it might come down to ODIs and whether you can improve your performance there. So I was wondering whether you could share some expectations on whether you expect that small outperformance to improve as we go through the period? And whether that could end up being material. Certainly, that's been one of the hopes that as opportunities on the ODIs as companies to do that to net in the last period. Second question is on acquisitions. And you mentioned Bournemouth, although obviously I won't ask you to comment on any specific potential targets, but there have been reports in the press that you're looking at big targets. I was wondering whether you could just share how you think your ability to secure synergies from a large target compared to a small one? With Bournemouth, it was very easy, maybe not easy, but you stripped out a lot of their costs, which is perhaps harder to do with a large water company? And then thirdly, just a quick one. You mentioned a limited COVID impact that was in line, I think you said that you expected a GBP 10 million impact at the beginning of the year for the full year. Is it in line? When you say you're in line, are you kind of half that at GBP 10 million, is it GBP 5 million in H1?

Yes, James. So if I start with the first question around ODIs. I mean, if you looked at our half year results, if you exclude the impact of the pollution's ODI, then we're probably around about GBP 4 million reward position for this half year. So can we see rewards, yes, we can, and we are delivering on those, and it's a key focus area for these solutions, but obviously, in regards to Dominic's questions, I'll talk about the work that we're doing there, and is significant in terms of the work that we're doing there. And I said we've changed our processes, we've changed our management team. We are focused on hotspot interventions, and we are on that 7 to 8 weeks. And I'm leaving boards on that 7 days a week to make sure we can turn that performance around. So very much focused on delivering on the ODIs. In terms of acquisitions, yes, we saw synergies from Bournemouth Water. But as you'd imagine, for any water company coming together, whether it's large or small, there will be some synergies to make both operationally and financially as a result of that. We obviously, from Bournemouth Water, there were learnings that we took into Bournemouth Water and vice versa. So you might imagine the same with any combination that you get. And those are the types of analysis that we are undertaking when we're looking at opportunities across the sector. Paul, do you want to pick up the COVID point?

Yes, of course. So in this set of results, we've set out a COVID impact, an overall COVID impact on revenue of GBP 10 million. And an impact on profit before tax of GBP 5 million. And the reason there's a slight difference between the 2 numbers relates to a proportion of the GBP 10 million relating to Pennon Water Services out of South West Water region revenue. So when that reduces also for Pennon Water services, and therefore the group's costs also reduced. So on that element of the COVID reduction in revenue there is little PBT impact because you're only looking at the margin in terms of the not household retail margin. So those are the numbers that effectively have come through the results. They're in line with our expectations as we set out back in June. And the guidance that we've effectively reiterated on a net basis is very similar for this -- for the full year as we see it now. So we're not expecting any more significant impact at this point. Although clearly, do need to carry out that because it does depend to some extent on the developments of the pandemic and continued government support measures. But I think we did see the largest impact was clearly through the April and May period, and things do seem to have stabilized somewhat since then.

Our next question comes from Fraser McLaren of Bank of America.

Just a few questions, please. Just another one to begin with about that press speculation that you may look at acquisition targets that were much larger than South West Water. I'm just wondering in a scenario where you wanted to do more than existing resources would permit, would you be willing to include new equity as part of any deal so that you can still return some cash to your shareholders? And then secondly, just on the time line, will you set an actual deadline to make a decision on user cash either way, and therefore provide clarity. And then just finally, just asking for clarity on the dividend, 6.77p for the first half, perhaps a little lower than just a mechanical 1/3 split of the previously indicated 22p. If I can just check if the 22p is still the plan for the full year, all else being equal?

Fraser, I hope you are well also. I'll just take the first question around acquisition and looking at larger opportunities. I mean, I think I said earlier, Fraser, we are working extensively now around the potential opportunities, we've not really ruled anything in terms of the speculation around that. So we are working diligently on it. And in terms of your question around new efficacy, et cetera around returns. Again, we've just been very disciplined in our approach to assessing those opportunities. We are looking at whether they're earnings accretive, we will look at value creation, and we'll look at what's in the best interest of both shareholders and customers, in doing that. And we will benchmark everything against the return of capital to shareholders. So I'm afraid Fraser, that's pretty much it. In terms of the time line or timetable around it, as I said, we have been working extensively. We continue to do the same to the end of that review, we will be obviously updating everybody with the outcome of that, and we have been narrowing down what we have been looking at, but we are not in a position to make an investment on that step.

Okay. And in terms of the dividend question that you asked just then, just to clarity on how that's been calculated. So you'll remember back in June, we announced a new dividend policy that talked about moving from a base of 21.11p. That is very much still the case in arriving at the 6.77p, the calculation done was to take the interim and final of last year as a proportion of the 21.11p. So that might not be a straightforward simple term, but that's how the calculation was done to keep it moving in line with historic trends.

Our next question comes from Verity Mitchell of HSBC.

I've just got a couple of quick technical questions, I suppose. And the first one is about Isles of Scilly, how one should think about that relative to the FD, given that you spent about GBP 36 million. I mean how does that work relative to South West Water? And then just on your technical guidance on the tax, you've got GBP 15.6 million. Is that how we should think about it for the rest of the AMP or are we looking at a continuing increasing profile? And then I was just curious about your common ODIs. You talked about pollution incidence. And one of them is the per capita consumption reduction and how you are going about doing that, which is obviously something that is of interest to Ofwat in terms of water conservation?

Well, Verity, I hope you are well. Thanks for your questions. So starting first with the Isles of Scilly. So yes, we took on the Isles of Scilly from April this year. And despite COVID, we obviously have been able to set up our operational teams and our supply chain in place and start delivering on the investments that are needed on those islands. The GBP 36 million that's noted in the slides is the investment that has been allowed, is a determination for the 5-year period. So that's what that represents. It's for the whole 5-year period, not what we've said this first half year. And obviously, that's been put into the determination and been part and parcel of that. So Paul, do you want to pick up the tax ones?