Pennon Group Plc (PNN) Earnings Call Transcript & Summary

Hello, and welcome to the Pennon Group plc Full Year Results 2021 Q&A session, sorry. My name is Emily, and I will be coordinating this call today, where we are joined by Paul Boote and Susan Davy from Pennon Group. [Operator Instructions] I now have the pleasure of handing you over to your host, Susan Davy, to begin. Susan, please go ahead.

Thanks, Emily, and good morning, everybody. And thank you very much for your time this morning. I thought it might be useful perhaps if I just summarize the results that we've issued this morning. I'm delighted to be updating on what a transformative year it has been for Pennon, and we have, to reshape the group. Perhaps, first of all, if I start with the sale of Viridor last year, which generated a net cash proceeds of GBP 3.7 billion. We focused on three aspects for the use of proceeds. First aspect, we've been positioning the group sustainably. So we've been de-gearing the balance sheet by GBP 1.2 billion as a responsible employer would. We've also been making additional contributions into the pension fee of GBP 0.1 billion. That's the first set of what we've been doing. The second one is reinvesting in U.K. water. So today, we're announcing the acquisition of Bristol Water for GBP 0.4 billion, a logical, accretive acquisition of a great South West-based water company. And we're also investing a further GBP 0.1 billion to support South West, to build that better with some of the investments that we've got planned in the South West Water region. That's the second pillar. And then the third pillar is recognizing our loyal shareholders, 2/3 of which are U.K.-based pension funds, charities, employees and more likely customers. And we plan to return GBP 1.5 billion of special dividends with a further GBP 0.4 billion to fund the share buyback program, which will be subject to further growth opportunities, which we may consider in the period out to September next year. So that's the first aspect of the presentation of this morning. The second is around the results of the continuing group for 2021. So we've had a robust start on what ascribes to the 2025 regulatory delivery period, both operationally and financially. 80% of our business plan commitments are on track or ahead of target. And we're delivering a return on regulated equity performance of 7.8%. On the Pennon Water Services side, we're growing in the business customer market. And we've had GBP 20 million of annualized contract wins during this last year. So that performance underpins our sector-leading dividend policy of CPIH plus 2% as well as resetting that going forward. Given all the changes I've just described today, we'll be rebasing that dividend by 2p or 9% going forward. So with that, I'll hand back over to Emily for Q&A.

[Operator Instructions] Our first question comes from Martin Young from Investec.

I mean a couple of questions from me. Firstly, in relation to Bristol Water, on the call earlier, there is an allusion to totex synergies and benefits for the wider stakeholder group in the greater South West. I wonder if you could elaborate on both of those points and perhaps put some financial quantum on the totex synergies. And then the second question is really just a general question for the water industry. Obviously, the little map that you have put up of the greater South West area shows your ownership of South West Water, your ownership of Bournemouth Water and your new ownership as of today of Bristol Water. There's a bit in the middle, Wessex Water. Should we be thinking longer term and bank the best structure for the water industry in England and Wales being one of integrated greater regional companies? This is not asking you, would you buy Wessex Water at some stage? Just thinking about the longer-term challenges for water in this country and whether or not those challenges would be better met by greater regional companies that span both water on the clean side and water on the waste side?

Okay. And thank you very much for those questions. Perhaps, if I start with your first question, which was around the benefits that we see from Bristol Water coming into the Pennon Group and how do they map out for the coming months and years. Well, quite honestly, we think it's a great opportunity to have acquired Bristol Water. When we had the experience of acquiring Bournemouth Water back in 2015, we put our proposals through to Ofwat and the CMA to demonstrate how customers from both companies could benefit from such an acquisition and merger. And that was going to deliver benefits to services and benefits to the cost base as well from operating in a way that could deliver that. And that is something that again we'll be putting those proposals to both Ofwat and the CMA to set out exactly how we think that will work going forward. And we very much believe that, that is a good place to be in. We also think it's really exciting that we're adding another company into the listed market, which again we think is a great thing to do, and there will be benefits for our customers and employees from that happening. So that's probably the answer to the first question. So to answer the second question, Martin, do we think you need to have a contiguous geography to make these things work? So it doesn't necessarily need to be contiguous. So as you point out, whilst Bristol is within the greater South West, there is another company that is in the South West as well. And obviously, we have diligently gone through what we think is a great opportunity for us. But you don't necessarily need to have contiguous advantages to make these things work. But obviously, it's an interesting comment that you put forward there, Martin.

Our next question comes from James Brand from Deutsche Bank.

Congratulations on the deal. So I have kind of two questions, one of which is a bit of a multi-parter. So the first question is on dates, and apologies if you've set it out somewhere and I kind of missed them. But the date of the capital return, is there a kind of fixed date for that or an indication? And then on the buyback, does that commence straight away over a 12-month period? Or does it commence at a later date for 12 months period? And then kind of the third part of the question on dates is do you have an expectation for how long the Ofwat's stroke, CMA -- I guess, it's more of a CMA review, how long that will take? That's the first one on dates. And then secondly, Bristol was obviously one of the companies that went through the CMA. And putting aside the fact that there should be scope for significant totex synergies as part of the integration, I think one of the reasons Bristol went to CMA is because it disagreed with Ofwat on costs. And although some of the companies got uplifts to their kind of totex allowances, they weren't huge. So I was wondering whether you could reflect on maybe some thoughts on how Bristol as a stand-alone entity felt that it came out of -- or how you feel it came out of that CMA process and whether the totex allowances, on a stand-alone basis, looks more reasonable after that appeal?

Okay. Thanks, James. So Paul, do you want to tackle the dates question?

Yes. In terms of dates for the special dividend, I think you were referring to that, we've got a few dates set out there first. So the first thing to note is that we're proposing that special dividend with a consolidation exercise. The consolidation exercise will be put to the general meeting, which will be held on the 28th of June. And then subject to shareholder approval, the dividend will be paid in July, on the 16th of July. So I think that probably answers your question on that one. And then in terms of the buyback, to have an orderly buyback, we'll obviously wait for the consolidation process to conclude, assuming we do get shareholder approval for that. And if once that share consolidation has concluded in July, we will then be able to commence the buyback program. And we expect the buyback program of GBP 400 million to conclude by the 30th of September 2022. So I think that probably hopefully answers your questions on dates for the dividends. In terms of the Ofwat/CMA process, I mean, obviously, these things will take as long as they take to an extent. We do have experience in the past, as you will know, of this type of activity. So we're obviously looking at weeks and months. And maybe around 6 months is sort of a fair point to be looking at, but it obviously could be plus or minus on that.

Okay. Thanks, Paul. And then I think in terms of the question that you had, James, around the totex for Bristol Water. I mean, obviously, Bristol Water, it went through the process with the CMA and that landed where it landed. And I think they pretty much came back to nearly where the original business plan was. So I'm not particularly going to comment on that process or where that landed. I think the key thing is that we're going to focus on what we do going forward to make sure that Bristol Water can obviously deliver on its plan. And if we look at the RORE potential for Bristol Water, you can see there that they have a potential to get up, to an extent, a return on regulated equity that's within the plan that got determined. So there are opportunities for customers and for the business to deliver on its plan. And that's something that we will be supporting them to do.

Our next question comes from Mark Freshney from Crédit Suisse.

I actually have four questions, but I will refrain and ask two. In terms of the filings that you make to the CMA, I think clearly there's the opportunity for you to offer what might be called remedies to help offset any concerns elsewhere from Ofwat. Can you -- I think you spoke around some of the issues to the arguments. But will you be offering remedies as part of the process for getting merger clearance? And secondly, further to that, in terms of synergies, I know you've highlighted in the presentation what synergies could be. But clearly, there are benefits through taking out costs, sharing best practice and purchasing power, et cetera. So can you talk about those two aspects, please?

Yes, absolutely. So again, another two great questions. So in terms of the process that we'll go through with Ofwat and the CMA, I think from my perspective, we all want the same things from this. We all want the same outcome. And we want services to go to customers. The efficiency benefit we've revised that again can end up in lower bills for customers going forward. Now when you technically go through the process with Ofwat and the CMA, the question that's being asked is, is there a detriment that they need remedying through that process? Now first of all, you have to determine whether it's a detriment or not. Now putting all that to one side, we think the right thing to do is to do what we have done when we acquired Bournemouth Water and what we've demonstrated with South West Water is that we can deliver outstanding service to our customers and deliver on efficiency that ends up [ with the villages ] going forward for customers. And that's something that we will be focusing on. So we will be putting forward our proposal to Ofwat and the CMA that outlines why we think this will be a great deal for customers and for the Bristol business. So that will outline that. And whether you want to call it remedies or not, as I said, technically, that would presuppose there was a detriment to remedy. But aside from that, we think that's the right thing to do. We will be obviously looking at what we can share with customers. We will obviously be looking at how we make sure the balance sheet of Bristol Water is in a good place going forward, where we focus in terms of, for example, our gearing levels. And we'll make sure that it's a great package for all. So that's probably the first thing to say on that. And then the second question, which was around synergies. I think your point hit it right on the head there, I think, Mark, in terms of what synergies will there be. Well, operationally, for example, we know that in South West Water, you'll see in our presentation that came out today, our performance around supply interruptions has been very good this year. We've delivered on one of those metrics for supply interruptions, our 2025 target, this year. So that has been excellent. And we know it's an area that Bristol hasn't yet met its business plan target for. So again, there'll be learnings that will be great to share. And then the other way, Bristol Water is better than average in terms of its CMF performance. And South West Water is not quite average in terms of its CMF performance. And again, I think there will be things that South West Water can learn from Bristol Water. And it really will be the best in the best. So we're very excited about the opportunities and very excited about what this can do, not just for customers but also the sector more broadly. Getting another company back into the listed market is a great place to see.

[Operator Instructions] Our next question comes from Chris Laybutt from Morgan Stanley.

The first question is just on the GBP 400 million buyback and, I guess, whether that continues as currently planned, if you do secure any other opportunities on the M&A front in there becoming 18 months. And then secondly, just on Bristol's performance in fiscal '21, you've given some pro forma unaudited information. Can you give us an idea of their RORE?

Okay. So I think, Paul, do you want to take the buyback question?

Yes. In terms of the buybacks, we've set out the number there of GBP 400 million and we've talked about that being a buyback program up to 30th of September 2022. And you're right, if we do see attractive growth opportunities in that period up to that point, we may look at using that financial flexibility to put funds to use if we do see an attractive opportunity. So that is very much a possibility. As you'll know from Pennon's history, we've obviously been acquisitive in the past with Bournemouth Water, which obviously had an equity placing alongside it at that time and then clearly today, in terms of Bristol Water. So Pennon is an acquisitive company by nature. And we are always interested in attractive opportunities that may or may not be available. And this just provides a bit more flexibility for a period of time whilst providing clarity to shareholders over that time period and what happens in the event that nothing does come to fruition.

Okay. Thanks, Paul. And I think your second question was on the pro forma results that we have in there, where Bristol Water was on its return on regulated equity. I think in terms of those pro forma results, I think that there's a slight negative in terms of bid for ODI position. But I think, obviously, there's some good aspects to the performance on Bristol Water. And as I said at the beginning, there are lots of opportunities that Bristol Water has set out in their plan to really perform for customers. And they will be absolutely targeting that. And having spoken to the team today, we're here at Bristol offices this morning, they're a great team and they're really focused on doing well for customers and employees.

Yes, I think the performance improvement is one of the things that we're excited about. Do you mind if I ask a follow-up to Paul now? So just in terms of potential targets, are you continuing to look at the same sort of remix, which is U.K. water? And I guess if you can give us some -- just some commentary around that. And will the strategy continue to be consistent with that of the past?

Yes. Well, I think it's fair to say that kind of the strategy, as you know, has focused on the U.K. water industry and that will remain so. In terms of this GBP 400 million buyback and potential other uses, we have referred to growth opportunities. Now that may be organic, it might not just be M&A as we've shown today. The package that we've put out here today includes a Green Recovery and it includes the acquisition of Bristol Water. So there are other ways, not just the acquisition. But you can be assured that we will use our usual highly disciplined approach to evaluating all of those opportunities and benchmarking it against the continuing of the share buyback in terms of returns to shareholders.

Our next question comes from Dominic Nash from Barclays.

Two questions for me, please. Firstly, looking at AMP8, so obviously, Ofwat is kicking off the process on that. And if you read documentation around this, there appears to be a potential for quite a big step-up in this sort of promised totex and CapEx numbers in sort of the medium term. And I think one of the big projects that would have been sort of bandied around for quite a while is water link between the Bristol region and the South West and the potential for these sort of like new reservoirs or other forms of getting water through. What are your thoughts on the medium-, long-term growth prospects of AMP8 and beyond, but also in particular on the integration of Bristol and the synergies that you'll get from increased totex? And the second question is on your Ofwat RORE. Obviously, ODI is minus 0.7%. But you've also got a tax of minus 0.6% this year. Your ambition is to get ODIs, I think, positive 0.5%, I think, remind me on that one. Do you think ODIs will go into positive territory this year? And secondly, is that tax -- negative tax, is that a one-off? Or is that something that's going to continue throughout this AMP8?

Yes. Thanks for that, Dominic. So perhaps if I take the first question around AMP8 and what do we see going forward in terms of a potential for investment and kind of outlook in respect to water resources. So certainly, whenever we have been looking at the longer-term plans in the region, we have seen that there's probably as much investment into the next 25 years as we've had in the past 25 years. Whether that's around the South West Water, whether that's around some of the work we are doing around the environment, whether that's something that we need to do around resources, then we definitely can see that there is investment to come. Now we're all part of the regional resource group in the South West, so Bristol is part of that as is South West and Bournemouth Water. And we obviously know that there are potential schemes and projects that could help with the resource situation south and east in the country. And that is something we're very interested in looking at. And I think that's something that has been great. And regulators have really encouraged us all to work together as a U.K. sector to really focus on it. And I think that's something that we will be looking at going forward. And it makes a lot of sense to do that. And that's something that we're going to be really focused on. So yes, great to raise it as a question and something that's in most of our minds to come forward. But in terms of the return on regulated equity and the ODI performance for Southwest that you can see in the results today, yes, there is a negative in terms of the impact for this last year that we have principally as a result of our performance not being where it needs to be around pollution. We are addressing that. And you will see in the presentation today that our performance around pollution, since we kicked in a new plan and delivery last September, has been halving the number of pollution incidents compared to the previous year month-on-month. And we're in a much better place than we were for that delivery. And we do say in the presentation that we are targeting to get back to a net positive in ODI for this year, '21/'22. And then I think the other question was around tax on the return on regulated equity. And I think that is around how it's accounted for in the RORE calculation for this time. With Ofwat obviously [ note there is some shield ] around tax. And therefore, that will obviously impact on a yearly basis. And that's something we will update on as we continue the increase. Overall, our return on regulated equity performance is in a great place on where it needs to be.

Next, we have a follow-up question from Mark Freshney from Crédit Suisse.

So on the B2B water suppliers, Pennon Water Services and the one that Bristol brings, would you consider merging the two together or running them as separate suppliers? And are there any considerations there such as with regards to minority in your own business?

Okay. Yes, thanks for that question, Mark. Paul?

Yes. In terms of -- well, just for everyone on the phone, just to make sure we understand those shareholdings there. So in terms of Pennon Water Services, we own 80% of that. And in terms of water2business that comes through the Bristol Water acquisition, that's a 30% holding in that particular entity. So those are separate entities obviously at the moment. In terms of Pennon Group, clearly it expands Pennon's share, looking at it as a pro rata. I mean, I think until we speak with Ofwat/CMA on how we progress this transaction, I think these are items that will be considered at that point. And then we'll have a look at the best way forward. But in terms of being able to share best practice and to get the best in the best, it will be a similar approach that we'd like to apply. But we'll have to wait and go through that due process.

In terms of the valuation of that business, B2B water supplier, I mean, there was the premium to RCV, there's the considerations that we can work out, I think it's around GBP 25 million that you're ascribing to businesses that are not the wholesale Bristol business. Is that the value you're ascribing to that water supplier? Or is there any other nonregulated businesses that attract a valuation now?

Yes. I mean, so you'll have picked up from the announcement, when we're focusing on the RCV premium, we're very much focusing on the regulated business, Bristol Water plc. In terms of other operations, clearly this water2business is the main aspect there. But there are other elements that we would have also considered in that formation. I think the GBP 25 million that you're quoting feels a little bit high to me. But I'm sure you must have deduced that in some way.

Our next question comes from Martin Young, a follow-up question, from Investec.

It's a similar sort of question to Mark. But looking at the wholesale business, obviously South West Water and Bournemouth Water are treated as one now for regulatory purposes. Do you envisage that Bristol Water will be amalgamated with those other two for the purposes of AMP8 and onwards and get a single settlement across the three businesses?

Okay. Thanks for that, Martin. I think we said at the beginning of the call, we've got a process to work through with Ofwat and the CMA around exactly how this is going to work going forward. When we acquired Bournemouth Water, we reported separately on the performance for Bournemouth Water for that regulatory period of K6. And that obviously is helpful for the regime and was helpful for them to understand then how Bournemouth Water was performing. So we will want to understand how Bristol Water is performing. How that then works going forward into future regulatory period is something we'll look at. But I'm going to reiterate again the purpose of this acquisition, the purpose of what we're doing with our strategy, we believe that there are benefits that can be unlocked from doing this. And both ourselves and the regulator want the same thing, we all want customers to benefit and we want benefits to flow back to customers. And that's something that we will really be focused on.