Pennon Group Plc (PNN) Earnings Call Transcript & Summary

[Operator Instructions] The first question comes from Sarah Lester at Morgan Stanley.

I'm sorry, I'm going to jump straight into the environmental aspect. Could you please just walk us through the steps needed to get from the current 1 star to the 4 stars by 2024? It's obviously quite a steep trajectory. So any color would be great on how and why you're confident that that's achievable?

Thank you for the question. So I said, we're obviously investing significantly and we are investing for our environmental performance. Now some of that investment, I talked about in some of our releases aren't covered by things in the environmental performance assessment. But what is covered in the environmental performance assessment are pollution incidents. And for the last 10 years, we have been 1-star, 2-star company, and predominantly, that's been as a result of our pollution numbers being higher than on a normalized basis were targeted to achieve. So we've been working at pace over the last 2 years to reduce the number of pollution incidents that we've been incurring, and those pollution incidents, if we don't achieve target, then we obviously end up with either 1- or 2-star rating as a result of that. Now if you look beneath the star rating headline, the actual numbers of pollution incidents have been reducing, and have been reducing in 2021 from 2020, and they're due to reduce again in 2022. So we're driving kind of a sustainable reduction in those numbers. Now in terms of the trajectory to get us back to target and to 4-star company, I said previously that we are on a trajectory to get there for the 2024 year, and that's what we're aiming for. We probably won't see a change in our star rating this year. Obviously, the pollution numbers are getting better, but they're still not back to the original trajectory, but they are getting there. So our star rating for 2022, I would imagine would stay where it is. But we are very much focused on getting back to that 4-star position where we need to get to for the 2024 year.

Our next question is from Dominic Nash of Barclays.

Yes. A couple of questions from me too, if I may. Firstly, on the revenue number reduction with lower consumption and sort of change in customer behavior, and also with your increased sort of costs, the GBP 225 million of sort of total improvement sort of like coming through or outperformance coming through. Can you just give us some color on what of that is recoverable? Like is the revenue reduction going to be recovered in future years? And how much of your extra spend on desal and all the rest of it will be recoverable as the totex mechanism? And the second question is the very quick one is -- I was sort of figure this -- what happened about the Interserve Viridor legal action? Have you got any color on that? And do you still have that on your books for how much cash you could still get in it if that goes your way?

Dom, thanks for those two questions. So I think, Paul, you're going to pick those up?

Yes, happy to. So well, I'll start with your last one, first. I think that's pretty straightforward. So the Interserve legacy point from Viridor was all resolved. I'm sure over a year ago now, and it resulted in a cash inflow of GBP 9 million that we will have reported at the time. So there is no further amounts to come or to be recognized in any way. That's totally closed. And then in terms of your second -- I'm sorry, your first question. So the first point was around revenue. Now clearly, we flagged in our announcement earlier this month, as well as again in the announcement today, we are incentivizing customers in Cornwall for all the right reasons to very much use less water and save water to boost the water resilience in that region. And with that incentivization, we will give them GBP 20, if we get a reservoir levels to 30% in that region by the end of the year. Now that actually itself could cost up to GBP 10 million. That would be the cost of the incentivization. Then in addition to that, customers are using that if demand does fall as we're trying to get behavior to change. I'm trying to get a strengthening the water resilient position, particularly targeted at Cornwall. Now within that GBP 75 million, that's GBP 10 million financial revenue incentive, as I've already mentioned, and that leaves GBP 65 million has a totex focus, not added together with the GBP 45 million is a totex reinvestment effectively from that GBP 225 million of that performance. Worth noting that when we're talking about reinvestment, really that's a shared element, 50-50 broadly, between customers and shareholders. So that's really half of that impact is what will come through.

Our next question is from Mark Freshney at Credit Suisse.

Paul, on the debt refinancing that you've done post period end, could you talk us through that in a bit more detail? And where I'm getting to, I mean, real rate -- fixed rates are higher or have been higher and inflation has also been higher. So presumably, it would be swapping index-linked debt into fixed would be expensive at current levels. So can you talk us through the rationale and how that generates value there.

Yes, of course. And really, there's 2 aspects of what we've been doing in terms of debt. So one is the swaps that you've just talked about there. Now as you're sort of indicating, and whenever you enter into a swap use, it's our market and, therefore, there's no value at the point in time you enter it because it is literally an on-market swap. So we will be taking whatever the fixed rate is relative to the inflation index that we've swapped out. So really, it's not about value per se. That's about managing volatility. So that will smooth out volatility in the P&L in terms of this 3-year period and reduce our exposure to further increases in inflation from where we are now. And it's really about inflation expectations as opposed to inflation delivery because those expectations are baked into the market price. So to your point, from a value perspective, it being a swap, there is no value per se from the transaction, but it does provide a lower level of overall exposure to indexing debt from this point. So that's the first point to note. And then the second point is we have repaid the Bristol Water bonds that was index-lined to GBP 40 million Bristol Water bond. We were able to do that in a time when rates, and particularly, bond yields were very elevated, which very much reduced the termination cost of that bond. And that's led to a GBP 20 million gain, which will be coming through in the second half of the year. So that bond is very much giving value from that position.

Our next question comes from Martin Young at Investec.

And maybe we could just spend a little more time on the guidance for the full year, particularly the sort of the interaction of the Slide 14 with what you set out in the technical guidance. Obviously, you've talked quite extensively before about the power costs. You've now put a number on the net financial expense expectations for the full year, but there's obviously been a significant change of direction on revenue, as Dominic has already alluded to. So if we sort of run through those, in my back-of-the-envelope calculations suggest that in the second half of the year alone, you'd have to see a revenue drop of about GBP 40 million to get the full year number below FY '22. And is that something that is going to feed through in a negative way to where consensus expectations for operating profit currently sit? And of those significant items that you mentioned on Slide 14, are they all within your definition of underlying? Or are some of them excluded, particularly with reference to the Bristol Water bond, GBP 20 million? Is that an underlying or outsided?

Okay. Thank you for the question, Martin. So just taking the last point first. So those significant items, obviously, we're going to work through that process, and there's process to go through in terms of internal governance and, of course, with auditors. But clearly, they are, in their nature of one-off terms. And in the past, for example, WaterShare where we've had big financial terminations, they have been seems not underlying. So you can take from that what you will, but there's a process to go through before we establish finally where we are on that. In terms of the broader guidance, I think we have -- perhaps if I take financing, yes, we have given a more specific range. I think, clearly, we feel able to do that. I think unlocking those derivatives in is an element of that because it reduces the volatility. As you will have seen, all companies that have indexing exposure, have seen their interest charge moved around quite a lot this year. And so putting those swaps in place to reduce that volatility, and therefore, increase certainty. And that's why we've put a figure around that number, and we're expecting our H2 financing cost to be under what our H1 was, H1 being GBP 75 million and our full year guidance being GBP 130 million to GBP 140 million of the financing costs coming down in the second half of the year. In terms of revenue, I mean, I think I'd probably repeat what I've said to Dominic really. In terms of guidance, what we're doing is updating for the revenue incentive mechanism that we announced in November, and that really is around encouraging people to use less water network and that will in itself reduce revenue, and that could be between, as I said, GBP 10 million and GBP 20 million lower in terms of our revenue expectations.

And the 20 -- the GBP 20 million financial income on the Bristol Water bond termination, is that going through your financial expense line? Or is that going to be popped out as something that's a one-off?

Well, yes, when we've had those in the past, it would have been one-off. So as I said, we haven't finalized those points, because they are obviously subject to review and audit, but that will be for the second half. That's where we've had similar one-offs in the past. That's been the case.

Our next question comes from James Brand at Deutsche Bank.

Two questions from me. Firstly, on the GBP 75 million of additional investment that you're highlighting today, of which GBP 45 million was announced, you said GBP 45 million was announced today and GBP 30 million have been announced earlier in the month. And I wasn't 100% sure what the GBP 30 million that was announced earlier in the month referred to, whether it was -- obviously, you had the announcement out on filling the reservoir, maybe it relates to that, but I didn't kind of feel that, that was GBP 30 million of additional investments. So maybe you could just clarify what that GBP 30 million that had already been announced refers to? And then secondly, Paul, in your comments in the recorded presentation. When talking about power costs, those are comments that regulatory true-up mechanism should partly mitigate the impact of higher power costs. And I also just was looking for clarification on that because I didn't realize there was a true-up mechanism for power cost that maybe you referred to or something else.

Okay. Thanks for the questions, James. So in terms of the GBP 75 million, as Paul mentioned earlier, in that GBP 75 million, GBP 10 million, which is the revenue incentive scheme, which obviously, we announced earlier this month. And obviously, that will be a credit that we're giving to customers' bills. So that's the GBP 10 million representing that Stop the Drop campaign. That GBP 65 million, of which the vast majority of that is investments into the asset base, whether that's the China trade hits that we've invested. The new schemes that are giving us extra resources across the Cornwall region, and so there are schemes that we are just completing indeed in the next few days, which are increasing the take from some of those China clay pits, either the new ones or existing ones, and we're recommissioning achievement works as part of that as well. And then into next year, we are, again, investing into ex-mines, quarries some small-scale desalination given we've got experience that we've had on the out of filling. So that's what that investment represents. But as I said, in terms of the funding of that, given the GBP 225 million of outperformance that we have delivered, then obviously, a portion of that is going in towards this reinvestment. I'll hand over to Paul for the next question.

Yes. In terms of our mechanisms, so that was referring to the general totex true-up, not any specific mechanism, James.

Our next question is from Sarah Mitchell at HSBC.

I've just got a couple of questions. One is the GBP 20 million on storm overflow investment, was that in the FD and that's not additional spend? Secondly -- and well done on refinancing during the volatility. Only a few companies have actually successfully done that. And that's real shareholder value. So good to see that. And my question on the GBP 75 million using desal, isn't that quite a carbon-intensive technology to use for water resources? Those are my 3.

Okay. And [Indiscernible]. And yes, just to start with the first one, in terms of the storm overflow investment, in particular, GBP 20 million that we referenced. That's part of this GBP 45 million WaterFit that we announced back in April. Again, that's part of this reinvestment of that outperformance. So that is new investments. So add note 1 in the regulatory plan per se. So that is new investment going in there to -- so to make sure we can deliver on that. Second question -- go on.

I think you were congratulating us on that point ...

I was just congratulating you, yes.

Thank you very much, Verity. And then I think your final one was around desalination.

The desalination. So the desalination there is the -- so I think one of the things going through at this year, which has been a record year in terms of climate impact for us is that we need to have a diversified mix of sources. So in our region, 90% to 90.5% of them are sources, rely on surface water, reservoirs and, in particular, takes from the river. So our reservoirs in our region, certainly for Cornwall, are largest strategic reservoir [indiscernible] used to -- and obviously...

Using quite low power technology, desal technology?

We -- you're not wrong in the sense that it is power hungry, but what we're looking at is how the renewable aspects of that will work alongside. If you think about the scale of what we're talking about, we're probably talking about single digit, negative in terms of what these small kind of plug-and-play containerized reversals, most of these plants are going to give us. But they're going to be useful for us in the region. That have pinch points. So one of the areas where we have in North Cornwall and impact to customers this summer, whilst we're delivering all the water that they needed, that we did obviously have the situation where we called upon communities to stop using their hose pipes. That community is 3,500 customers that were impacted. Having desalination plants of a small scale to help through those pinch point periods will be useful. And we are looking at how renewable aspect of that will work for those modules that we're putting in.

Our next question comes from Martin Young at Investec.

Just a quick follow-up question on the guidance, specifically your thoughts on where consensus is at this particular moment in time for operating profit in FY '23, I believe it to be around about GBP 178 million. Given everything that you've said this morning, are you now suggesting that, that number is perhaps somewhat too high?

Yes. I mean, I think, obviously, it's been quite a year in terms of there's not many moving parts. It's been quite dynamic. And obviously, we provided guidance for the full year, we've provided guidance again in our trading statement in September. We then obviously, have issued the announcement at the start of November. And I think really the consensus perhaps needs to catch up with that announcement at the start of November. And then, yes, reflect those, particularly that revenue point, I think, is the key thing to reflect that expectation of revenue will and should be lower because we are asking people to use less water. And that probably hasn't fed through to consensus yet. And obviously, we'll be picking that up kind of where we are after the close of the period.

Our next question comes from Dominic Nash at Barclays.

A couple of questions. On Cornwall, your reservoir levels are very low indeed at the moment. So the first question is this, are you worried at all that we might actually run out of water in Cornwall? And then the second sort of leading question here is that your business plans that you're going to be submitting next year, I'm sure you're already sort of setting what may or may not be in them. How much extra investment do you think we're going to need for both water resilience? So link it to that first point. But secondly, with your CSO issues, do you think that you might be needing to put through into your CapEx going forward?

Okay. Thanks, Dominic. So in terms of Cornwall, we obviously have been doing a great deal of work this summer given the climate impact that we've seen for a region that's dominated by surface water, reservoirs and river takes. So what we need to do is make sure we've got a diversified mix of sources that we're able to draw on, hence, the investment in further ex-quarries, ex-mines and some of the small-scale desal, which is what we will be on with. Now in terms of the work we've been doing, winning alongside that, we've been working at pace with the regulators and the government to make sure that we're in a good place given the river takes that we rely on that are abstractions, and our permits and our licenses are in a good position for when both rivers are plentiful, that we can pay from those rivers to recharge the reservoirs to take us through into next year. And I have to say, the regulators have been -- the government have been incredibly supportive to work at pace to get those in a good position. So it's the abstractions, we're working at pace to make sure the reservoir is getting recharged going into next year. We've got interventions that have just come on stream now, 2 of them, one, we've increased the takes that we can get from one of our ex-China clay pit [Indiscernible]. We've done the same in Japan, which another China clay pit. We've got Hawkstor, which we obviously bought in March this year, which is giving us about 10% of the needs of Cornwall going forward. And that's in days coming on stream. And then we've got [Indiscernible], which we've recommissioned and it's going to be up and running before Christmas, which again gives us another 10% for kind of the Cornwall needs. So that, plus the Stop the Drop campaign, which again is going well, and we are seeing customers reducing their demand, which has been pleasing to see given the investment we put into that scheme, but obviously helpful in terms of the reservoir levels, that, plus these schemes will get us into a better place going into the beginning of new year. And then the new schemes that we're looking at with the mining water, the clay pit and the small-scale desal will come online for next year's summer period. So we are moving at pace. And given we bought Hawkstor in March, and that's up and running as of this week, then you can see how quickly that we can respond and work at pace to get these resources up and running. So our trajectory for reservoir recharging and the ability for these other schemes to support next year, we're confident that, that will be seeing us through into the future. Now with those schemes that come on and that investment that we're going to make, so the GBP 65 million, which is the GBP 75 million less the GBP 10 million we've got on the customer incentive scheme, that should give us about half again of the Cornwall's needs going into next summer. So that's the resilience that we're building at pace for next year. So that probably answers the question twofold in the sense that, yes, we can see our trajectory to get back to where we need to get to, and not having to rely so much on the climate. That will get us there. But also in terms of resilience for the future, we are building that resilience into Cornwall now. So in terms of future schemes, there will be more investment, which [Indiscernible] in a moment for the wider region, but in terms of Cornwall getting ourselves into a good place now. And that's the benefit of outperforming, having that agility and being able to move people for -- to invest where you need to invest quickly on schemes that weren't in the business plan, that gives you the ability to do that. And I have to say, that government with us have been incredibly supportive and have been working at pace to help us to do that.

Can I just follow up with that, sorry? Have you been explaining all of that? I've been getting this kind of horrible feeling that what you are doing using your outperformance elsewhere really probably should have been in AMP7 business plans. And I know that Ofwat was focusing on bills rather than on investment in the current review. But I'm looking at it kind of going, this should have been 100% recoverable by you, not 50% recoverable. And I'm looking at the numbers that you're looking at. This is our bookables, isn't it? Or am I missing? Could you not actually go back and say, "Guys, this should have been in, and you didn't, and we would have been in the next AMP, and we're just bringing it forward. So it gives us a 100% recovery for it." And by the way, is over 10% of our revenue?

So I think, Dom, we're focused on making sure we're delivering for all our stakeholders. We're delivering the double base returns. We said we were going to do that. We have our performance over and above that. And we are reinvesting it into the asset base to deliver. In terms of what we experienced in this region this year, and if you look at any of the reports on it, this has been a record year in terms of climate impact. So could it have been foreseen, well, it's happened, so we need to invest. We've got the hedge room to do it, so we're getting on with it. So I think that kind of deals with that aspect. In terms of what comes next and future investment, you're right. There will be a requirement. And having experienced this, there will be requirements for us to invest further. And I said previously about our acquisition of Bristol Water, the ability to then think about the Cheddar Two reservoir up in Bristol, and that opens up opportunities for us to develop a resource there that helps the Wessex Water with its resourcing requirements that then perhaps frees up half the reservoir we share with them in Wimbleball that again allows reservoir volumes to be used at South and West as required. And there will be obviously costs for that going forward that will be part of the future plan. So I think, to be quite honest, Dom, we're in a good place, we're outperforming, we're investing in shareholders, again, what we said it would get, doubling the base returns. And we'll obviously look to the new plans as further as it is going forward.

Our next question is from Bartek Kubicki from Societe Generale.

Just one question from my side. I just wonder what's your intention to do with the inflationary increase in tariffs for next year, whether we are going to the -- whether you are going to undertake the full inflationary increase, which could be around 10% or whether you are planning to do some deferrals. And if so, how would it work?

So in terms of tariffs, obviously, we're very much aware of the cost of living crisis and the impact that has on our customers, probably most notably from energy builds, not from water per se. But that said, obviously, it's a challenging time for every one. So we've certainly -- when we prepared our indicative tariffs, we've looked very hard at what levers we have and where we can try and mitigate some of that impact, particularly in 1 period alone. So we have been speaking with the regulator in that regard and seeing what we can do for deferrals. What we're proposing would effectively defer elements into the next regulatory period on an NPV-neutral basis. But we are certainly looking at what we can do, and we're trying to reach an outcome, which would mean both Bristol Water and Southeast Water average bills by certainly less than the headline rate of inflation. So yes, we are actively seeking to do that.

Okay. And if I may, one more. Do you think in -- while speaking on the next regulatory period, the regulator would be again focused on affordability? Or this time the focus will maybe increase more towards higher investments given whatever you are saying on water resilience and what has been said on the CSO issues?

So good question, Bart. I mean, I think, we always have to be mindful of affordability. You want to look at the cost of living crisis and then the support that customers need is obviously quite acute through that. And that's twofold really. One is making sure that we are able to target those customers who finds themselves in difficult circumstances and make sure we're giving them the support that they need, but also being efficient with what we deliver. Now that efficiency helps in terms of mitigating bill increases. But you're right, there is investment on the horizon given the government legislation in the area, certainly around the environmental aspects that will need investment. So we will obviously be speaking to get the balance right for the next business plan, but yes, there will be more investment that we see on the horizon. So how efficient we are with that is going to be incredibly important in how we protect those customers who find themselves in difficult circumstances is going to be part and parcel of that plan.

We have no further questions on the call at this time. So I will hand the floor back to Susan.

Okay. Thank you very much. First of all, thank you everybody for joining us this morning. And as you can see from our results, it was a set of resilient financial and operational results, and our long-term fundamentals of the group remain robust. Thank you.

Thank you, all.

This concludes today's conference call. Thank you all very much for joining. You may now disconnect your lines.