Pennon Group Plc (PNN) Earnings Call Transcript & Summary

Thank you for your patience. We'll begin the Q&A shortly. But first, I'll hand it over to Susan Davy, CEO; and Laura Flowerdew, our CFO, for a short presentation. Please go ahead.

Great. Thank you very much, Alex, for that. And good morning, everybody, and thank you for joining. So obviously joining myself this morning is at Laura. And as you will see from the presentation that I hope you've all seen this morning, just before Christmas, we were given the green light from our regulator, Ofwat, for the business plans, the Pennon's water businesses, South West Water and Sutton and East Surrey. So what do we get from that? Well, we've got clarity on the record GBP 3.2 billion cash on investment needed across the regions we serve for the 5 years to 2030. So today, we have confirmed acceptance of Ofwat's final determinations. We will not be referring to the CMA for those. And then we have carefully thought how we fund that investment. And today, you will have seen we have launched a fully underwritten rights issue of GBP 490 million as part of a comprehensive financing package. The GBP 490 million rights issue obviously sits alongside the funds you will seek from our debt investors as we finance our investment over to 2030. Now recognizing the need to provide returns for that support, we have considered the dividend policy at 2030. And our policy to 2030, which we are announcing today, will be to maintain the total dividend from 2023, '24, rebased on a dividend per share basis as a result of the rights issue and growing thereafter by CPIH inflation. Our water businesses will maintain the long-held gearing policy of 55% to 65%, and we anticipate debt gearing levels to be between 60% and 65% over the period to 2030 for those water businesses, consistent with a strong investment-grade credit rating profile. So this keeps us in a strong financially resilient position to deliver for our customers over the period to 2030. And with that, I'll open to questions.

[Operator Instructions] Our first question for today comes from Dominic Nash of Barclays.

Really, if I may, first one is on the quantum of the GBP 490 million rights issue. Could you give us some sort of color as to the wiggle room that, that allows for changes in or estimates going forward in, say, fines coming from the Environment Agency and Ofwat or potential for new CapEx to be brought through or changes? How much wiggle room have you sort of baked into this GBP 490 million? Essentially the question is leading to, is this enough and unequivocally enough? The second question I've got is that you've got a 7% RORE guidance real, which is close to 200 bps outperformance. Can you just give a bit of color on where that outperformance is coming from, please? And finally, just a technicality one. Can you just confirm us what the shares of trading come at rights today? And the record date that I think that you had from last night, what's the meaning of the record date? And if you buy a share today, you're buying it with the dividend and with the rights intact. Can you just confirm that, please?

Yes. Dominic, thank you very much for those questions. So perhaps if I start first with the GBP 490 million, is that the right number. It is absolutely the right number. We have looked at our forecast having received the final determination for the water business pre-Christmas. As you might imagine, we have worked through numerous scenarios. We looked at what we'll have to deliver. And let's be clear, we've pretty much got what we asked for in the original business plan. So our plans, which we have been developing and indeed starting to deliver on, are very clear for us out to 2030. So we've been able to look through, see what we need in terms of our financing and also scenario planned around various aspects of performance. So we think this is absolutely the right number to be going out with. And we think the quantum as the rights issue combined with the dividend policy that we're presenting is a good comprehensive financing package. So that's the first question. Second question around return on regulated equity and what we are targeting. So yes, we are targeting to perform. We think that is the right thing to do. It absolutely gives us headroom going forward through this regulatory period. We have a 5.1% return on equity as a base allowance. Yes, there are extra basis points available. For South West Water, that was extra 30 basis points if we achieve at certain metrics and deliverables over the K8 period and 5 basis points for Sutton and East Surrey. So taking that into account -- taking into account where we can outperform, whether it's on driving our cost base efficiency, which we can come onto and talk about in a minute, whether it's driving efficiency on our financing or whether it's targeting in terms of our ODIs, we've looked at it in the round, and we are comfortable with the target that we set ourselves for that period out to 2030. Then in terms of the last question, Laura, do you want to take that in terms of the -- some lights on the dividend piece.

Yes. So yes, the ex-dividend date will be the 30th of January, which is tomorrow, and we will go ex rights on the 3rd of February from a timing perspective. So that process will happen over the next few days and the process will then complete over the following weeks with the finalization of that timetable. So yes, as of today, we will be trading with dividend and with rights, but that flows through over the next couple of days.

Thank you, Laura.

Our next question comes from Pavan Mahbubani from JPMorgan.

I've got two, please. Firstly, can you walk through what your thinking was in terms of alternatives and whether you considered certain alternative sources of financing. I mean, the two I have in mind are a scrip alternative to the dividend and also whether a stake sale or anything around Pennon power, really. It would be great to get your thinking around those and why you chose not to go down that avenue today. And my other question is you're targeting 7% RORE. Do you expect most of that to come from financing? Do you have in mind what a potential split would be? Any color around that would be helpful. And on the RORE, do you expect that to be something that we should see from the first year of K8? Do you think that the outperformance will be more back-end loaded? Anything around the timing of that would be really helpful as well, please.

Great. Thanks for the questions, Pavan. Great questions. So in terms of thinking through how we've got to this comprehensive financing package and how we thought about it. I mean, as you might imagine, we have thought of as how to position this. The first thing to say, which I said to Dom as well with the first question, we're very clear that we think we've got the balance right in terms of what we're coming out with today. And coming out with the rights issue at the GBP 490 million level obviously sets up for success for the whole period. So that's why we've done what we've done. So you mentioned, do we think about things like scrips? And we've had historically a scrip dividend for Pennon. But we think the way we have structured this and coming up strongly with getting ourselves in the position for the whole period with this rights issue is the right way to do it. So that's the first thing to say. Second thing to say in terms of other assets that we have at the group and you mentioned Pennon Power, where obviously, we have assets under construction and the development with the renewables side where we're investing in solar projects across the country, we absolutely are keeping those assets under review and we will consider optimizing ownership of those over time. And we will obviously want to maximize shareholder value of what we're doing. Now the reasons why we put Pennon Power in place, we used to have Viridor in the group. But obviously, threw up a lot of electricity with a good natural hedge for the energy and electricity consumption that we had from the water businesses. Having sold Viridor, we have now obviously wanted to put in more natural hedge back in the group. And also those projects are stand-alone at good returning projects in their own right. We are going through construction with those. And given where we are with the construction, first energization for one of those projects is at the end of this current financial year and then the others flow from that in successive periods. Given where we are, we think it's best valued shareholders to continue with that construction. Just to be absolutely clear, the funding and the rights issue is wholly to be used for the water businesses. This is not about Pennon Power. And as I said, we will keep the consideration about how to maximize shareholder value for those projects under review as we walk forward. So that was those 2 aspects, Pavan. The second one was around the 7% return on regulated equity and what was the split. We currently haven't given a split because we've run quite a number of scenarios and looked at how we can manage and balance in terms of the portfolio of what we need to deliver. There are 3 buckets, for want of better term, of where we can drive for headroom and outperformance. One is around our efficiency and our cost base. And then you'll have seen previous presentations where we've talked about rightsizing, right-shaping the organization with an GBP 86 million per annum target that we have been on with and we are delivering against. So you can see initiatives that are obviously helping us drive for an improved efficiency position. The second aspect is around financing, and I'm sure Laura can talk a little bit about our financing performance and outperformance.

Obviously, financing is an area where we had a strong outperformance in the current period. That comes off the back of our diversified debt portfolio, which has allowed us to ensure that we are flexible but locking in through our hedge policy outperformance where that is available. We continue to hold that diversified debt portfolio as we go forward and continue to target financing outperformance. We issued a bond in December, GBP 250 million under the EMTN program, which came in at a level in real terms that would demonstrate we can continue to issue efficiently compared to Ofwat's allowed cost of debt. And so we believe we're in a strong position to continue to deliver some level of financing outperformance as part of that overall target the 7% real RORE as we move forward into the next regulatory cycle.

Great. And then the last area of bucket of potential performance comes from outcome ODIs. Now let's be really clear. If you look at the common ODIs and metrics, which are the ones that have flown through from K7 to K8, it has been challenging for the entire sector. I don't think there's one company that, on the common ODIs as a basket of those, have made an incentive to the upside on those. And Ofwat has recognized that and Ofwat have obviously done a lot of work between draft determinations and final determinations to go through that both at a sector level with a mechanism they put in place for that and at a company level, to make sure that we've got stretching challenging targets, but ones that we can obviously plan to achieve. Now obviously, we haven't had a situation in K7 where we've had outperformance for ODIs. We have stretching challenging targets for K8, and we are -- our plans in place to deliver against those. But let's be clear, those will be challenging targets and we have put in place plans to achieve them. So we have looked at outperformance in the round for those 3 buckets, whether it's cost base whether it's financing, whether it's the ODIs. And we're comfortable with our target that we're putting forward for performance that obviously gives us headroom through that 5 years. I think, Pavan, you asked about profiling and whether it would be any kind of profiling guidance. We haven't given any profiling guidance. I talked about the work that we're doing already on the cost base and efficiency that we started last year. So we are comfortable with the 7% RORE that we are targeting and driving for the period.

Our next question comes from Mark Freshney of UBS.

A question for Laura, just on the bonus element. What's your interpretation of the accounting rules and when would you set the bonus element for accounting purposes? Secondly, Susan, just on operational performance. I mean, I think it's clear when we look at the stats, whether it's ODIs or environmental performance, it spills that are the massive issue. And there's not -- there's a lot you have to do, but in a way, there's not a lot you have to do to get that down to an acceptable level. So can you talk about performance on that in the last couple of months and your targets of getting to an EPA assessment of 4 stars subject to how they calculate it next year in relation to this year? And if I could ask, finally, just on -- just coming to the dividend. I mean, clearly, Ofwat wants management remuneration and dividend linked to operating performance. You clearly tested with the market the GBP 2.4 million fine deducting that from dividends. How will you think about that going forward? Would you deduct that fine from the dividend? Or would you do something at the opco, holdco level? How would you accommodate those objectives?

Okay. Thanks very much, Mark. So I think in terms of the accounting question that you have, I'm sure the team can follow up on that one.

Yes. I guess I would just say, obviously, international accounting standards require adjustments, don't know for the bonus element of the rights issue. That's an estimate until we go through the timetable and the process. So we will finalize that in due course and give further information and follow up on that once we're in a position to do so.

Okay. Thanks, Laura, for that. And then in terms of operating performance and where we need to get to, obviously, there are a whole basket of measures, Mark, that we need to target for at K8. And one of the new measures coming in, as you rightly referred to, is around at spills and spill numbers. But let's be really clear. We've got a 15-year investment program that we will be deploying, starting with this first 5-year regulatory period to get us at where we need to be in terms of the use of storm overflows in the system that we have. So we have significant investments going in over this 5-year period, very much targeted on storm overflow and it is over GBP 800 million worth of investments that we're putting in for the storm overflows and obviously a significant program to get our spill numbers down. And you're absolutely right. The target for that is also wrapped up in the bonus aspect of the returns that we might get, given the outstanding state we've got for the business plan. So if we achieve our spill target by the end of the period, then obviously, we get the extra 30 basis points as part of that assessment. So we are very much targeted on it. Yes, over the last couple of years, we have seen significant rainfall, which having had all the monitors put in by the end of 2023, we can absolutely see what's going on in the network and in the system, and we are now starting to tackle those. And at the half year, we talked about that we've taken out some 10,000 spills from the system, and we are focused on doing that. But you're absolutely right. The weather impact over the last couple of years has meant, now we've got all the monitors and we can see what's happening, and we're going to get on and tackle those. Now in terms of you noted at EPA and EPA at star rating, again, another one of those aspects of the 30 basis points potential increase to base returns if we achieve EPA 4 Star status by 2028. I think that base obviously give some understanding of what we need to do to try and make sure we achieve that. And the EA are out to consultation and considering what the framework will be for the EPA assessment currently. So that will come into force from 2026 onwards and are out to consultation with that. So our target to achieve the 4 stars to get the 30 basis points has to be by 2028. And obviously, our plans will be honed to achieve that. And the last question, you have, Mark, was around how do we view the dividend, areas like REM, given I think what you're referring to, certainly on the REM side, will be what's going through the special measures, water bills, that's obviously progressing through the various reviews that it needs to undertake through Parliament. I mean, obviously, we will wait to see where that lands, and that will be over the coming weeks. And we'll see what that has in terms of legislation and any reflections that we have on that. I'm sure the Board will pick up. And in terms of the dividend adjustment that we made when we had a fine for an environmental prosecution. I think I said at the time, this was a one-off and it was something that we thought we needed to do to reflect that we were listening to the situation that we're building around water companies more generally and water company's performance. Now obviously, the special measures still is picking aspects of that and we will await where that lands in the coming weeks.

Our next question comes from Ajay Patel of Goldman Sachs.

I think it's more clarity on the questions I heard earlier, and maybe I didn't hear the answers correctly. The way I look at this, and I think it's on Slide 10, you have this bridge of the financing. Is that -- if you put in place this equity issuance and the outperformance that you achieve, it looks like, on what I can see, you'll probably be towards the top end of the leverage range that you've highlighted. And then I'm just thinking about levers here and then a little bit more granularity to that picture. I guess, there's no assumption of any disposals here. So that potentially is a lever in the event there is any fines, for example. And then in terms of what you've assumed on the outperformance, is it mainly financing, which you've historically been very successful at? Or is it actually the other parts that really become -- is there any rough portion so we can understand, is it something that you will build up like your ODI capability and the outperformance you're going to see on that side? Or something that's tried and tested and you've achieved before in the sense of the financing side. I think that to start would be really helpful.

Yes, of course. Thank you very much for your question. I'm not sure that we have had a question on Slide 10 earlier. So perhaps you didn't miss here. But I think on Slide 10, it talks -- there's a little bridge in there, but give some indication of one of the ways we've thought about the size of the rights issue today. And that's clearly just saying, look, we can see there's growth in our CV that we're needing to fund the GBP 3.2 billion investment equates and comes through in terms of an RCV growth over time, and you see GBP 2 billion of that. If you are going to assume FX expense gearing level and debt funding for that, that leaves you with an amount that otherwise you would think about funding. But we are going to drive some outperformance. And so our equity funding that we're raising is the GBP 490 million. And that's really all that bridge is saying. If you want to try and triangulate it in terms of how we come up with what we think is the right number, we've done an awful lot of modeling to make sure we're very comfortable with that. This was just a way of triangulating it so that people can understand where we've got it from. And Laura, do you want to comment in terms of the gearing and how we see that profile over the 5 years?

Yes. So obviously, subsequent to the rights issue, the gearing levels will come down towards the bottom end of the range that we've given. And what we then see over the 5-year period is a front-end loading of the CapEx profile you may have spotted in some of the slides, which means that we will see then the gearing move back up a little within that range. And then it remains relatively flat on our sort of core scenario over that 5-year period. To answer your question about, perhaps a little indirectly, around where we sit in that range. What we have done is look at a number of scenarios, as Susan touched on earlier, around where we might end up in terms of both outperformance, in terms of the ongoing investigations should that not outturn where we believe it currently would and therefore, understanding what that means in terms of the gearing levels. And based on all of that, we believe that we're in a good position with the benefit of this rights package and the mix of debt that we envisage continuing to remain within that gearing range that we've provided, notwithstanding a number of scenarios that we've looked at.

Thanks, Laura.

And just on the outperformance, is the bulk of that financing? Or is it -- any rough sense that you can give us that half of it is financing, the rest is to totex and ODIs or...

I think what we've tried to do is look at it in a number of different scenarios. And obviously, we're very much at the start of that 5-year period where there are a number of different whether that's market volatility, whether that's challenging ODIs or whether that's totex performance, there's a number of elements. So what we've really tried to do is rather than split it into those buckets in terms of financially, if you look at individual components and scenarios that might outturn and still provide a level of confidence in being able to deliver that 7% real RORE over the period. So we are not providing sort of further split of definitive numbers in each of those buckets but are confident in our ability to deliver that level of outperformance over the period as a whole.

Our next question comes from Jenny Ping of Citi.

Just one question from me. Just to understand the totex outperformance piece and the operational underperformance that you've had over the last 2 years. Can you confirm, as we look into '25/'26, i.e., the first year of next AMP, where really you're going to be matching very closely in terms of your cash OpEx that's going out of the door versus what the FD OpEx delivering. On the FTE numbers, I think it's the low 300s. Your run rate in the last 2 years has been about GBP 400 million. Can you just confirm that to give us a bit more confidence around that totex outperformance piece, please?

Yes. Jenny, I think it's probably safe to say if you look at the consensus numbers for the first year of the new regulatory delivery period, I think those appear on consensus to reflect more DD than FD, that's probably the first thing that I would say. And therefore, we obviously need to make sure we're giving some guidance and make sure the market [indiscernible] with all the changes from DD to FD and the improvements that we've seen from that. And then obviously, today, we are talking about the fact that we are driving for headroom in our performance and looking at 5.1% to 7% return. So I think if you're looking at the consensus guidance for '25/'26, I would suggest that, that doesn't yet reflect DD to FD, never mind FD to today. So I think that's something we will be obviously giving more guidance upon in terms of our Capital Markets Day, which we're having on the 13th of March. And I'm sure we'll be able to give some color on that. Now in terms of operating costs, you have seen at the half year presentation that we gave last November, we talked about the fact that we're driving an GBP 86 million target in terms of cost base. that comes from, obviously, the integration work we've been doing with not just Bristol Water over the last regulated period, but certainly Surrey and then our overall efficiency targets we've been driving to get the cost base in the right place. And we are in a largely throughput program with that as we sit here today. I don't think there is any other updates or guidance from today, Jenny.

So effectively, you're saying you can reach the Ofwat FD OpEx numbers from year 1?

Yes. We'll provide more guidance as we move forward. But I think, obviously, some of the challenges we've had around OpEx over the last few years has been reflective of some of the elements like power, which gets reset as we move into the next financial period. Some of the pressures around storm overflows and drought, which we've invested to make sure that for the long term, we are resilient and sustainable. And some of those elements then are adjusted as we move into the next financial period. We received the returns on some of the investments that we've made, including things like the Green Recovery, accelerated investment, which we've invested without the revenue returns accompanying it in this financial period, but which come through our income statement in the next year as well. So we are working hard to ensure that next year, we are aligned with the FD position and indeed targeting that 7% RORE outperformance over the period as well.

Our next question comes from Johnny Campbell of Bank of America.

I've got two. First one is on the timing of investigation. So I think you've got the Ofwat one, the EA one, the [indiscernible] one with the drinking water inspector. Do you have any new details you can provide today in timing of the outcomes of those investigations? That's my first question. Second one is a more broader for the whole U.K. water industry. So we saw, I think just before Christmas, even after final determinations have been published, that the government had asked regulators, including Ofwat for ideas to promote economic growth. Do you think this bodes well for something like an AMP8 Green Recovery style program? And if you reckon that it does, when do you think that could occur, I suppose, maybe mid-AMP when firms are bedded into their AMP8 business plans, et cetera?

Great. John, thank you very much for your question. Perhaps if I'll start with the second one first and then I'll go back to your first one around investigations. So let's be really clear, this is going to be a period of record investments, GBP 3.2 billion that's saying across the regions that we serve, the biggest investment that we we've had in a 5-year period since privatization. So this is a really big program and it's going to deliver economic growth for these regions, especially in and around Devon and Cornwall. It will be sporting and creating over 2,000 new jobs and this is a significant program in and of itself. We have set ourselves up for success and to deliver. We have our capital alliance who have been in play for a good number of months. And we have already put across them over GBP 600 million worth of projects for them to start delivering again. So we are going to have a fast start and hard start to the regulatory period, which will see us investing and driving some of those improvements that we all want to see for the environment and for our customers. So is there a potential as we move through that period to accelerate other investments? I'm sure as we start delivering and then getting through the program, we'll be thinking about the next regulatory period. But let's be clear, the position that we've put out today on financing, package, our comprehensive position gives us a good strong balance sheet to underpin what comes next. So that's that question. The first one around time of investigations. I'd love to be able to sit here, John and say, yes, we know the dates of when those are going to conclude. But we don't have any more information or updates to give you. Obviously, the regulators worked diligently through these aspects, and it does take time. So as soon as we have any more information, we will be updating.

Our next question comes from Ahmed Farman of Jefferies.

My question is also on Slide 10, where you're showing the -- I guess, the funding or financing rates. I think from your comments, I take that you're obviously quite comfortable on delivering the 7% RORE and implicitly, the outperformance that you are, I think, as I understand, at least not giving a lot of visibility on the profile at this stage. My question is that in the context, are you comfortable on the financing plan if the indicative of performance was to be much lower, but there is enough headroom with the equity raise that you're doing to have -- to be comfortable on the balance sheet under that situation? Or is that a situation where you would be considering potentially disposal of certain assets? So I'm just trying to get a sense of the headroom embedded within the financing program you're setting out today.

Okay. Thank you. A good question. So perhaps I'll just reiterate a point on the sale of assets. Look, we have had on power, I briefly mentioned it earlier, those are assets, and we have our business retailers at Pennon level as well. We always keep under review what we think the position is to maximize shareholder value and we will obviously consider that over time and on an ongoing basis. Laura, do you want to talk about the gearing point and hedge room aspect?

Yes. So I think, again, as we've said earlier, we've looked at a range of scenarios, taking into account a number of considerations, including things like the investigations and so on and the confidence in the outperformance. I think for a range of reasonable scenarios, where the rights issue puts us in a really strong position, and we're confident with that. But obviously, we will continue to keep all options under consideration to ensure that we can remain within that gearing policy as well.

At this time, we currently have no further questions. So I'll hand back to Susan for any further remarks.

Well, thank you, everybody, for your time this morning. Obviously, we're incredibly excited about the delivery that we are on with for our customers and for the environment and the investments we'll be making in the period to 2030. It is a record level of investment we will be making, and we believe that we obviously have talked through this morning what is a comprehensive financing package that underpins what will be a great period of delivery. So thank you for your time this morning.

Thank you.

Thank you all for joining today's call. You may now disconnect your lines.