Severn Trent PLC (SVT) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to today's Severn Trent presentation. [Operator Instructions] I must advise you that the conference is being recorded today, and that's Tuesday, the 28th of January 2020. I'd now like to hand the conference over to your speaker today, Liv Garfield. Please go ahead.

Thank you very much, Lianne. Hello, everybody, and welcome, and thank you for joining us this afternoon for our webcast. So I'm Liv Garfield, Chief Executive, and I'm joined today by James Bowling, our Chief Financial Officer; and Shane Anderson, our Head of Economic Regulation. So hopefully, you would have already seen that this morning, we made a market announcement with 3 pieces of news. So firstly, our Q3 trading update. And in this, we outlined no material changes for the outturn of this year. Secondly, that the Board of Severn Trent yesterday accepted the final determination for Severn Trent Water. And thirdly, following of [indiscernible], we outlined our dividend policy for AMP7, and it's a smooth transition from this year to next with no cap and growth of at least CPIH for the next 5 years Now we've got literally just a handful of slides to talk to these points in a little bit more detail, and then we'll open up for Q&A at the end of the call. So I'll start by covering off with our Q3 trading update. In our interim results in November, we've reported we are on track to deliver in line with technical guidance, and I'm pleased to say that this picture has not changed. We've got good control of our costs. We've now delivered GBP 870 million worth of totex efficiencies over the past 5 years. Our capital program is in really good shape, with our largest-ever project, the Berlin Resilient scheme, in the commissioning stage, which is ready for completion in March. And we still expect to deliver at least GBP 25 million worth of awards from our customer ODIs this year. As I mentioned at the half year, our customer ODI profile for this year is going to be a little bit different than previous years. So the end of AMP environmental measures are the ones that really take center stage. And in particular, it's around the work and the investments gone into our water framework directive measure and that's all about helping to improve the quality of 1,600 kilometers of river in our region across the whole of the 5 years in AMP6. And don't forget we've also got plans to improve a further 2,100 kilometers in AMP7. Now given the significantly more stretching targets that we accepted from Ofwat for the uncapping of all of the waste measures than some of the more established metrics we've spoken about before, such as flooding, for example, they will incur a penalty this year that will partially offset the environmental award, which was the real reason we wanted to uncap the access those rewards. Now in water. We talked at length in our interim presentation in November about the fact that we'll continue to just steadily improve quarter-on-quarter, half year to half year, measures such as leakage, water quality and supply interruptions, and they definitely continue to see that improvement, continue to benefit from the investments in new working practices that we've implemented in the last few years, so a positive story continuing there. So overall, we feel that we're in good shape over on AMP6, and we persist to deliver the AMP7 and that's perfect to take us onto part of this infographic which brings to life AMP7 for us. Now we've reviewed literally thousands of pages released back in December, and I'm pleased to say that having done all those reviews, we've now closed the book on our PR19 discussions and last night notified Ofwat that we have accepted our final determination for the next 5 years. If we look back in time, we first started writing our plan a couple of years ago. It was clear to us in order to be successful, we'd need to deliver for a large number of stakeholders and really balance how we did this, not for the crucial winning formula would be. So we've thoughtfully balanced the desire to keep customer build low. And there's a 9% build reduction as the end reduction whilst continuing to invest in our assets for the benefit of future generations, as such, also creating RCV growth of 3.8% in AMP7. We've put in a hard job, at least fair to say, in AMP6, indeed within the right cost efficiencies and that enabled us to 1 of only literally a small handful of companies that was given all of our requested totex allowance for AMP7. With our customers, we jointly created a suite of ambitious customer ODIs that will deliver really tangible improvements for the services we deliver on the matters that customers care about most, but also give us an opportunity to be rewarded for that success in those efforts going into it. And actually, overall, we've delivered a plan, which considers not just what we'll do in the next 5 years, but very significantly, how we do it. We placed social purpose and sustainability of the environment as heart of our activities, and I think that really comes across in our plan and also in our plans for the future. Now under no illusion this is a tough settlement for us and for the whole industry. And as we reflect on the plan, we're confident it's absolutely the right [ indiscernible ] for us to deliver for our customers in this manner, and we just look forward now to moving into that delivering phase with the conversations now closed with Ofwat. Now I understand that whilst I might have very excitedly spent Christmas reading every last page of every last plan, it might not have been the way that you guys spent it. So we thought we'd bring to life over the next couple of slides just a few key messages that probably Fast-Track you that analysis and try and summarize it in a situation. So to close off the movements that we saw from our draft determination in April through to the final determination that we've just accepted, I think what you will look at is the chart on the left. And there's a few ups and downs, but in the round, will be made broadly whole from a value perspective. So of course, the WACC did come down by 38 basis points from Ofwat's early years, and that took off as on revenue GBP 180 million. Now [ indiscernible ] was offset by increases to our totex allowance, so we actually gained an extra GBP 185 million on revenue. And the change came from the shift in the efficiency frontier to 1.1% for the 1.5% that was signaled earlier as well as some other areas where we'll be making representations which came through, which is following conversations over the last few months. If you think about the RCV runoff rate, that was tweaked by -- a little bit by 0.1%. And that took off GBP 60 million of the revenue. But don't forget that GBP 60 million just adds back on to our RCV, so that helps tick up the RCV growth rate. I've made a few other smaller PR14 legacy adjustments which also added GBP 30 million back onto revenue, means that overall, net-net, across all of this, you're seeing revenue down by an average GBP 11 million a year, but you're seeing RCV growth rate increase by 3.4% previously signaled to 3.8% that we're now signaling. Now on the service revenue. Also worth mentioning, just to give you the whole picture, that our revenue profile actually changed with more phase into the early years, which is helpful for customers. It gives them a smoother transition to build for customers of AMP6 and AMP7 for a more progressive adoption of the 5 years than was originally stated. So I hope that all makes sense. We'll jump on now to customer ODIs. So we've seen some positive small tweaks on ODIs between the draft determination now. Now you'll recall that back in January, we elected when we got Fast-Track status, to lock in most of our ODIs. We believe that we had a fair set of measures with little intervention on the target of that date, and our operational teams could gain some clarity, allowing us to make the right investment plans and begin to announce such in the future. But we did choose a handful of measures to keep the conversations going with Ofwat for a little bit longer, and I'm pleased on those. The representations we made over half of industry as much as ourselves with regards to 3 of them, supply interruptions, CRI and mains repairs have been taken into account in the very final target and glidepath as stated by Ofwat. So for Severn Trent, the overall impact has the effective increase in the opportunity to earn outperformance by 20 basis points on RoRE rate as well as reduce the risk of underperformance by around 100 basis points on RoRE, taking our final P10/P90 ranges to between 1.9% positive and minus 2.8%. So as we head into AMP7. We've got 41 customer ODIs that we really got our teeth stuck into, and they're across a whole range of areas the customers told us they care about. And we've known about these for a good chunk of time, over 2 years preparing for this journey. We've got a mix of new measures. They're going to be new friends, established metrics, which we've really got grips, I think, in the last years. And as such, we're confident that in around net-net, we can be a net award for AMP7 on ODIs. So with that, I'm going to hand over to James to talk a bit more about our totex round for the next 5 years, and of course, what this all means for our dividend policy. James?

Thank you, Liv. So just focusing on totex. Altogether, Severn Trent Water has been allowing totex of just under GBP 6.8 billion as a combination of our base totex, enhancement totex and, of course, our real options. Now base totex is the money that we need to run our network day-to-day, and that makes up the vast majority of our spend. When we submitted our plan back in September 2018, we asked for GBP 5.6 billion of base totex, and we've been allowed an extra GBP 126 million on top of that. And this really highlights the scale of efficiency we've delivered through our AMP6, and I'm pleased that we'll be able to exit AMP6 on the run rates needed to stay within these AMP7 cost corridors. Enhancement totex is investment to fund a variety of additional schemes across areas such as resilience, supply and demand and environmental improvements. Now we asked for just over a GBP billion for these schemes, and Ofwat has allowed us around GBP 900 million. And as you'd expect, we've already started to refine some of our plans to ensure we're going to deliver the outcomes we need for the money that we've been allowed. Now the final piece of totex I just wanted to remind you of is real options. And these are mechanisms which trigger additional funding should certain criteria be met, and these could be worth over GBP 150 million in additional totex. So altogether, we were given slightly more than we asked for, which is a great position to be in as we face the challenges of AMP7. So just turning now to the next slide and the final of our announcement of the day, which is our AMP7 dividend policy. So I'm sure that many of you will be familiar with this slide and our dividend building blocks, so I won't go into too much detail. But as a reminder, the base regulatory dividend forms the largest of our building blocks. But remember, on top of that, we have in the region of GBP 177 million of revenue from our outperformance on AMP6 ODIs. We've got the premium for Fast-Track, outperformance we expect to deliver in AMP7, and of course, the contribution from our nonregulated businesses. Now these building blocks, taken together with our current performance and our final determination for the next 5 years, have shaped our AMP7 dividend policy of at least CPIH throughout AMP7. The policy will be applied to this year's expected dividend of 100.08p. And as a result, we expect the dividend for next year, the first year of AMP7, will be 101.58p. And with that, back to you, Liv, for your favorite topic.

Indeed, it is. Thank you, James. So just one last thing for me, which is literally and almost shameless plug for our sustainability-led Capital Markets Day here in Coventry on the fourth of March. So I'm super excited about it, so I thought I'd mentioned it one last time. My invites have gone out from the Investor Relations team. So please do RSVP, and let the team know if you'd like to attend. Whoever's going to do it is going to get a sandwich. And it promises to be a great day with some very special guests as well. So I look forward to seeing as many of you then who can make it. So with that, we're going to open up for questions, if that's okay, Lianne.

[Operator Instructions] Currently no questions coming through at the moment. [Operator Instructions]

Give it a sec. Let's see, Rachel, your plan [indiscernible]. Is there anyone in the web for me?

No. Nothing so far.

We've just had some phone questions come through. I can open the first one. It's from the line of Verity Mitchell.

Yes. Great to see you have healthy dividends. And I just wanted you to pass a bit more your replacement it's true whilst your challenges have seen supply interruptions, you mentioned in the beginning of the call, the replacement of pipe. Can you just unpack up a bit more? Could you just introduce the topic where that will be of interest? I'm just looking back at your service delivery for 2018/'19. I mean it's been something that you've been having to focus on. If you could just talk us through that a bit more, that'd be very helpful.

So I think it's fair that water has not been as good for us in AMP6 as we would like it to be. And we've seen that appear in a couple of measures. Certainly, supply interruptions has been poor for us over a couple of years, and that came out quite clearly in the third delivery report [ indiscernible ]. And we've seen on improving trends but still it takes a penalty on [ indiscernible ]. We said we were confident to ending this AMP, so the next AMP will it will be a reward measure for us. And likewise, it also obviously had 1 year in 5, so we missed on leakage. So we hit it last year but missed it the year before. So water, as a focus, has been big for us. And we've spend more money in the same time we're on totex we're investing in the water. And what we're seeing, as we talked about the half year and then improvements in the winter, we've seen continued progress in limiting supply interruptions, so literally consistently, the investment in pipe work, the investments in understanding what we can do in terms of quick response, the investment in the tankers has all paid back with the improved supply interruption performance, which we'll outline at the end of the year. But again, incredible year-on-year improvement, which is great. We've also seen that by really understanding how we cleanse the pipe in-sourcing our own in-house activity on pipe maintenance around that, we've been able to limit water quality complaints and [ sticky ] discoloration, and again, you'll see that at the end of the year. Our measures are closed for the year now. It's a calendar year measure, and we've seen another strong double-digit year-on-year improvement, which is great. So we're seeing that come through. So I think the feedback I think I'm sharing is that we know in order to be successful in AMP7, we can't have the negative performance on water that we've had this time around. And mains placement has been part of that quest and journey. We've spent good money on that with AMP in terms of getting ourselves in good shape with good partners. And we're going to strongly complete this quarter with our mains replacement activities as well. So I think it's a whole heap of things in that water space, which adds up to increased confidence around a stronger performance in AMP7. Not guaranteeing green on every measure for certain, but definitely seeing an improvement.

And we do have another question from the phone lines, and it's from the line of Mark Freshney.

Listen, can I please ask on the dividend? I mean the growth policy is at least CPIH. So I guess, if I think back to 5 years ago, I think you made a similar -- 5 years ago, a similar kind of commitment, and then ended up growing it by a little bit more than RPI, which was the metric at that time. If I think as to how much above just CPIH you could raise the dividend, can you talk about some of the factors that would drive that?

Yes, you're absolutely right. So we announced at the start of AMP6, we announced a dividend policy of at least RPI. And this time around, we're going for at least CPIH. And what we said is the things that could drive it is operating outperformance. And whether that comes through an operating outperformance in ODIs or whether it comes through an operating outperformance on totex, in AMP6, that's what drove this particular really stellar ODI outperformance, but also our strong cost efficiencies. And that led us to have the comfort to then share that in year 3 AMP6. We're right at the start of a new AMP. There are very new stretching targets. There is a new cost curve that we've not seen before. So it's a bit premature to think of anything in that space right now. The key thing for us to really focus on is delivering strongly year 1 AMP7, which see the real step-up in the amount of ODIs that we've got at financial levels, but also a very strict off base with more efficiency curve. So attention right now is purely on delivery of AMP7, but that's how the mechanics work, if that helps give you some context of AMP6.

Okay. And if I could follow up on that. I mean if I look at the regulatory assumptions or some of the amount of regulatory equity, Severn Trent is paying out. I mean it's paying out well above I think some of the numbers that Ofwat used in their financeability assessments. I think Ofwat was assuming some of that 4% of regulatory equity would be paid out. So when I look at the numbers, it seems that that 1.9% RIC -- RPI will -- or 2.9% CPIH will return, it seems to me you're paying out everything in interest and dividends. So it seems to me that you're almost reliant on the outperformance on the incentives and efficiencies to actually be able to grow your equity and keep leverage flat. I was just wondering, and it's more of a question for James, that when you do your sort of like sensitivities and things that could happen through the review, how much risk is there that you might actually find the gearing rise more than you would expect? What would need to happen for you to start to question your own dividend policy?

Thanks, Mark. Yes. So just keep in mind that the dividend policy that we've announced today is for the group. And so there are -- it's not just the regulatory dividends that we focus on, and of course, we have our nonregulated businesses, including property profits, our operating services in Green Power and so on. So it is kind of layered in that respect. I think, as Liv said, it's the start of an app. So we are -- we back ourselves to absolutely be able to manage within the cost corridors. I think we're exiting out of AMP6 with exactly the right level of cost in our business, and we hope, and we expect that the business will continue on within that cost corridor. And of course, we have -- we've got -- we are confident that we'll be able to manage to deliver some ODI performance through AMP7, but it's a bit early to be saying exactly what that is. So I think we've got all the building blocks we need to be very confident that this is the right dividend policy for us through AMP7.

The other thing as well, Mark, just worth emphasizing again, we've got GBP 177 million, which is a difference for us versus anybody else. That was formed so strong in AMP6 and carried that over. That is a -- that's a key part of our building blocks is that extra best part of GBP 200 million.

Yes. And as you'd expect, Mark, we obviously did some extensive resilience and scenario testing when we considered the dividend policy. So Liv and I, we're very comfortable with the policy that we've laid out.

Okay. And just one final follow-up. Sorry, there won't be other follow-up from me after this. But my understanding is that the ODI incentives in this coming cost control are mostly revenue and are mostly paid 2 years in arrears. So would it also be true that if you make a flying start to AMP7, then, yes, 3, 4, 5, you could get further revenue from years 1, 2, 3 also coming through the top line?

Yes, so it's true. For us, it's no different than the last AMP, if you think about it. So we chose an AMP6 to take them as end year numbers the same way, and then actually elected to move some of that over into AMP7 when we see the AMP7 was going to be a tricky settlement. But you're absolutely right. Any outperformance in year 1 does give you extra revenue in year 3, and likewise year 2 to year 4, year 3 to year 5. And that's clearly been in our mind. It's why we chose to lock in target early on, is to get the organization focused on delivery and not end up waking up now in January with new measures going live in January instead to look in a situation. So our organization has known these numbers for a long time. We shared our reporting for a long time. So they are highly stretching, but we have backed ourselves to be a winner in the world of ODIs in AMP7 as well as we were in AMP6.

There are currently no further questions. [Operator Instructions]. We do have a follow-up question from Verity Mitchell.

Yes. You were put on review for downgrade for A3 by Moody's in December after final determinations. And I understand that you're probably quite comfortable with that. You should just talk us through it likely -- you probably are going to be downgrade to Baa1. Is there any disadvantage or are you completely comfortable with that likely rating?

Let me pick that one up. So I think you will have seen that following the publication and final determination, Moody's placed us and 11 other U.K.-based companies on a review to -- for downgrade. It's too early for us to really -- to talk about what they're planning to do before they publish their reviews. We did say that our target credit rating for AMP7 was BBB+, which is equivalent of Baa1 for Moody's for the operating company. So we're really going to have to wait to see what Moody's do in the next few weeks across the sector.

Okay. But clearly, it wouldn't have any implication on your dividend policy because you set it now. So you will just be working with the Baa1 rating?

Correct.

Yes. I mean yes. We've planned on the basis of a BBB+ Baa1 rating, and that's what we expect to be working with.

Now Rach, do we have any questions on the web?

We do. We've got a couple of questions. And the first one from Peter Atlas has asked how soon will AMP7 ODI outperformance become apparent.

So we haven't started yet. So I guess 1st of April is going to be the first day of AMP7 for most of the measures. There are 3 or 4 that go live now in January. So I think what we'll probably do in May is just give you an education on what the measures look like. And then I think what we've normally done is given a bit of guidance -- a bit more guidance by the time it's November. So the latest will give you some sense of the first year in November. You won't see what the measure are for a while. But we'll also be able to give you a bit more education in May as to what the measures look like across the piece, just to make sure everyone will be able see them. And so November for definite real guidance; May for an earlier -- some sense of what the first year in terms of the types of measures that are there.

Okay. We now have a second question from Deepa from Bernstein who asked 2 questions. What are your expectations for ODI performance AMP7 on average in pound millions? And a follow-up, would you look to increase dividends if ODI performance is better than your base case?

It's definitely too early to give either those, I'm afraid, Deepa, which is probably quite frustrating. You've asked 2 quite good things -- questions. I mean we've got to begin the AMP first, and we've got to actually begin to learn to live with the whole lot of new measures, and then we'll just keep them -- I think it's good as we've been quite transparent in keeping the market informed. So we've got good touch points in May and November already in the diary. We'll keep everyone up to date as it feels then as we go through the year on how we're doing against measures.

Okay. We've got a question from Ruth from Utility Week. She's -- asks for an update mentioned further measures in the FD are significantly more stretching than proposed. Has anyone come to try to meet these expectations to minimize penalties? I think there's been a little bit of confusion there between the current year guidance and the FD.

Fair enough. Okay. So yes, Ruth, we took harder measures, in fact -- harder measures in some of them than the AMP7 measures as part of our uncapping agreement with Ofwat. But what we'll do is just pick up directly, if you like. So we'll just call you directly. We can just have a conversation just to make sure we're clear. So I'll get Jonathan to do that straight after the call.

And then the final one on the webcast from Ajay is can you give us details of financing needs and strategy in AMP7 in addition to the refinancing?

Yes. So we've got around GBP 3 billion of this -- of financing to raise in AMP7. About $1.2 billion of that is new and about GBP 1.8 billion of that is refinancing existing debt. I mean for us, that is -- we've probably got a slightly better ratio than the average and the allowance that's been set by Ofwat for AMP7, which is good, because currently, what we're looking at is being able to refinance at significantly lower levels than the embedded debt rate, and indeed, our existing debt. So I think we've got a lot to look forward to in AMP7, and you'll see us starting to roll out our plan later on this year.

And that's everything we've got from the webcast.

We do have a further question from the phone line, if you'd like me to open that line for you.

Yes, please.

And it's from -- oh, they've just took their question away. [Operator Instructions] Currently no phone questions.

Great. I think we'll call it a day there, then. Thank you very much to everyone for dialing in. Much appreciated. And we look forward to seeing you all for an update in May, which is, if not, at the Capital Markets Day, which I hope is in your diary for the 4th of March, which is going to be amazing. All right, then. Thank you much, everyone.

Thank you.

Thank you all. Ladies and gentlemen, that does conclude our conference for today. Thank you all for participating. You may now disconnect.