Severn Trent PLC (SVT) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Liv Garfield, Chief Executive of Severn Trent. I'm joined by James Bowling, our Chief Financial Officer; and Shane Anderson, our Director of Strat and Regulation. And I hope you can all hear us, and hopefully, you can also see the slides on screen. Now if anyone is dialed in on audio only, that a PDF of the presentation is also now available on the website. So the last few days, we've been eagerly digesting all 1,454 pages and 151 data tables of the draft methodology since it was released last Thursday morning. Now, you might not all be quite as keen as we are, so we thought it might be worthwhile having a quick phone call today to share both our key takeaways, but also the opportunity at the end for some questions and answers as well. So let me start with a bit of a summary as to how we take it. So overall, it's certainly an evolution of PR19 rather than a revolution, but it is a complicated methodology that is going to take a lot of detailed reading to really get to the bottom of understanding every last point. Happily, Shane runs an expert regime, and they're busy digesting all the changes of nuances we need to make sure that we've captured every last point. Now the good news, though, is we've done a few retools already. And while there will be plenty of us to chat through in the coming months with Ofwat, there don't appear to be any big standout issues deep in the document that you might have missed. It is broadly, as it's covered off upfront. So as we expected, given the current cost of living situation, customer affordability is a clear priority. And it's actually 1 of the 5 tests that Ofwat will use to grade all of the plans, and Shane's going to touch on that grading in just a moment. So as well as it's been just the right thing to do, to be honest, the launch of our new affordability strategy back in May, with the goal of making sure that nobody in our patch dreads their water bill hitting the doormat, puts us in a really brilliant starting position on that test. The second big focus area that, again, isn't surprising to any of us, is long-term multi-AMP investments. And that's shown upfront in those 5 tests again, with Ofwat expecting companies to show ambition on big programs, especially when it comes to environments. So our take is things like our net-zero target, our Get River Positive plan and the WINEP program will all be key features. Now of course, our focus is going to expect companies to keep getting more efficient and spend every last pound of customers' money wisely. And we're encouraged by the innovation [indiscernible], with the continuation of the Innovation Fund, established this AMP, and now there to stay for another 5 years. Similar to PR19, there are going to be winners and losers. It will come as a no surprise that we fully planned to be a winner, and the continuation of the ODI framework into AMP8 and beyond. And the strength in incentivizations attached to it is one of the key areas that we focus on, making sure that we deliver the right cycle for customers, whilst achieving meaningful rewards against stretching targets. And last point on the summary then is that financing continues to be an important part of the next price year and a key component of our success to date, and there's a particular focus on financial resilience and strong governance. And again, companies will be assessed against that. So before we dive into the detail, and I'll let Shane get excited about all the things that we've picked up, let me, first of all, have a quick look at the 4 ambitions that hopefully sets up PR24. And this is almost like the Ofwat ambition Ofwat strategy situation. And they want companies to focus on the long term, to truly understand their customers and communities, to deliver greater environmental and social value, and to drive efficiency and innovation. Now they want us as a sector to achieve these ambitions against the backdrop of climate change, affordability challenges and rising customer expectations. Now hopefully, that kind of large strategy is not a surprise to anyone on the call today. And I believe it's fairly aligned with our own ambitions and our own expectations. And we can see each of the ambitions and challenges are clearly reflected in the details of the methodology. So stay through the process, let me hand you over to Shane, and then James and I will cover some more things later.

Thanks, Liv. So just touching on Ofwat's approach to PR24, and starting with the 5 tests that we're using to grade all our plans. So Liv has already highlighted customer affordability and acceptability and the long-term delivery strategy, the 2 of the tests. We also have 3 other tests. The first related to data information and assurance; the second, on risk and return; and finally, cost and outcomes. So across these 5 tests, Ofwat will expect plans to be high quality and ambitious. When it comes to quality, there are a lot of requirements of what have set out in order to get the top marks. Hopefully, we have an experienced executive team, with most of us having been here throughout PR19. And of course, a very strong regulation team who will practice in producing high-quality reg submissions. For example, just last year, when we were able to secure 566 million for our green recovery program. On our ambition, second part, we've never shied away from looking to set the benchmark for the sector, as you'll have seen from the recent Get River Positive plan and our affordability scheme. But of course, our overriding aim will be to make sure that our plan is the right plan for us in the long-term interest of our stakeholders. So once Ofwat have graded our plans, we'll land in one of the 4 categories shown that's outstanding, standard, lacking ambition or inadequate. Just to put PR19 into context, the standard category is equivalent to what was fast tracked, which we landed up here at AMP7, PR19. So if we're to achieve the same again, we'd retain a 50-50 totex cost-sharing ratio, and we get a WACC benefit of 0 to 10 basis points, which is broadly in line with fast track benefits. If a company were to make it in the outstanding category, and as a reminder, no company made into that top category at PR19, then they would receive a 30 basis point increase in the WACC. And that also be protected for any decline in the WACC between the draft and final determinations if it were to occur. If you don't make it into 1 of the top 2 categories this time, then there is a bit more downside risk. Any company which ends up in the lacking ambition category will be facing a 55-45 totex cost sharing mechanism and a penalty of up to 30 basis points on the WACC. And any inadequate plans will have 60-40 sharing ratios and again, a penalty of 30 basis points. Back over to Liv to talk about customers and what matters most to them.

Thank you very much, Shane. Now it comes as no surprise that customers are named as being right at the heart of PR24. As we mentioned earlier, having ambitious strategy affordability is going to be an entry requirement for any plan in the sector. Now one of the changes of what looks at the company to show that their customer engagement has been really, really needful, and will also be offering their own research as well as proposing that every company has what's been called open challenge sessions. So we're looking forward to these. We think it gives us the opportunity to really test our plan with our customers and make sure we're truly delivering exactly what they want, which is, of course, right at the heart of how we want to actually run the organization. Of course, let's move on and understand how ODI plays into our conversation. Our biggest interaction with customers is in the service we deliver to them each and every day. And the way we should get measured is predominantly in ODIs. And again, it looks more like an evolution or a revolution on ODIs, the framework and how they operate is pretty much in line with what we have in PR19, with the same RoRE range and the continuation of both common and bespoke ODIs. A few things that are new. So for new common ODIs and for bespoke ODIs, there's going to be a cap and color of plus or minus 0.5% of RoRE. And unlike in this sample, ODI, is much more weighted to the downside of what had indicated the PR24 RoRE are going to be largely symmetrical. Now that won't be the case for the common, where companies can get enhanced and uncapped rewards for frontier performance, providing more upside opportunity. And that's one of the areas we've seen some strong incentivization. Another is to rate themselves, which have increased up to 70% of customers' willingness to pay in terms of value terms versus the 50% for PR19. And the final thing that's new then is there are bigger suites of common ODIs, 20 that apply to us, but, of course, we're only expecting a very small handful of bespoke ODIs from each company. Now in terms of getting ready, because this is like the starting kind of a price as to how we see it. One of the good things is that we've got a really clear view of all 20 of the common ODIs. So plenty of us to be working on. And here on this slide are the 20 common measures that we'll all get very familiar with in the course of AMP8. Many of them are straight lift across from PR19 to PR24. In fact, 14 for Severn Trent are measures we've been delivering against AMP7. Some of those have been common already. Some have been bespoke for us for the last few years and some actually measured to the annual environmental performance to EPA assessment, which, as you know, got a strong track record of being a 4-star. Of the remaining 6, whilst there may be new with ODIs, they're all actually pretty familiar to us in terms of the topex. So let me talk through them. So storm overflows are something that we've been hugely focused on for a while now. We've already made great process in our community to get to an average of 20 spills a year by 2025. And that's the ODI baseline Ofwat is expecting every company to achieve. That's where you start the next AMP. You've then got operational greenhouse gases, and there's an ODI for each of water and wastewater, which is why there's 6, when you see 5 boxes. So this is something we've been working hard to understand and also to make a progress as part of our Triple Carbon Pledge and our delivery of our approved science-based targets. On river quality, it specifically refers to the reduction of phosphate coming out of [indiscernible], but also the prevention of phosphorus and to rivers wider partnership working. Now again, 2 activities, we've got plenty of experience dealing with. There's going to be a new experience measure called BR-MeX, which is going to measure the experience of business retailers when they deal with us. Now it's something that we've been working on for a little while to improve, and we've got a transformation program to see a step change in performance over the coming months. And finally, there's a new measure all about water demand. So whilst the measure is still to be defined, and it's not actually particularly specified yet, it's made of the whole suite of quite familiar topics and activities. You've got leakage, per capita consumption, business demand and different forms of sublevels of leakages, supply pipes or whether it's -- and main pipes. So nothing new in terms of the topics, but definitely a brand new measure for the whole sector, which we'll learn more about during the course of the next few months and so forth. So next, one of the great things is we've got an early view. So we know exactly what we are going to be measured on in AMP8. And I'm not saying that our performance on each and every one of you today is exactly what needed to be. There are, of course, a few in any listed measures of 20, but we need to show a bit of improvement. But actually, that's what the ODI regime is for, is to drive performance forward. And what I'm pleased with is that we actually recognize the vast majority. We're pretty good performers on a very good chunk of those. What we know, in Severn Trent, style. So if we set our minds to something, we can definitely make improvements. Let's move on now to talk about totex. So this link is one of the other big areas that is the lengthy part of the document, and it's all about investments. We're seeing some helpful consistency in the base models from the last AMP to this AMP. We are seeing references to an appreciation of future cost pressures and for example, from the inflation that we're experiencing right now. And definitely a clear long-term investment -- long-term focus on investments, and especially when it comes to environment. And that's a good indicator of future growth. So let's touch on what's the same in a little bit more detail, and then I'll talk about a couple of things that might be different. So the main thing is that the models are based on totex, which makes up the majority of your allowance as a company in our sector are pretty consistent with what we had at PR19. We're familiar with them. We know what to expect, and we know that Ofwat will be tasking companies with an efficiency challenge, as you would expect. So we'll have to begin working on that. On the new news, again, a few of the things are quite familiar actually, but there's helpful clarity and some certainty around some specific areas that we've been all talking about recently. It's clear that the methodology statements are supportive and encouraging of long-term investment planning, and that reflected in a few areas. On costs, Ofwat is considering some different options, including forecast in the models. There are also going to take into account huge cost pressures. One of the examples that they give, and one which we definitely experienced at AMP, is the increased complexity and costs associated with ultraviolet treatment, which is being used more often. And that wouldn't have been reflected in the base models of PR19. So that's a helpful indication for the future. Similarly, Ofwat acknowledged different solutions might have different cost profiles, and then provide more certainty about how this cost will be allowed for. A really good example is nature-based solutions, where the CapEx outlay might be lower, but there's a much longer ongoing OpEx and ROE cost, and that requires funding. As I mentioned at the start, there's also a bigger focus on environmental enhancement spend. So net-zero, I would have indicated that work to reduce process submissions will be funded and for anything that can't be achieved to absolute reduction. And so, for example, [indiscernible] offsetting, there'll be a bidding competition within the sector to win more funding for somewhat companies to go further and faster. And our big environmental program on WINEP. There's a pleasingly greater degree of flexibility on timing, meaning we have the ability to accelerate our work and make those vital improvements even quicker. And one last comment, and I know it's a bit niche, but I guess I am a originally a regulatory team person. Where I guess what the change is we are seeing is developer services. And you see the developer services is actually being removed from the price controls. We see this as positive. It will make the whole model a lot simpler. But again, that's a change for our regular team to work through is to make that change happen. So with that, I'm going to move on to now to James to talk about different elements of financing.

Thank you, Liv. So first, I'd just like to highlight that as in PR19, the opportunity to outperform on financing and hold on to that outperformance remains in PR24. The cost of debt will continue to be a blend of embedded and new debt, with embedded debt based on the existing balance sheet of companies and new debt being indexed and trued up to reflect changes in interest rates during the AMP. On the cost of equity, Ofwat will continue to use the cap end model, in combination with a number of cross-checks. In terms of what's new for PR24, there are a few points on financeability that I'd like to highlight. So first, and I think hopefully, Ofwat is adding some new credit metrics to its suite of metrics used to assess planned financeability. And these are more closely aligned to those used by Moody's and Standard & Poor's, which we, of course, reflect in our own planning assumptions. Now they're also considering lowering the level of notional gearing from the 60% that it stands at today and that we think that's to encourage greater financial resilience in the sector, which they have hinted should be made possible by the high inflation environment we're currently experiencing. And they're also looking at the level of indexing debt in the sector and considering whether that should be reflected in the notional company. Now when it comes to the financial levers available, companies will continue to be able to propose their own pay-as-you-go and RCV runoff rates, but within an acceptable range. And finally, Ofwat has recognized the important role that dividends play in equity financeability, a positive point, we think, for the listers. So moving on now to market developments, and it's a similar theme of evolution, not revolution. The price controls themselves have remained largely unchanged, with the same number of controls as in PR19 and no real changes other than to buy resources. And here, Ofwat is proposing an average revenue control that brings the sector closer to the kind of gate prices that are experienced in other waste markets. Now it's a bit too early for us to say much more on this change. as we're expecting a more detailed consultation from Ofwat in September. And one other area of competition is indirect procurement for customers, which will be carried over from PR19 to PR24, but with an increase in the threshold at which point DPC becomes default, and that's up to GBP 200 million of the lifetime totex. And with that, I'll hand you back to Liv.

Thank you, James. Now just work -- talk about this for a moment. And just to remind you that we're right at the beginning of the PR24 journey. There's an awful lot of details to pour over, and many discussions and many consultations to be had over the next 18 months or so. So the next big day in your diary, if you want to put it in your calendar, is in December this year when Ofwat will be publishing their final methodology. And before that, of course, you can imagine, we're responding in lots of detail to the various consultations set out in the draft. So there you have it, our key takeaways of the literally 1,500 pages of methodology. And certainly, a lot of continuity from PR19, with no big new surprises. Of course, a good number of challenges, and we're working through those over the coming months to understand the details of it and also discuss it with Ofwat and plenty of opportunity as we go into the next period. So those companies can deliver to very much be winners versus the sector, and I firmly consider Severn Trent to have the opportunity to be able to do that. So with that, we'll open up for any Q&A. Okay. So the way it's going to work, I think if you just click on the link, and I think people got very good questions ready. And I guess if everybody else can stay on mute, that will be it. So James, we're going to go to you first if that's all right? James Brand.

I have 3 questions. I hope that's not too many. The first is on ODIs. You mentioned that the kind of indicative range for outperformance was unchanged, but there'd be some uncapping. And then there is showing mechanism that's coming in over 3%, which, I guess, implies Ofwat thinks that some companies might be outperforming by more than 3%. So do you think there's likely to be more to go for in ODIs in this upcoming period and the period we're in at the moment? That's the first question. Secondly, pay-as-you-go and RPV runoffs and now goes down to [indiscernible] ranges. I don't recall you in an outlier on either of those, but maybe you could just clarify that you're not on either of those measures? And then thirdly, another large listed water company has been talking about significant investment in the next regulatory period related to combined sewers and reducing sewage overflows. Do you have a lot of that combined sewers? And is that a theme also for you?

Very good. I'll take 1 of 3. I think Shane will jump in on number 2. So you allowed 3 questions, James. That's fine. I mean, as it stands on ODIs, I think -- if we look at what is that, it said that broadly the range is not dissimilar to this period is what they've said at their assessment of the range. I mean, the targets are very hard. So I think -- as it stands now, I think it looks harder to achieve the same numbers. So I guess when you look at it, and it's worth being clear that they are capping the vast majority of metrics. So the metrics in the current version of the document, the vast majority of the metrics were capped at about GBP 9 million a year. Now they're colored as well, so that's downside, but they are capped. So you'd have to make good money on the uncapped ones, which are the common. So the kind of the 2-plus ones and solution. You'd have to make good money on those, and to get to similar numbers. So I think there's not as many bespoke as you had before, and typical the effects are quite strongly at this stage. So my sense of it is, there is a good opportunity at this stage because you know the areas. What you've now got to do is get into the detail. We don't know quite a lot of detail, quite a lot of measures. So for some, the detail is still to be issued as to exactly what the actual measurement process is. And of course, the key is we don't have a target. So I can't tell you if the numbers are going to be same. We need to see the target. It comes down from those targets. And the great thing is Ofwat commits to a very strong continuation between performance in this AMP through to the AMP. So if you perform strongly in the next 5 periods, years '25 to '30. It will be the same measures in years '30 to '35. So it's really worth being a good ODI performer because they're committed to the very long term on ODIs. That's great news for us. It's from the debate we've had with you guys for a long time is that you don't factor in the models long enough, ODI performance outperforms for longer because you're worried that the regulator might get rid of ODIs. They're firmly in on them for the next 2 or 3 AMPs is what they say in their own statements. And when you look at the metrics, you make more money on waste measures, but the other factor we can see is that of the 20 metrics, way more of them are waste and environmental metrics, a much smaller number are water ODIs. So that's the fact that we've seen so far. In terms of number three, so what the documents says is it says that every company, in this 5-year period, has to get down to an average of 20 CSOs from their own funding. So they won't fund but thereafter, the regulator will fund scale investment from an average of 20 CSOs, to a max of 10 CSOs every company over a 15-year journey. So we will all have an equal opportunity because the reality is, everyone have to fund themselves down to an average of 20 by 2025. And thereafter, we actually have more CSOs than anybody else. And so I guess, on paper, we have a good funding opportunity of long-term RCV growth on that basis. We're on track to get ourselves down to that average of 20, which is a start to gate position. We are upper quartile already in the sector. And we're 1 of only 3 companies committed to get to the average of 20 by 2025. So yes, so it is definitely one of the focused investment areas that is laid out in the document. If you look at our most recent newsletter, we've also listed in that newsletter the other investment areas that have come out of here as well. So that might help as well with other investment themes. And so we're not an outlier are we?

I'll touch on that. So Ofwat has said on financeability levers, you got flexibility to pay as you go and run off is within a narrow band. So on RCV runoff, at PR19, the range was 3.7% to 7.1%, and our rate was 4.6%. So we're at the bottom end of the range as compared to PR19 rates.

We want to be lower. Lower is considered to be better. Just in case that was another question somebody is going to ask us. Martin, you're up next, if that's all right?

Just a question around the categorization of the business plans. Getting fast track in PR19 was obviously great for people going to get an early start of getting totex programs, et cetera, and running. But when we think about those 4 categories for PR24, where would you need to be in order to get that head start? And sort of a linked question to that. What about sort of your management incentivization to get PR19 into the outstanding category? What's the sort of the broad thinking about that?

I mean, it's one of the interesting things to me on the price ratio, Martin. There is no head start. So last time around, if you've got fast tracked, you did actually settle earlier and you went through quicker. Actually Ofwat's not got back in this price. So one of the things they've done is they've gone from 3 gates to 2 gates. So there is no head start. So there's no reason that any company in any categorization actually can't have an equal start on their performance. So that's one thing. And the second thing is, if you look at it, then the way I would do plan at this stage is you need to get the right plan for any business for the long term. So at this stage, you need to make sure that you understand the detailed document, you go into consultation with Ofwat to really discuss all the details in the areas where we've got views. And then we'll work through the investment priorities in the portfolio, and we need to make sure that actually the right investment is funded for the long term. That's the most important thing. I'm confident we'll put forward a quality plan. I mean, there are a lot of boxes to tick for a quality plan. I'm sure my rec team felt slightly nervous when they saw the sheer list of things you go to do for a quality plan. We let ourselves to put forward a quality plan. I think it will come down to the scale of investments and where we land on that and the conversations with Ofwat. It's important to note as well that actually, if you look last time around, fast track is the equivalent standard. So nobody -- there was always an exceptional situation last summer as well, but it was never handed to anybody. So the outstanding is the same as last time's exceptional, which hasn't been handed to anybody. The fast-track status is equivalent to standard, just to make that clear as well. I've got a question here that's been typed in. Thank you, Peter. So questions follow, this is just a draft methodology. What do you expect of the outcome of the financial resilience consultation, which could potentially have an impact? Great question. So I know that Shane and James, I think James wants to chip in first, and then Shane might add a comment he wants to offer.

Yes, it's a great question, Peter, and we've been obviously looking to -- we provided our response to the consultation as I think many others did earlier in the year, and we've also been kind of keeping an eye on things as they go. I think they're going to be coming out later in the year. I think you're going to see something probably in the autumn on this. So I think it's very much watch the space on that. I definitely get the impression that of our wanting to focus on those companies that they believe lack financial resilience. And I think they will be probably focused on those companies. So it's less -- something that I think is probably of less concern to the listers, which are broadly much of -- are at the lower end of the kind of gearing range, if you will. So I think there'll be some targeted -- I'd like to think some targeted approaches from Ofwat on that. And yes, I think it will be something that we'll learn more about in the autumn.

I suppose the only other thing to add is we'll probably have more data on it as well. So when the things Ofwat does a lot more information to monitor the sector. Some of that will come more reporting requirements.

Very good. Any other questions that people have got? There's no more coming through on the view question situation. Anybody else on the phone who has a query of anything? There's a question coming through. Pavan?

I have two questions, please. On gearing, I mean, if Ofwat does reduce the gearing levels, what is your thinking about being in line with that notional versus potentially staying up the -- at the 60% of discount? Like what is your thinking on? Would you want to be in line with what they say? Or would you make your own decision? And then my second question is, can you just highlight, in your view, kind of what you're going to submit to Ofwat or maybe things in the draft document that you're not particularly happy with?

So on the first one, we've always said we're happy with gearing up to about 67% and 68%. So that's been our long-term answer on gearing. So we want to be in the 60s. And nothing has changed for us as it stands today. Now we're liking the fact. So we've been able to work hard on our cost base. We've not overspent on the AMP. We've managed inflation well, in spite it being a challenge, which means that we entered into the situation with a good gear position. So strong cost control and good delivery has been good. We also did an equity raise in the green recovery, which again has helped or going off what called out document. So we've worked hard to have a decent gain position because we know we want a strong investment AMP. So -- but that's -- in terms of like achieve the number, we'll just wait and see how time plays out of that. But that's why we've been comfortable.

Yes, I think it's important to note that the gearing that they're using is how they kind of look at the national company and the financing. So it is largely sort of the way that the WACC is calculated for the sector as a whole. And I think Liv is absolutely right. You have to -- what we have to do is to get the right gearing for us, and that will be ultimately a decision we'll make that's in the interest of all of our stakeholders and works for the plan that we want to have for AMP.

And in terms of the second part, I mean, if we began to lift out every last comment we've got on 1,500 of pages, you'd still be here tomorrow morning. So the best use at the moment is we've got teams of people calling through pulling out things. And then what we have to do is spin down to what we're very energized about and what we're not. The one thing that we -- is a big overarching thing that we're really surprised is in there, and we've openly said Ofwat already is past delivery is impacted. So we find that, I guess, interesting and probably not right for the sector reputation. That past performance hasn't actually been flash as being a real criteria for success going forward. So that's our one kind of overarching comment. But I can promise you, there's a lot of other stuff we'll work through Ofwat on and have good conversations about. And it's the start of an 18-month dialogue is the key position, I'd say. No more questions coming through. We'll just say that one last time in case somebody was tempted. No? In which case, thank you very much for dialing in. And hopefully, that saved many of you having to read all of the documents, and we'll keep you up to date as we go through the next few gate and spaces. Thank you very much, everyone.