Severn Trent PLC (SVT) Earnings Call Transcript & Summary

So good evening, well, certainly for us. Good morning, I suspect for any of you that have dialed in out. So I'm Liv Garfield, Chief Executive of Severn Trent. I brought with me Helen Miles, our CFO; and Shane Anderson, who looks after Strategy, Regulation, Sustainability and Transformation. And what we're going to do now, I guess, is we're here to answer any questions that you've got in terms of the draft determination presentation that we issued earlier today. We know that there are literally thousands of pages, thousands of models, a whole heap of commentary from lots of analysts on it, and we thought that we're trying to cover investor calls at different times of the day or night to enable any investor that wanted to ask us anything specifically to do that now. Now we've got a couple of questions that have come in already in the last couple of minutes online, but we thought we'd see any live questions at any stage, then just literally put your hands up, kind of like to the normal flag and we'll come straight to you. In the meantime, I'm going to start with the 4 or 5 questions that have arrived online. Is that's all right?

So Helen, you're first up. So one of the questions coming is, so how does transition spend actually appear when we look at our RCV growth rate?

Great question. So the RCV rate that you see in slides that we made in the presentation is 28%. That assumes all of the transition spend, which we have forecast GBP 450 million goes -- is in unpaid. The reality is that spend will come into this financial year and will be adjusted in the RCV at the end of [ Severn ] and that takes our RCV growth then to 24% when you adjust that expenditure. So that's how you'll see it flow through.

Very good. Okay, good technical one to start off with. Shane, I've got one now, which is a bit more of a high level one, which is, what do you think could change between the draft determination and the final determination?

Quite a lot. I think even of what's singled out in its documents by comparing previous draft determination and final determinations. So I think a few things that will change. So first of all, it always utilizes the latest data. So they'll have another year of cost information and another year of debt information and ODI performance. So that will flow through. So you expect what, we'll look at the cost of debt that companies have been taking on in the last 12 months and updated the embedded debt. They'll be looking at totex performance, so what we've been spending on our assets, and that will flow through the cost models and given companies are spending more at the moment, that will naturally lead to an improvement in the base cost models. And on ODI as well, Ofwat's been very clear they're looking to set a very balanced package with equal chance of upside and downside. Still we're looking to perform [ as ] data to inform their decisions as well. So I think in the round, we think of what use that data. And then of course, we'll be making representations on business cases. And Ofwat has given us very clear feedback on what we need to do for some of the cases like WINEP and things, so that's -- the WINEP is the environmental national program. And so we'll be providing feedback to improve our enhancement cases, and that will obviously lead to higher totex and RCV growth.

So quite a lot. And you can imagine that we're in detailed conversation with Ofwat. So where the time [indiscernible] works, might be touching on it as well, Shane?

Yes. So we'll be working through until the last Wednesday in August when we submit our business plan, I think it's 28th of August. At noon, we then have some more engagement with Ofwat and then it's quiet until the middle of December.

Well, I'm quite sure it's quiet. But effectively, we have a whole lot of documents that go in now over the next few weeks. And then typically, the requery process begins again. And so we'll submit a lot of information on everything what was asked for. They will then query, and we'll get involved in individual conversations around the specifics. That's probably a pretty busy time we'd expect between now and Christmas, for Shane. Now one more detailed specific question, Helen, just for yourself is can you comment specifically on what you think will happen in terms of cost of debt and what Ofwat has said, whether it's the cost of debt being put on part of the WACC, what has Ofwat said around that?

Yes. So the cost of debt that has gone into the WACC in the draft determination is up until '22, '23. What it doesn't include yet is the most up-to-date data. So that will be from financial year '23, '24, where we know across the sector, cost of financing have gone up. And Ofwat said they will update the cost of debt in the WACC for those latest costs and also potentially for FY '25 an estimate when we get to the final determination in December as to what we've seen so far this financial year. So we are expecting those cost of debt to go up.

So one for me now. And don't forget, by the way, if you've got more questions you'd like to ask live and then just use your hand feature in the normal Zoom chat situation. And by the meantime, one that come through for me is which of the enhancement business cases did Ofwat not approve? Well, the good news is that they approved all of them, just not all of them to their full amount. So I think for some of them, it did literally get an almost 95%, 97% tick through. And that was typically on anything where we had good models, good benchmark models across the sector, then we were able to evidence that an Ofwat could look at it, so metering or I guess, new water resources, things where you can see what the cost would be. Ofwat was able to cross compare, and we came up very efficient, and we typically got the vast, vast, vast majority of the money. Where there was maybe a business case, it was unique to us or maybe one other, I'll get Shane to flesh out a couple of examples in a second. Then on those ones of what they call shallow dives or deep dives and what they've seen across the sectors because they've not been able to really get through all of it. They now need more information from us to evidence it, then you've seen pretty severe cuts on a number of those cases. So the need has been agreed on all 13 business cases whether we've yet been able to provide all the evidence or whether they've been able to read or they able to go through it and cross compare it to the same apples-to-apples basis with every other company is where the debate still remains. And we expect to see quite a bit of movement on that between draft and final. Shane, do you want to flesh that out?

Yes. So a couple of good examples would be the Water WINEP program. So as we've talked about, we have to make a number of cuts to our instructional licenses as part of the environment agencies program to restore sustainable instructions and the like. And so ourselves and Affinity both have this challenge where we're going to be reducing abstraction and then building new capacity and replumbing the network. And this has never been done before at the scale we're doing. So both ourselves and Affinity have seen quite material cuts here because Ofwat actually can't build a cost model when they've only got 2 examples. So looking for more evidence. So there's one very large example. And the other would be on Bioresources, where we're building the first pelletization plant, as we understand, in the U.K. And Ofwat can't benchmark that. So they want more information to be comfortable at the cost allowance.

Very good. And this is the last of the questions that's come through. So I guess we'll take this. We'll see if someone's hand dramatically is up or another question comes through. And if not, then we've given you a nice cheerful start to the day wherever you are, maybe afternoon, nice cup of tea. And for us, we'll call it a day as well. So the last question then is one for you, Shane. So can you talk through the comments that were in the draft determination that related to the fact that we need to do an equity raise and the linkage in terms of what they would expect from the dividend policy as a result of that equity raise.

Yes. So when Ofwat said we need to do an equity raise, it's not Severn Trent actions. It's the notional company. So Ofwat price review always assesses the notional company. And they said, given the high RCV growth rate, the 28% that Helen talked about, to maintain your gearing at a sustainable level, you need to raise equity. And their solution was to reduce the base dividend yield to 2% and assume a GBP 500 million equity injection. Of course, in the actual company, we've raised GBP 1 billion and set our basic dividend yield at 4%. So it's not disputing or are having any problem with what we're doing, just they have a certain way they deal with the financeability constraints at the notional company. So I think they're quite consistent with what we're doing there. So there's no dispute with our equity raise or our 4% dividend yield.

Very good. Good, Paul has come up with a question. Excellent.

A couple of questions. Just on the outstanding status of your submission. I'd just be interested to know in the discussions with Ofwat, I'd imagine there was some toing and froing between yourselves and Ofwat. And so I just like to know how that occurred. And were you fairly a part, say, in the early days or where you fairly aligned. And so this was fairly straightforward to get to this position.

Good. So you remember the last time around in the last price review, Ofwat had this top category called exceptional, but they never gave it, they had exceptional. They then have fast tracks. They then had standard and then whatever they had as the [indiscernible] and -- but they never gave it. And when we discussed it with the last time around when we were fast track and said, what would it take to be exceptional. They were like the list would be too long, you're too far away for anyone to get to that situation. So we've decided not to offer it. And one of the things we've said, I guess, constantly over the last couple of years is if you have a top category in this case, outstanding, then it's really important to us to understand what needs to be true to actually reach it and often made a commitment that actually they would look at across the piece, the most ambitious plans in the sector, but it was always clear that they would also maybe have a couple of our asks that were with that kind of sense of. You've got a really good ambitious plan, but we also have a couple of things that we think is important for us to announce alongside that. So the 3 things that they asked for. We did have some good conversation about the detailed specifics of those 3. But actually, I always for the first, second of the conversation, understood why those 3 were important. There was no bigger topic in the U.K. right now than spills. And so it's fair that they wanted to see real commitment in that space. It's the reason that our plan was kind of like so outstanding is the fact that we are going bolder than anybody else in place. And they want to make sure that we don't embarrass [indiscernible] fail to deliver. And so what they've asked for is us just to deliver an average of 14 spills once in that 5-year period along with the investment committed to. I'm delighted to commit to that because I want to go beyond 14. I've always been clear that that is the right regulatory target that is different to all our internal ambition as an organization. We need to get down to world-class best practice on spills. We take it off the debate point for our investors to be something you don't need to worry about the investment in Severn Trent. You don't need to worry about spills, we fix that, right? So that was the first thing. The second thing was around 4-star status. And I think what was important here to them is that it is a big accolade. It was announced actually yesterday that we're now 4-star for 5 years on the bounce. And it's important to Ofwat that the companies do attain that. I mean that is what they expect every company to try and reach is 4-star status. That's what the environment agency said, and therefore, we are today. Now again, they've asked us to deliver 4-star once in 5 years. So they're really saying, "Look, we trust you. We've just got to ask you to show that you're going to do at least once in 5 years." That's not unreasonable by any stretch. We've delivered every year for the last 5 years. We're on track in for this year. And we've been mortified to not deliver 4-star again in our future, that will be something that will be alien to us as a senior team. So that again, is very fair. And then the last one was linked particularly to the fact that our bill increase is moving, and we are getting a lot of RCV growth because we've got really good stats on our customer support. But it didn't -- again, it felt right. But now that we know that we are getting at least 28% real RCV growth and that's likely to increase based on what Ofwat said themselves and based on new asks that we can see coming in from government for some more spend, then they said, as it is now confirmed a real 28%, we would like you to contribute a little bit more to the affordability situation. And we looked at the team and said, yes, certainly fair enough, actually, we don't want anyone to be in water poverty. We are now increasing by a decent percentage, then we feel comfortable putting in the next GBP 25 million. And don't forget, they've given us GBP 80 million extra on the retail model. So we'll be able to fund the GBP 25 million out of the extra contribution they've also accepted we are an efficient company, second most efficient on retail by resources and waste. And that means we've been given all the base cost that we asked for in those areas. That also assists us in being able to fund that. So hopefully, that gives you a little bit of the color of the conversation.

No. That's fabulous. And just a follow-up question. Like in the very unlikely event, you don't meet those conditions for outstanding plan like maybe it's more of a practical question. Like I presume it obviously it has to wait until the end of [indiscernible] and there's an assessment made [indiscernible], and then you have to pay back return or something or some sort of true up.

You have to pay back -- you have to true up. You have to pay back the GBP 93 million or GBP 92 million. Fundamentally, the easiest way to solve that is we need to hit the 4-star status and the 14 spills early in the AMP and then we've not got any investor worried about. What does this mean? So the answer is not to leave it to be a back-end loaded delivery, isn't it? So internally, that's our ambition is just we're confident we can definitely do these targets. Let's just show that by delivering that in the first 3 years. And if we can do that, then we're not kind of waiting until year 4 and 5 to achieve it. That's got to be our ambition. It's to go early and to achieve it early. Very good. So that was exciting. We know the technology in our work for least, which is always good. I've now got a question on my -- So David Costello, thank you very much, David. So 2 questions. So get ready team. So the first question then is, having seen more detail regarding the regime, are you comfortable that you can deliver at least a net neutral incentive outcome under the scheme? This is the first thing, so my guess around ODIs. But I think it's also about ROI, right? So let's just cover that off. And the second one then is, is the price control ROI risk range, a subset of the outcomes ROI risk range is subject to the same aggregate sharing mechanism? So I guess, Shane, I'm going to [ see ] the detail of the second one first, right?

Yes. So I think Ofwat's increasing the coverage of the aggregate sharing mechanism. So previously, the mixes weren't part of what was going to be including in the sharing mechanism. So they are proposing now that C-MeX, which is more high-powered D-MeX, which is definitely more highly powered and BR-Mex will all be part of the aggregate sharing mechanism. So the answer is yes.

Good. Hopefully, that quickly answers that one. On the first part, I mean -- so if you look at what Ofwat says openly in their document, their methodology is it says very clearly that they're going to have a symmetrical up and down. They're going to have fair metrics based on performance and life, and they're going to make sure that it's possible for good performance to perform well. Now do I think they've got every metric correct yet against that, then no, I don't. So for example, C-MeX currently shows, as an example, is a symmetrical measure and actually, no company is going to make money on C-MeX as it currently stands, because they're putting extra triggers, which means it's impossible. Now this is not a measure we've earned money on in the last period of time. We've got hopes of the future. But nonetheless, the point is it's a very good example of how currently the risk range isn't quite right because you've got something showing as actually symmetric, which is definitely completely asymmetric. So there will definitely be movement on the incentive regime between draft and final.

It's probably important to emphasize, Ofwat's methodology said they want to address asymmetry at the source as well. So that's why we're making these representations.

So the key thing that they will say to us is just make it really clear. And the way Ofwat will have created the regime up till now is that they have looked at it purely from a kind of like psychological, what am I trying to drive value against. So I want to do a lot of more focus on pollution that's increased the pollution or lot focus on leakage, I think increase the leakage rate. What they'll then need to have is all the company's latest performance metrics, all the company's latest forecasts, they'll need to look at all the representations that will come in and make it clear that some of these things probably are a bit punitive in some areas. And then it will tweak again while you try and get to the final determination. Now last price review, this negotiation has gone on behind the scenes before you accepted fast track status. This time around, that's not how it works this time around is that you receive your outstanding status regardless of the representations you now make, but it means you don't get to negotiate behind the scenes, you have to negotiate as part of the draft determination process. So am I confident in the end that good companies will earn fair rewards? Well, that is all over the Ofwat methodology. So I believe that is where it will end up. Do I think currently all of the ODI targets are right? I don't, but I don't think Ofwat would also say they've got everything right at the stage either. It's why they have a draft, they get a draft to get the representations to get to the final. Hopefully, that answers your question, David. But I think you're also online, so you can ask another question live if you'd like to.