United Utilities Group PLC (UU) Earnings Call Transcript & Summary

Good morning or good afternoon, all, and welcome to the United Utilities Group plc Half Year Results for the 6 Months Ending September 2020. My name is Adam, and I'll be the operator for this call. [Operator Instructions] I will now hand over to Steve Mogford to begin. So Steve, please go ahead.

Thanks very much, Adam, and good morning, ladies and gentlemen, and welcome to United Utilities Half Year Results Presentation for the Financial Year 2020/2021. COVID-19 restrictions mean that once again we can't meet face-to-face, but I do hope that this presentation and the Q&A that follows will give you an idea of the great start we've made against our AMP7 plans. It's been a unique start to a new regulatory period in having to adapt to the operating conditions necessary to protect customers, employees and supply chain partners. And the EU team has done a fantastic job, and I'm extremely proud and grateful for the flexibility and dedication shown by everyone right across the business. Notwithstanding these challenges, we remained very focused on delivering our AMP7 objectives. So here are the headlines this morning. First, we provide a critical service to customers 365 days a year, 24 hours a day, and never has it been more important that customers have access to water for sanitation than in this pandemic. With around 60% of our employees working from home and the rest at our COVID secure facilities, our services have been robust in satisfying the higher water demand we've experienced. The Northwest is one of the regions that's been most impacted by COVID, and includes those areas that were first to enter the toughest Tier 3 restrictions as a result of high infection rates prior to the second lockdown. Alongside this, we serve some of England's most socioeconomically deprived communities that can be most susceptible to the impact of COVID and associated lockdown restrictions. And so it's been one of our key priorities to continue to provide support to those customers facing difficulties during these times. Many of the communities in which we operate are struggling, and we've played our part in trying to help. More of this in a few moments. Second, we were well prepared for AMP7. Fast track status, and our early investment in the last year of AMP6 gave a supplying stop against our AMP7 targets, and we're doing well. We've accelerated our capital investment plans, spending more over the next couple of years than our original PR19 business plan to secure improvements earlier in the period for customers and the environment, along with accompanying ODI rewards, and contributing to the green recovery in our region. Third, and Phil will take you through the numbers, our financial performance has again been strong over the first 6 months of this year. Revenues have held up well, cash collection has been good, and our balance sheet and pensions position remains strong. And finally, dividend policy, again, Phil will give you more color, but we now have a clear understanding of the impact of COVID on our business, which remains robust and supported by a strong balance sheet. This, together with a stabilized inflation outlook, gives us the confidence to reaffirm the AMP7 dividend policy we announced earlier this year of growth in line with CPIH inflation. I'll now unpack some of the details, starting with our operational performance over the last 6 months. I mentioned that our services have been resilient to the unusual demand patterns we've experienced. Over the first half, we've seen a 3% higher net demand for water, with domestic demand exceeding the reduction in business consumption. At peak, demand was up 22% during the hot dry spring. Domestic retail cash collections remained strong due to a tremendous effort by our cash team in working to help customers in difficulty and collecting from those that can pay. Domestic bad debt has therefore been held at 1.8% of revenue over the first half. As COVID restrictions continued, we're seeing businesses make more redundancies, which could impact customers’ ability to pay. But as we stand, we're comfortable with the GBP 17 million additional bad debt provision we took at the end of last year. Our confidence is enhanced by the agreement we secured earlier this year to expand the scope of our social tariff. This has the capacity to extend support to up to an additional 45,000 customers who are struggling to pay their bill. The business retail environment remains challenging, but the liquidity support provided to retailers during the pandemic, including our joint venture Water Plus, has been invaluable. This will unwind progressively by year end. Retailers are now beginning to build those customers for whom billing was suspended. And Ofwat is currently consulting on the bad debt release retailers may be given beyond 2% of revenues, and we await the outcome of these deliberations. I'm extremely proud of the focus and empathy that our customer-facing team has shown during these unprecedented times. We have an extensive range of schemes available to help customers, and so far this year, these have helped over 3x more customers than for the same period last year. In total, around 142,000 are currently benefiting from support with their bill, representing about 5% of our domestic customer base. We committed to provide GBP 71 million in financial support to customers of our AMP7, and we've accelerated payments this year to provide much-needed assistance. We've also sought to play our part in helping the communities we serve get through the pandemic. Just a few examples. During school closures, our education team created a home learning hub, which supported teachers and children across the region with material for home schooling. The resources were accessed by over 7,000 users, and our reach even extended to schools in Italy. We hosted the sector's first Social Mobility Summit, of which more than 100 organizations joined us to launch our opportunity action plan, outlining our commitment to the Social Mobility Pledge. Recruitment of apprentices and graduates has continued uninterrupted, along with our youth program, helping young and employees, including our support of the Kickstart program, offering training and meaningful work placements for initial 250 young people with scope to increase further next year. And finally, our ongoing charitable support, including the Board's voluntary salary reduction, has helped provide welcome support to local communities. One of our donations to the FareShare charity has supported them in delivering 600,000 meals to half press families via local food banks. Our investment in skills has continued throughout the pandemic. Our Technical Training Academy, established in 2014, has to date provided skills development and certification to around 2,500 employees and includes programs for those individuals not in education, employment or training. I mentioned earlier that we're fortunate to have a workforce that has shown flexibility and commitment to maintain customer services. In surveys, we consistently find ourselves among U.K. high-performing companies for employee engagement. But our employees aren't immune from the hardship that has beset so many families in our region, and so we've established a staff outreach scheme that provides financial support to those whose families are struggling financially as a direct result of the pandemic. Like many other businesses, the pandemic has been a catalyst for the acceleration of our digital strategy, and I can't see us returning to the way we did business before COVID, and we're carefully considering what our new norm will be. I'm very pleased with the start we've made through AMP7. As I mentioned earlier, securing fast track status in PR19 gave us early certainty of our targets and time to get a flying start to the new regulatory period. We invested around GBP 130 million in the last year of AMP6, in projects that improved customer or environmental outcomes and the opportunity to outperform our ODIs. In AMP6, we accelerated our capital expenditure in the first 2 years to deliver schemes early, and we're doing the same in AMP7, with around GBP 500 million of our total expenditure brought forward mostly into this year and next. Our AMP7 scope has been extended with the enhancement of our wastewater treatment facility in Bolton, and work on our critical Vyrnwy Aqueduct, totaling around GBP 150 million in AMP7. Operational performance in the first half has been another year-on-year improvement, and customer satisfaction remains high and on track for a first year reward under the new C-MeX incentive mechanism. We've maintained our sector frontier performance with no serious pollution incidents so far this year, and we're on track for industry-leading 4-star environmental performance for 2020. And I'm pleased to say that we've successfully completed the replacement of the Hallbank section of our Haweswater Aqueduct. The work was initiated AMP6, funded from AMP6 outperformance, delivered on time and within budget and replaces the section of the Aqueduct considered to be most at risk of failure based upon surveys conducted in AMP5 and 6. Our AMP7 business plan was assessed by Ofwat as being amongst the most efficient in the sector, and I'm happy to report that following the action we took during AMP6, we start AMP7 at the target totex run rate. So we're confident we can deliver our AMP7 scope within our final determination totex allowance. And our plans have us delivering the committed outcomes, investing to drive further efficiencies and delivering ODI outperformance. Whilst our goal is to deliver totex outperformance, we will invest totex, where we're confident that we can deliver greater ODI performance through improved customer or environmental outcomes. AMP7 is different to AMP6 in that our ODIs are measured annually and result in a revenue adjustment 2 years later. We're currently on track for a net ODI reward for the first year of AMP7. As you know, we have 46 ODIs in total, but this slide shows you where we're currently predicting to be at year-end, for the main contributors through a net ODI reward. The largest rewards are expected for our performance in reducing the risk of hydraulic internal flooding, pollution and reducing the number of void properties. Against some of our tougher ODI targets, we anticipate being in penalty, although system thinking is playing a key role in improving our performance in these areas. And we'll be talking more about plans at our Capital Markets Day in the new year. Currently, we expect to earn a net reward of around GBP 10 million this year. Our total outcome will clearly depend on performance in the second half, and we awaited to get through, but we also have opportunity to do better. Across AMP7 in total, we're targeting a net ODI reward in excess of the GBP 44 million we achieved in AMP6. And finally, AMP7 dividend policy. Phil will add more color in his section, but we now have a clear understanding of the impact of COVID on our business, which remains robust and supported by a strong balance sheet. This, together with a stabilized inflation outlook gives us the confidence to reaffirm the AMP7 dividend policy we announced earlier this year of growth in line with CPIH inflation. Phil, over to you.

Thanks, Steve. Good morning, everyone. Having met many of you when I was Group Controller and prior to that Group Treasurer, I'm delighted to be presenting my first set of results to you today as CFO. This morning, I intend to highlight our strong financial performance and drive the main financial points in relation to COVID-19. As COVID-19 is now regressively part of everyday live, we have not made any adjustment for its impact on our non-GAAP financial measures reported today. I will then discuss the robust nature of our balance sheet, focusing first on our customer receivables position before covering familiar ground on RCV gearing and of course, pensions. Having summarized our strong financial performance and robust balance sheet, I intend to provide more detail on the Board's confidence to reaffirm our AMP7 dividend policy today. Lastly, I intend to give you some high-level forward guidance for full year outlook. Here are the key financial highlights for the half year. Revenue of GBP 894 million is down 4.4%, largely reflecting the known price reduction in this, the first year of the new regulatory period. Household bad debt is 1.8% of regulated revenue, which is consistent with the pre-COVID rate in the prior half year. Underlying operating profit of GBP 319 million is down 18.5% as a result of the falling revenues and planned higher infrastructure renewals expenditure. As a result, underlying EPS of 25.5p per share is down 16.1%. Our balance sheet remains one of the strongest in the sector with low customer debtor risk, RCV gearing of 63% and the pension scheme is fully funded on a low dependency basis, all of which support the stabilized A3 credit rating from Moody's. I'll now consider these points in further detail. On the left-hand side of this slide, we provide a bridge of revenue from the first half of last year to the first half of this year. In summary, revenue of GBP 894 million is GBP 41 million lower, largely reflecting a no price reduction in this, the first year of the new regulatory period. Now turning to each of the components in the bridge. Revenue in the first half of last year was reduced by GBP 6 million due to the impact of the wholesale revenue forecasting incentive mechanism, which does not apply in the current year. In this first year of the new regulatory period, we had a known reduction in the revenue cap, which in the first half is GBP 40 million, representing a 6.6% reduction in average household bills and a 1.5% increase in CPIH. In the nonhousehold market, we have seen a GBP 40 million reduction in revenue due to lower consumption and businesses being assessed as temporarily vacant during the first COVID lockdown. In contrast, in the household market, we have seen GBP 26 million increase in revenue due to the impact initially that people being locked down at home with the warm weather in late spring and then many of them continuing to work from home longer term. On the right-hand side of the slide, we set out our market guidance for full year revenue to March '21. In the second half of the year, we expect the impact on nonhousehold revenue to be broadly consistent with the first half, while the impact of household revenue is likely to be reduced as we won't benefit from the increased consumption due to the warm weather. Our current guidance is that full year revenue to March '21 will be between GBP 60 million and GBP 110 million lower than the prior year, with the volume impact estimated at between GBP 10 million and GBP 60 million. Under the revenue cap, this volume impact is recoverable in 2 years' time. I will now talk through 3 key points on household cash collection and bad debt. The first key point is that cash collections remained robust through the first half of the year, with cash in relation to current year charges in line with last year. The support that government has provided to the job market has been helpful. And although inevitably, there remains a degree of uncertainty into the second half of the year as we have seen with the second lockdown, government policy remains to provide the support necessary to protect jobs. Over recent years, we have focused on relenting way on improved data quality, business processes and systems to ensure that we are able to accurately pursue payments in an efficient and timely manner. I was, therefore, delighted that this was recognized in the 2020 Credit Awards with our customer team winning the Best Use of Technology Award for their work on the new debt management system. The second key point is that while cash in relation to the prior year charges is slightly down than last year, this reduction is less than we expected when we got the GBP 17 million incremental provision in March '20, which also prudently assumes the low level of cash flow persisted into future years. As such, we remain confident that balance sheet is adequately provisioned more on this [ shortly ]. Where customers want to pay their bills that have a clear affordability issue, we're able to offer the widest range of affordability schemes in the sector. And as Steve has already mentioned, these have been extended this year with the addition of a third social tariff, providing GBP 15 million per annum to support customers struggling with the consequence of COVID-19. The third key point is our household bad debt charge for the first half of the year has been maintained at 1.8% of regulated revenue. This is consistent with where we work in the first half of last year and the underlying position for the full year to March '20. In the current year, we've also enhanced our credit reference sharing process to include another agency with a greater high street focus. This will further extend our footprint and improve our collections activity. This is just one example of our comprehensive approach to collections activity, supporting our ability to collect cash from customers who have the ability to pay but attempt to avoid doing so. In the current climate, it is totally reassuring that customer team's comprehensive approach to collections activity was further recognized winning the headline award for Utilities & Telecoms Team of the Year in the 2020 Credit Awards. These factors give us confidence that we will continue to be able to perform well as the job market and unemployment picture evolves. On this slide, we provide a bridge of underlying operating profit in the first half of last year to the first half of this year. Underlying operating profit of GBP 319 million is down GBP 73 million. This principally reflects a GBP 41 million reduction in revenue and a GBP 15 million increase in infrastructure renewal expenditure as a result of ongoing work to optimize the performance of our network as well as including adverse weather-related expenditure of GBP 3 million. Property rates are higher, largely reflecting GBP 8 million rates refund received in the first half of last year. Employee costs of GBP 5 million higher, partially reflecting a margin reduction in capitalized costs with only 45% of employment-related costs charged through the capital programs. Having ended AMP6 with required totex run rate for AMP7, we are confident that we can control our cost to [ live ] within the AMP7 final totex. Lastly, we have incurred GBP 3 million of extra COVID-related costs, which along with the GBP 3 million adverse weather-related expenditure, I've already mentioned, have been absorbed within our cost base. In total, this is GBP 6 million of expenditure, which has not been treated as an adjusted item when calculating our underlying operating profit. Focusing next on the remaining key lines of the income statement. Our underlying net finance expense is GBP 109 million, which is GBP 34 million lower than the first half of last year, predominantly reflecting the lower inflation applied to our investment debt. Our share of profits of joint venture is GBP 3 million, mainly relating to our current JV. Our share of Water Plus losses for the prior year resulted in us reducing the group's net investment in Water Plus to 0 at March '20. As a consequence, our GBP 6 million share of Water Plus losses for the first half of this year is not recognized in the income statement. Our underlying tax charge for the first half of the year is GBP 39 million, representing 18% of underlying operating profit -- underlying profit and excludes the impact of deferred tax, all of which results in underlying profit after tax of GBP 174 million and an underlying EPS of 25.5p per share. Now looking more closely at financing performance. Over at AMP7, we have around GBP 2.4 billion of financing to raise. Since our full year results in May, we have raised around GBP 600 million, taking advantage of attractive rates and extending our liquidity position out to September 2022. Over this period, Central bank stimulus has been very supportive of strong investment-grade companies like ourselves, and we expect this to continue to be the case, providing us with efficient access to the debt capital markets in the future. This chart shows our projected debt balance across the AMP, together with the rates that we have locked in. These rates have got favorable compared to the price of your assumptions to AMP7. In August, we executed our first CPIH swap, resulting in GBP 50 million of debt, now linked to CPIH, and therefore, a perfect match to the regulatory regime, we believe this will be one of the first CPIH swaps and is the first step to increasing our CPIH linkage in our debt portfolio. And finally, on financing. Yesterday, we published a new sustainable finance framework, allowing us to raise financing based on our strong ESG credentials. We have always had a sizable proportion of funding supporting environmental projects, and this historically has been funded by the European Investment Bank. Post Brexit, something raised through our sustainable finance framework will replace our green EIB funding and sits alongside our conventional issuance. Now turning to our customer receivables position. Given the uncertainty created by COVID, we anticipate that be a keen focus on the comparability of household debtors. As discussed earlier, this has been an area of intense focus for us the most of the last decade. The chart here shows our household net debt position over the last 5 years. The position has been robustly managed, and our strong performance manifests itself from the balance reducing from GBP 115 million in 2016 to GBP 78 million in 2020. As of March '20, our net debt balance of GBP 78 million was the lowest that has been for 5 years, and it's one of the best managed customer receivables positions in the sector. Our bad debt provisioning policy ensures that debt more than 3 years old is fully provided, and as we believe this is the extent of any credible recovery period. And as you can see, the balance sheet exposed to debt more than 1 year old is just GBP 17 million. Knowing that our customer receivables position was well-managed coming into pandemic crisis, gives us added confidence as we look to navigate the challenges ahead. This slide bridges the net debt to March '20 to September '20. Net debt of GBP 7.4 billion has increased by GBP 35 million since March '20. This incorporates the change to our definition to exclude the impact of derivatives, but are not hedging specific debt instruments, and therefore, gives a better reflection of debt balances we are contractually obliged to repay. This updated approach is now more consistent with that taken by the credit rating agencies and better reflects the regulatory economics. The change in definition reduces net debt by GBP 178 million at September '20 compared to GBP 135 million at March '20. A full description of the adjustments are included in the appendices to this presentation. The usual movements in net debt are shown in this bridge. The credit rating agencies also make further adjustment for any IFRS pension deficit, which is not relevant to United Utilities given our IFRS pension surplus position. Now considering pensions in more detail. As we know, pensions can be a nice progress. While the focus is often on the IFRS deficit that can be observed, the full extent of the pensions issue, measured on a low dependency basis, is unobserved below the waterline. Back in 2010, we did have a pensions iceberg with an iceberg deficit of just under GBP 300 million. Ofwat has just concluded the PR09 [indiscernible] and drawn a line on the future funding of pension deficits beyond the 60% support for the deficit that existed at that point in time. Recognizing this, we established a joint working group with pension trustee to manage the pension risk collaboratively, and within acceptable risk and affordability envelopes. This innovative approach to government is another example of ESG in practice at United Utilities, driving long-term value for all stakeholders through responsible strategic financial management. The impact is illustrated in the center of the slide. In terms of the recent evolution of acquisition, you can see that at September '20, our IAS 19 surplus was just over GBP 650 million, and that temporary spike in credit spreads due to COVID that we witnessed in March '20 is largely unwound. This compares to a fully funded position on a low dependency basis, which means we have no further pension deficit contributions payable. Furthermore, because the pension schemes are fully hedged with interest rates and inflation, we would not expect the pension scheme position to be -- to be rise -- we expect the pension scheme position to be largely insulated from market volatility. Our strong pension position is consistent with the pension regulators proposed fast track classification, and we would not anticipate having to take any further action as the pension regulators approach evolves alongside the current consultation. As the time when balance sheet strength is more important than ever, it is reassuring that we don't have any pension icebergs to contain with United Utilities. I will now provide more detail on why we are confident today to be reaffirming our AMP7 dividend policy. Back in May, the unsolicited COVID has clearly resulted in a significant degree of uncertainty. There was a risk of sustained low inflation over a 3 to 5-year period. The government and Central Bank response was still in its infant state, and the ongoing impact to our business was unclear. Since then, monetary and fiscal policy has been deployed extensively and persistently in support of the economy. The Bank of England retained the capacity to act more and to provide more support, and has been clear that in times of uncertainty, it is better to act aggressively. While the lease care authorities more generally committed to maintaining support to the economy as long as it is necessary to do. So although we're now in the second national lockdown, the picture is very different today even in May. Most businesses continue to operate and COVID secure ways of working are normal. Policymakers have repeatedly shown they are prepared to act and provide -- they're prepared to act, most recently in November, with further monetary and fiscal policy support. Medium-term inflation consensus has reverted to a book pre-pandemic levels and increasingly the risk of these forecast is to the upside. All this activity, along with the increased likelihood of mass scale vaccines becoming available, remain supportive of the economy and importantly inflation over the medium term. This positive inflation outlook, alongside our expert operational performance and our strong balance sheet position is why the Board is confident today to be reaffirming our AMP7 dividend policy. This slide sets out our full year outlook. As already discussed, we would expect full year revenue to be in the range of GBP 1.75 billion to GBP 1.8 billion, reflecting the known year 1 bill reduction and the net impact of COVID on both household and nonhousehold consumption. Underlying operating costs are expected to be higher year-on-year, reflecting small inflation increases coming through core costs, alongside higher IRE to maximize performance of our network. Having ended AMP6, we require totex runway for AMP7, we remain confident we can deliver AMP7 scope within the final determination totex allowance. Underlying finance expense is expected to be lower year-on-year as the reduction due to the low inflation in the first half of the current year is expected to continue in the second half. CapEx for the year is expected to be in the range of GBP 590 million to GBP 640 million, reflecting the acceleration of our AMP7 program. And although dependent on our performance in the second half, we would expect to earn an ODI reward of around GBP 10 million for the year. So to summarize, we've delivered another strong financial performance in the first half of the year. Cash collection in our bad debt position have remained robust. We have locked some debt at low rates compared with positive assumptions and have retained good access to credit markets, meaning we are well placed for AMP7. We benefit from having one of the strongest balance sheets in the sector with a leading pensions position and a low level of customer debt at risk. And finally, we have seen inflation forecast stabilize, supported by Central Bank stimulus and government intervention. This alongside our excellent operational performance and our strong balance sheet position gives us confidence today to be reaffirming our AMP7 dividend policy. Thank you, and I'll now come back to Steve.

So thanks, Phil. Before concluding, there are just a couple of areas I wanted to update you on. First, the sector has been supporting the government to play its part in the post-COVID green economic recovery, namely investment in infrastructure that will benefit the environment and create more jobs than would otherwise currently be the case for AMP7. And there are 4 components to this request. The first is that companies should be on track in delivering their current AMP7 commitments, and we are. The second is the companies are encouraged to accelerate existing AMP7 investment plans, and we are, to the tune of around GBP 500 million, as mentioned previously. And the third is company should convert potential AMP7 enhancement projects to commitments through engagement with quality regulators, and we have, with around GBP 150 million of additional investment now planned in AMP7. And finally, companies may propose the acceleration of schemes that might otherwise feature in AMP8 within company's PR24 business plans. We're in dialogue with Defra, the environment agency in Ofwat, regarding proposals in the fourth category, and as much to resolve in terms of scope, cost and funding, but this presents an opportunity to supplement what we're already doing to contribute to the green recovery, creating jobs in the region hard pressed as a consequence of the pandemic. More about that when we meet again. And finally, a reminder of our strong performance across the range of ESG indices. Our approach to ESG has been clear and enduring. And our responsible behavior in supporting customers, colleagues and communities through the challenges of COVID is more important now than ever before. Earlier this month, we were pleased to once again achieve world-class status on the Dow Jones Sustainability Index, a status we've now held for 14 consecutive years, demonstrating our long-term commitment to ESG. And this level of performance is replicated across the broad range of industries shown on the slide, many of you -- many of which are used by investors. Some of you will have seen the investor guide to our approach to ESG that we published in September, and we hope you found it helpful. And as Phil has already mentioned, we're leveraging our strong potentials in this area through our sustainable finance framework to raise debt and replace the green EIB funding that's no longer available. So in summary, I'm hugely proud of the job the UU team is doing in maintaining services and providing support to struggling customers, employees and communities in a region hit hard by COVID. Higher domestic consumption is helping to offset reduced business revenues, and we're well positioned from a bad debt perspective. We started AMP7 extremely well, having benefited from around GBP 130 million investment ahead of the start to the end, and the certainty that fast track status in PR19 provided. We're driving value for all stakeholders. We're leading the way on customer satisfaction, on track for an industry-leading 4-star environment status and expect to deliver outperformance in year 1 of the AMP. And finally, we're reaffirming our AMP7 dividend policy of growth year-on-year by CPIH out to 2025. So thanks for listening, and we now be happy to take any questions.

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

Congrats on a good set of results. A couple of questions from me, please. Firstly, on ODIs and the relationship between ODIs and totex. I think you're basically saying that ODIs in this AMP will be higher than the last AMP. Last AMP was GBP 43.9 million. Can you just confirm that number? And does that mean, that we're looking at this sort of run rate throughout the 5-year period? And it does look quite reliant on the flooding ODI. Is that reliance going to shift during the 5-year review? And on the totex versus the ODI, you said there's a trade-off that you might sacrifice some totex for ODIs. How do you look at the returns and the payback of that? And also the sustainability on the ODIs going forward would you put on the cost of the totex, please?

Okay. Dominic, I'd just pick that up. I think, yes, on ODIs, you're correct. We do -- we are targeting better improvement -- sorry, better performance on ODIs in AMP7 than we achieved in AMP6. And I think the number that you've got there in terms of top performance for AMP6 is correct. So yes, we are aiming to improve on that. And obviously, first year positive result is a great place to be in terms of great start. As you've said, there are a whole number of contributors to ODIs, both positive and negative, as we are seeing. Part of the issue that we've got going forward is, and it's where we essentially looked at some of our early investments, both in the last year of AMP6, but also what we're spending money on now, is those areas where, particularly, we are seeing up in ourselves in penalty performance, so those are areas like supply interruptions, like internal sewer flooding. And so what we're doing is currently investing and we've got pilot teams operating in the first year, which essentially are aimed at mitigating the downside that the targets we have there is in those areas. We are -- if we just carried on as we are, we'd be in penalty territory. So part of our investment strategy is to improve performance in those areas where we effectively have a penalty regime, a significant penalty regime. And one of those, for example, is internal sewer flooding. And I think what we plan to do, we don't have time this morning, but we can take you through more of that when we do Capital Markets Day to talk about the specifics in that area. In terms of trade-off, I mean, you're absolutely right. You've caught the tone of the comment we've made there. I think if you actually look at underlying position as far as totex is concerned in AMP7, then at the outset here we look at delivering an outcome which was not dissimilar from AMP6 in terms of delivering our FD commitments with a totex efficiency. I think when you look at the trade-off, another way to look at this, I mean, clearly, if you're looking at totex expenditure, you'd be looking at an ODI return, which was a better return on that investment in terms of the ODI return that you would get would be greater than the totex cost to shareholders. And so what we're doing is essentially encouraging our teams in all respect to look at opportunities to improve outcomes on ODIs, which clearly has a benefit for either customers or the environment and that we're delivering a better service to customer or a better environmental performance as a consequence. But we are encouraging our teams to look for opportunities. So essentially, if there is an opportunity for greater investment that would earn a better return, then please come forward with those. So rather than essentially accepting the -- our FD predictive performance, is exactly what we want to do, we actually want to see improvement. And I think the other area for that, of course, is that when you look at areas where we're already frontier of our own performance like on pollution, for example, where we're a frontier performer, clearly it's an area where we want to maintain frontier, but we've also got an eye to AMP8 and to -- an expectation as we go into AMP8, we want to be as close to upper quartile as possible because you can only expect that as you go into AMP8, you're going to get further challenge. So I think you've picked up. Where we do see opportunity to earn, we will because essentially it's value-creating when you look at the return on investment that you make.

And Dominic, just to add. I guess, that Steve's outlined there, it's all about sustained performance into the medium term, really.

Yes. So does that mean that you think that AMP8 ODIs and performances are going to be similar to AMP7? I mean you're going to have to review on the sustainability of the measures themselves.

I don't -- I mean, nobody knows. I mean that it's a crystal ball, isn't it? I mean what's been interesting, if you look at the CMA review of the sector. They haven't fundamentally looked at -- revisited either the econometric models or the incentive regime significantly. So that's not an area that has been revisited in that particular challenge area, notwithstanding the appellant positions on that. And I think if you expected that the train has left the station on upper quartile performance and a drive for the sector to go for upper quartile, you've always got to have an eye as to what that is. And what we've always done really as a business is look to deliver sustainable performance in investment we've made rather than essentially to go short for short-term targets. We'd look to deliver something which is resilient to -- for the future.

Our next question comes from Martin Young of Investec.

So I hope everybody is well. And 3 questions, if I can, please. The first relates to your observations around the potential COVID impact for the full year on volumes. I appreciate, to a degree, not trying to nail a jelly to a wall. That minus GBP 14 million in the first half of the year and then those observations around stability on the nonhousehold side of things or stability in line with the first half of the year, should I say, but perhaps less of a pickup in the household side of things. Just wondered when you're sort of elaborating that narrative, how you come up with minus GBP 10 million at the bottom end of your range? Surely, we should be looking at something a little bit tighter. The second question relates to the GBP 150 million additional totex that you talked about. Is that on top of your final determination? And if so, where can we see this being set out? I guess, by a revised final determination to show its flow through to revenue over the AMP. And then the final question, bigger picture one, the CMA and their provisional determination in respect of the forward talents. Obviously, something that doesn't really impact you that significantly in the year and now, but potential longer-term implications. Just wondered if you could share your thoughts on what that might mean for yourselves and the sector in longer term if the CMA does not move significantly from where it landed with those provisional determinations?

Yes. Martin, I'll do with 2 and 3 and then hand over to Phil on the revenue impact, if we can. So the GBP 150 million additional totex is principally 2 projects. One is associated with the treatment work we have at Bolton and the other one is associated with one of our principal aqueducts, where we're doing some relining. Those are both additional to our final determination. And essentially, one of the mechanisms that exist in AMP7 is that if you get an environmental scheme, which Bolton is, which essentially has converted to a green status, in other words, approved, then essentially you will be reimbursed. So both of those projects, we will be -- we'll have full cost recovery. The mechanism is that we're likely to see that -- the revenue impact of that falling AMP8. So we will be delivering those projects, not in total, but in large part during AMP7, but we won't see a revenue uplift on our AMP7 income, but we will see an adjustment, a full adjustment when we get into AMP8. So we will see full cost recovery. The other one on CMA. I think you're right. The impact of CMA on those companies who aren't appellant is 0 in terms of expectation. I think when you look at it long term, as I said earlier in response to Dominic, if you actually look at what the CMA have done, obviously, they've looked at cost of capital as far as the appellants are concerned and made a higher allowance. That allowance still sits within what was considered to be a sort of a reasonable range. I mean Ofwat's -- well, reasonable perhaps isn't the right word, but within a predictable range, and Ofwat was at the lower end of that, obviously, CMA higher. Whether that has an impact in terms of investment and the considerations taken going forward. When we get to AMP8, it's anybody's guess, but obviously there is a sense that we need to attract investors. I think generally, though, when you look at it across the board, things like econometric modeling, some of the methodologies and approaches that are used have not been challenged. So it's really difficult to say what the impact will be. I think the one feature that I think has come through in the CMA's review is the need to ensure resilience going forward, and I think that's a fundamental issue for the sector as a whole. And in the way that perhaps for the energy sector, the ability to adapt to use of renewables to electric vehicles with the government having given very firm time scales for those now is like a call to action for the energy industry. And I think if you actually talked to anybody in the water sector and climate change adaptation and population growth, are a call for action as far as the water sector is concerned in terms of having resilience to the very, very evident impact of climate change. And I think that to me was something that came through in the CMA consideration and in some of the points made by the company. So I think and it's anybody's guess what will happen in AMP8. But I think those are the 2 probably key issues, both attractive returns for investors and be resilient, I think, are 2 key features that will be subjects. I'm sure we'll talk about, again, as we get into PR24. Do you want to -- Phil, do you want to pick up on the revenue point that Martin made?

Martin. Yes, on the revenue point, I guess, splitting it down between non-volume and volume. First, you can see at half 1 was on the non-volume side is a GBP 40 million price cap impact. So that's going to be around about GBP 80 million for the full year. Reward from mechanism and other items about GBP 12 million. So with respect to this circa GBP 30 million for the full year, that's effectively a net GBP 50 million reduction compared to prior year. And that's the difference between the guidance -- the revenue guidance and the volume impact. On the volume impact itself, at half 1, as you say, there's a GBP 40 million adverse impact from nonhousehold and that's offset by the GBP 26 million favorable household position, so GBP 14 million adverse. And we believe that will be slightly worse for half 2. And that's giving us the volume range of sort of GBP 10 million to GBP 60 million. I think it's important to recognize that there's a relatively high-level estimation uncertainty at half 1. One of the challenges for the whole sector has been the ability to get meter reads. As you can imagine, certainly through the lockdown period, meter reading was something that wasn't particularly possible. And so you'll notice that in our financial account, at the back of the announcement, we've adopted the FRC best practice in terms of providing guidance around revenue sensitivities. And so we're flagging there. For example, that on the household side of things, we've got 25% of meter reads and that's been used to help estimate the sort of household revenue and only 17.5% of meter reads in terms of the nonhousehold position. So it's all steps looking the facts, back to the facts in the accounts. But I think it is highlighting that there is quite a high degree of uncertainty there in terms of the overall position. And then, I guess, looking forward, as you said, in asking the question, it is a little bit like crystal ball gazing in terms of half 2 in terms of understanding how the economy will perform. So that's our best estimate today, and I think a reasonable range to guide you to. And the last point to flag, as you all know, is that the revenue cap has recovered, the sort of volume impact effectively 2 years later.

Our next question comes from James Brand of Deutsche Bank.

I had 3 questions, please. The first is a follow-on from Dom's question, just asking about the kind of trade-offs and how you think about totex versus ODI outperformance? And you mentioned that you obviously think about how much you could get out of the ODIs versus how much you're spending on totex. I was just wondering on that, are you thinking, when you make that judgment on what you can deliver on the ODIs in the current period? So you're thinking if we spend GBP 50 million in totex, we might be looking to generate an extra GBP 25 million in ODI outperformance, that kind of calculation? Or are you thinking multiple periods? Like if we invest in this today, we might be able to eke out a little bit extra on ODIs over the next -- over this period, the next period, a period after that. And it becomes a kind of NPV of multiple periods of potential ODI outperformance, in which case, a much longer payoff? That's the first question. Second question is on ODIs directly. I was just wondering whether it gets harder or easier to deliver on the ODIs as we go through the period. Obviously, the targets get tougher over time, but sometimes there's a step change in year 1, and then it might become a bit easier or it might become a bit harder as we go through the period? Question number 2. And then thirdly, a question for Phil. Given that it’s his first set of results presenting as new finance director. In the past, the -- with Russ, the company had a target of between 55% and 65% net debt to RAV, with a kind of broad aim to be around the midpoint, although that's always been reasonably conservative versus other companies in the sector, given that a lot of water companies have higher gearing. So I was just wondering whether there's any change in how you think about gearing? Is that still the target, the 55% to 65%? And if that is, why you want to live with lower gearing than some of your peers might do?

Yes. Thanks, James, and good morning. I think I'll pick up the first couple and leave the question for Phil, as you went back to him directly. I think as far as trade-offs on ODIs, we do tend to think about it, principally as an AMP issue. So we are looking at AMP7 ODI targets and investment in totex to hit AMP7, so that we see a, if you like, this AMP return on a totex that we might spend. I think the point I made to Dominic about AMP8 and beyond is that, clearly, we do have an eye to what upper quartile performance might look like in the sector. And therefore, the potential for further targets or even tougher targets as we go into AMP8, from where we might end AMP8. So improvement in AMP7 will give us a better launch platform is the way we tend to think about it. If you are looking longer term, then we will be looking for a very robust position. But there is -- undoubtedly, there is benefit for a pound of totex, a pound of ODI, it's worth more in a way that you actually see performance. And of course, it means you're delivering better service to customers and the environment as a consequence. So yes, in-period is definitely the way we tend to consider. I think as far as ODIs are concerned, it's very much a mixed bag called position. I mean, some of the ODIs with some of the investment we've made. So on leakage, for example, I've talked previously about all the things that we're doing with leakage, both in terms of use of technology, docks, satellite, sensors. We're probably going to have one of the biggest networks of sensors, loggers. In our water network, we're doing some piloting. We're actually doing well against our leakage target this year. And that obviously helps as you go forward. In other areas, you can see that on internal sewer flooding, that has been a challenge for us. We actually put forward a 10-year program of improvement of what they said, do it in 5. So that does get tough as you go through, which is why we're accelerating funding again in the area of how we manage our sewer network to be able to deliver faster improvement in our performance because we're simply spending more on cleaning and reacting to flooding is not going to get us there. So I think it's a mixed bag, quite honestly. But generally, as you know, ODI targets do get tougher over the period as you are moving towards an upper quartile status. Do you want to pick up on…

Yes. On the debt-to-RCV position, James, I guess the sort of position -- the group's policy hasn't changed. It means our position and our target credit ratings -- we made our target credit recognition to the -- back to the color to that. I think it's probably important to recognize that, that very much contributes to the financing our performance we are able to deliver and the good access to the markets we have. And I think as we look at this and we've talked about how we're accelerating sort of totex expenditure to deliver performance. So what you will see and observe is that, that ratio climbing and falling towards the back end of the AMP to really effectively. When we're looking at it -- if we're looking at it through the cycle and making sure we're comfortable that it's in a sustainable place.

Our next question comes from Mark Freshney of Crédit Suisse.

Can I please ask about Water Plus. As I understand it, there were 2 issues. The first one, surrounding basic business processes, which took time to refine following the creation. My question is, how are those performing? And secondly, clearly, there's COVID-19 collection issues. I think you alluded to the 17.5% meter readings and voids, et cetera, counting for writing that down. So I understand that you've written off the equity. Why would you not start to write-off some of the intercompany loans that you've made to that joint venture?

Okay. I'll do the first half. Phil will do the second half. The -- on basic business, yes, we've very clearly at the beginning of this year set about a very radical overhaul of Water Plus in the way that it looked at the market, in the way that it looked at returns from different market segmentation and at its underlying processes. And so we've had a program running right through the year of fundamental improvement. So a understanding where the business will best earn a return, looking at basic processes, looking at systems. And I think we are confident now that as we come out the other side of COVID, we'll have a business that will return to profitability. So I think much, much happier with the business -- it's business performance and its potential. I think the issue, obviously, now is to get ourselves through the COVID period. I think when we took a provision at the beginning of the additional provision, we could see ourselves being what we felt was adequately provided for bad debt. But I'll let Phil actually look at -- talk to you about where we are on those.

Okay. So I guess picking up the sort of COVID-19 piece on our business. I guess, Mark, you'd have seen from the full year position, obviously, we wrote down the equity value of net investment in water cost, and we also took a GBP 5 million expected credit loss charge in relation to the loans to water cost. So that was in the numbers that back at March '20. And that credit charge was based on sort of the businesses forecast at that time in terms of performance. And as we move forward sort of 6 months, actually, the business is performing and is performing marginally better than those forecasts at that point in time, which is why there's no further impact today in relation to the expected credit loss. Clearly, the second half remains challenging. But as Steve sort of said, the processes and the turnaround is starting to come through, and we would expect sort of effectively the second half to be a consolidation period heading into sort of FY '22, where we would expect to see the business returning to profitability.

[Operator Instructions] Our next question comes from Ajay Patel of Goldman Sachs.

Just really simple sort of granular question more than anything else. Just looking at the IRE, and you had a quite set up in the first half, is there sort of -- any sort of indications you can give us on how the profile of IRE will be over the 5 years? Does it only be more front-end weighted than maybe back end? Or -- and even looking to this year, would that -- would it be fair just to double the number for the half or the full year? Or would that be overriding it? I just wondered any sort of guidance you can give or direction would be really helpful.

Ajay, at a higher level, you're exactly right, I think, I would see the profile being broadly flat through this year effectively into double for the full year assessment. I guess, handing out through the rest of the AMP, profile will probably carry on much the same guidance. Is that okay?

Sorry? Did you say that broadly the same sort of level for the rest of the AMP. Is that correct?