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

Good morning, ladies and gentlemen, and welcome to the United Utilities Half Year Results Presentation for 2021, '22. We've continued with a great start that we've made to AMP7, benefiting from the acceleration of our capital program and investment in systems thinking. Global challenges such as climate change, and how we successfully emerged from the COVID pandemic remain areas of significant focus for us, and our digital transformation and investment in long-term sustainable performance are helping. We're delivering improved services to the 7 million customers in the Northwest and protecting and enhancing the environment in which we operate. This strong operational performance delivers efficiency gains and improvements to ODIs and is enabling us to drive further value for shareholders. Our achievements are a testament to the work of highly engaged and motivated colleagues right across the organization. And I'd like to thank the UU team and its partners for all they've done to deliver another great set of results for all our stakeholders. So here are the highlights. We're on track with the carbon reduction commitments we made that will see us achieve net zero by 2030. We have a deep symbiotic relationship with the environment in which we operate and are innovating to deliver our goals whilst also enhancing biodiversity. We've again delivered a strong financial performance, actively managing our cost base to mitigate much of the impact of rising inflation and locking in contracts for a significant proportion of our AMP7 capital program. And we continue to invest for long-term sustainable performance improvements, providing a better service for customers and the environment and creating shareholder value. We're a digital utility. Our systems thinking approach uses data and leading technology to optimize our operations, delivering efficiencies and better service to customers. And our investment in operational excellence is helping us to deliver regulatory outperformance. We're targeting a net customer ODI reward for AMP7 of around GBP 150 million and continue to raise debt efficiently. When we presented our full year results last May, I was able to tell you that the first year of AMP7 represented our best ever year and gave us a great start to the new regulatory period. And I'm pleased to say that we've continued with this trajectory, delivering strong performance across all areas of the business. On water, we've installed 70,000 sensors delivering real-time data to our integrated control center and allowing us to optimize the performance of our network. As a result, leakage is at its all-time lowest ever level and is currently 5% lower than when we started the AMP already a great start to delivering our 15% reduction target across AMP7 as a whole. Supply interruptions have halved since the beginning of AMP7, a significant improvement in the service we provide customers with fewer than ever experiencing a disruption to water supply. And on wastewater, our industry-leading 4-star environmental performance has now been confirmed by the environment agency. And our investment in Dynamic Network Management, or DNM, is on track and delivering. You know that flooding is an important ODI for us and we anticipate that as a result of our DNM investment, we'll be able to deliver a net ODI reward across our basket of flooding measures. Customer satisfaction remains high, and we're proud to have once again successfully achieve the Institute of Customer Service, service mark with distinction, 1 of only 15 brands across the U.K. to achieve this high level of recognition. And we continue to support those customers who are struggling most to pay their bills. The temporary extension to the social tariff that we secured at the start of the COVID pandemic to support those customers most affected has now been made permanent. And this means that we have the additional GBP 15 million per annum of support available for each of the remaining years of AMP7, providing an additional tool for us to help prevent customers from falling into debt. And this contributes to our confidence around bad debt, returning quickly to pre-pandemic levels and maintains our sector-leading age debt position. And we're backing the Consumer Council for waters drive to launch a national social tariff, which is a welcome development for a region that suffers with extreme deprivation. Our strong operational performance delivers better service for customers and the environment and ensures we're well placed to earn customer ODI rewards. In the first year of AMP7, we owned an ODI reward of around GBP 20 million, representing upper quartile performance for the sector. And we remain on track for our target of a further ODI reward of around GBP 20 million this year and GBP 150 million in total for AMP7. Now in a slight change from our usual format, I just want to take a few minutes to talk about some of the great work we're doing to mitigate climate change and enhance biodiversity. We're leaders in these areas and their key themes that the market is speaking with us about more frequently, particularly in light of investor engagement at COP26. I'll then hand over to Phil to take you through the numbers before I finish the presentation with a reminder of our totex position and a short update on DNM. There's no doubt that water U.K. -- the U.K. Water sector has a significant role to play when it comes to climate change. Here at United Utilities, with signatories to the UN Race to Zero campaign and are proud to be helping drive the sector's commitment to net zero by 2030. We've committed to 6 carbon pledges and you can see them here on the slide. And I'm pleased to say we've delivered 2 of our pledges, and we're on track with the plans for the other 4. From last month, 100% of our electricity is sourced from renewable technologies. And earlier in the summer, our science-based targets were approved, including supply chain or Scope 3 emissions. Our Scope 3 targets include both an engagement and an absolute reduction measure, demonstrating our ambition in this area. And this is an area of intense focus globally and the plans we have in place and the progress we're making against those plans will see us contributing to minimizing the future scale of climate change to manageable levels. Climate change is no longer an emerging issue. In recent years, we've experienced wetter winters and dryer summers. The climate has already changed and the impact is already being felt. Through our investment in becoming a digital utility, we now have a better visibility of our performance and are able to act earlier to deal with issues arising from climate change. And we've demonstrated we're better placed to deal with the extremes of weather that we're experiencing more frequently. While the action we're taking to mitigate the impact is critical, equally as important is how we adapt to ensure that we're resilient to future climate change. We use latest climate change research to assess the potential implications on operations and integrate the findings into our long-term planning and decision-making. And this helps us identify where, when and how we need to respond in order to secure the resilience of our services into the future. Later this year, we'll publish our third climate risk and adaptation report, which will support the robust consideration of climate change in our plans for PR24. And we expect this to be a key feature of our business plan, driving ongoing investment needs and growth as the sector and society more broadly tackles this critical issue. Whilst understandably, the current focus is around climate change, the impact the modern world is having on nature and biodiversity is not to be underestimated. With 56,000 hectares of land with the U.K.'s largest corporate landowner and accept that with this comes great responsibility, but also great opportunity. Our catchment consists of some of the country's most environmentally sensitive land and we, for many years, led the way in our approach to managing it, working with key stakeholders to preserve its natural beauty and protect wildlife, while also enhancing the quality of our raw water and minimizing risk of flooding. As part of our catchment systems thinking approach or cost, we work with partners to manage our catchment holistically. This allows us to access new funding streams in order to deliver efficiencies and a better overall environmental outcome. The picture on the slide is of the Haweswater catchment where we work closely with the RSPB, the Environment Agency and Natural England for the benefit of all. And the link on the slide takes you to a video of a great case study where we've worked together with these partners to improve the natural environment and water quality working alongside farming and flood prevention. And the 6 carbon pledges I referred to earlier, not only help us to achieve our ambitious carbon reduction targets, but also through restoring 1,000 hectares of peatland and planting 1 million trees were helping to enhance the biodiversity across the land that we own and manage. I'll now hand over to Phil to take you through the financials.

Thanks, Steve, and good morning, everyone. In today's presentation, I will highlight our strong financial performance before focusing on the current inflationary environment and how our hedging approach not only mitigates risk but is driving shareholder value. And to wrap up, I'll provide some high-level guidance for the full year to March '22. These are the key financial highlights for the half year. Revenue of GBP 932 million is up 4.2%, largely reflecting higher consumption from businesses as we see a return of activity to pre-pandemic levels. Household bad debt is 1.8% of regulated revenue, which is consistent with the rate we were achieving pre-COVID. Underlying operating profit of GBP 333 million largely reflects the increase in revenue, partly offset by small increases in core costs. As a result, underlying EPS is 28.4p per share and the interim dividend per share is 14.5p, in line with our policy. We continue to raise finance efficiently, adding to our financing outperformance and our hedging policies are functioning effectively, mitigating risk and driving sustainable shareholder value. And finally, our balance sheet remains one of the strongest in the sector with low customer debtor risk, RCV gearing of 62% and a pension scheme, which is fully funded on a low dependency basis, all of which supports a stable A3 credit rating from Moody's. I'll now consider these points in further detail. This slide shows the key movements in revenue from the prior half year. In summary, revenue of GBP 932 million has increased by GBP 38 million, largely reflecting higher consumption as business activity returns to pre-pandemic levels. Now turning to each of the components in the bridge. In the first half of the year, we had a GBP 6 million reduction in the revenue cap, representing a 1.5% real reduction in allowed wholesale revenues, offset by a 0.6% increase in CPIH. Business activity has returned to prepandemic levels faster than we previously expected, with higher consumption increasing revenue by GBP 68 million. In contrast, consumption from households has decreased GBP 20 million due to significantly higher consumption during the first half of last year, reflecting both the initial impact of lockdown and the warm weather in late spring 2020. For the full year to March '22, we now expect revenue to be around 2% higher than the full year to March '21 as the consumption impact was less in the second half of last year as businesses started to reopen. I'll now talk through our household cash collection and bad debt performance. Underlying cash collection performance remains very strong. We continue to manage the impact of COVID, with current household bad debt returning to its lowest ever level of 1.8% of regulated revenue. Our strong performance in this area is enhanced by 4 key factors. First, we have a low level of balance sheet risk with only GBP 12 million of household debtors more than 1 year old at March '21. Aged debt today is tomorrow's bad debt so we can be confident that the position remains strong, and we aren't starting up an issue for the future. Second, we have the widest range of affordability schemes to support those customers in need. Third, we're pleased with throughout the pandemic, we've maintained a high proportion of customers that pay our direct debit or alternative payment plans at around 80%. This provides a high level of collection certainty for a significant proportion of revenue. And fourth, we're using the latest developments in technology to help customers. 1 million customers now engage with us digitally, enhancing the customer experience as evidenced in our satisfaction scores, where we expect to earn a reward for both C-MeX and D-MeX. The most recent innovation is the use of open banking for real-time income verification. This provides immediate confirmation of customer eligibility for reduced rate social tariffs, allowing customers to be passported onto right tariff efficiently, which delivers a great customer experience. While there remains much uncertainty in the economic climate, as we look into the second half of the year, we've demonstrated that we have the right support schemes in place and focus in the right areas to continue to improve our cash collections and bad debt performance. This slide shows the key movements in underlying operating profit from the prior half year. Underlying operating profit of GBP 333 million is up GBP 14 million. This principally reflects the 38 increase in revenue, partly offset by small increases in our core costs. With a recovery from the COVID-19 pandemic, we and many companies right across the country have experienced inflationary pressures on input costs such as power, chemicals and labor. Through hedging, constructive cost challenge and commercial negotiations, we've managed to mitigate much of these cost increases to date. The inflationary increases we are seeing come through our core costs have resulted in an increase of around GBP 9 million compared to the first half of last year. On an operating cost base of around GBP 390 million, this represents a fairly modest increase of just 2.3%, reflecting our robust control of costs and the benefit of our hedging policies, particularly on power, where we have hedged around 95% of a power commodity price for the current year. And we'll continue to actively manage our cost base in the second half of the year to mitigate these inflationary cost pressures. Depreciation is GBP 5 million higher, reflecting the ongoing commissioning of our asset base. And in the near term, we would expect depreciation to flatten out, reflecting below our AMP7 CapEx program. We continue to drive the better operational performance for customers and the environment. And in doing so, have incurred GBP 4 million of costs targeted improving performance against specific customer ODIs. Here, we are confident that the improvements in the ODI position outweighs the cost of the ODI benefits forming part of our AMP7 guidance. In AMP7, Ofwat has introduced an innovation fund, whereby companies collect an additional amount of revenue from customers, which is subsequently reallocated to those successfully bidding for funding of innovation projects. Our contribution to the innovation funds since the beginning of AMP7 is GBP 9 million. In contrast, we have led or supported on projects that have secured funding from the scheme of over GBP 30 million, reimbursing the innovation spend we incur. Our success in securing funding to date is further evidence of our attitude towards innovation and our strength in this area. Focusing next on the remaining key lines of the income statement. Our underlying net finance expense is GBP 134 million and is GBP 51 million higher on a like-for-like basis, predominantly reflecting the higher inflation applied to our index-linked debt. Our share of losses of joint ventures is GBP 2 million, and now relate solely to water plus following the sale of our stake in Tallinn in April '21. Our underlying tax charge for the first half of the year is GBP 3 million, representing 1.5% of underlying profits. This excludes the impact of all deferred tax, including a one-off deferred tax charge of GBP 382 million in relation to the increase in the headline rate of corporation tax to 25% from April '23. The 1.5% underlying charge is lower than the 16% in the first half of last year as we've maximized super deductibility of capital allowances on eligible plants and machinery additions, all of which results in underlying profit after tax of GBP 194 million and an underlying EPS of 28.4p per share. Now looking more closely at financing performance. Over AMP7, we have around GBP 2.4 billion of financing to raise and have made a great start, having already raised almost half, taking advantage of attractive rates and extending our liquidity position out to February 25. Our effective interest rate for the first half of the year is 4.4% nominal. This, together with the projected debt balances at the locked-in rate shown on the chart on the left-hand side of the slide, compare favorably to the price of view assumptions for AMP7. The mix of debt shown in the chart illustrates our long-standing hedging policies, and I will now provide some more insight on these. We take a robust approach to financial risk management and adopt hedging policies but look through near-term volatility to deliver long-term sustainable performance. This approach has benefited us for many years, mitigating risk and delivering shareholder value through financing outperformance. A significant proportion of our financing outperformance has been achieved from our index-linked debt, which is used to hedge our inflation exposure. Here, we maintain a target of around half of our net debt in index-linked form based on a balanced assessment across a range of factors, including hedging the RCV and minimizing income statement volatility during periods of both high and low inflation. In the appendices, we included a chart produced by the office of budget responsibility in its most recent economic and fiscal outlook, but it shows a significant volatility in inflation over the medium term. This is more extreme since the onset of COVID, and our hedging policy helps to minimize this volatility, delivering predictable performance through both the peaks and the troughs. The inflation linkage in company's debt portfolios, however, only tells part of the story, with a pensions position also having a significant impact on the overall economic exposure to inflation. At GBP 3.3 billion, our defined benefit pension liabilities have a similar order of magnitude to our index-linked debt. Here, as a consequence of our robust pension risk management, we benefit from being fully hedged for inflation. Meaning, we don't expect our fully funded pension position to be adversely impacted by higher inflation. In summary, our consistent approach to hedging for both debt and pensions does not seek to take a view on where we think inflation might outturn, but rather provides protection to investors through an appropriately leveraged position to inflation delivering long-term sustainable performance that is well understood. I will now take you through a brief case study that illustrates our approach to inflation not only mitigates risk, but delivers shareholder value. As you know, in January '21, we issued our debut sustainable bond, raising GBP 300 million based on our strong ESG credentials. We subsequently swapped the bond to a CPI basis and avoid may seem counterintuitive to increase inflation exposure in the debt portfolio at the time of potentially rising inflation. I think it is helpful to illustrate 2 key points to share how this transaction delivers shareholder value. First, the initial bond issuance together with the subsequent swap to CPI outperforms the index used for regulatory assumptions by around 150 basis points, walking in GBP 40 million of financing outperformance regardless of where inflation outturns. And second, by swapping the bond to a CPI basis, with a yield of CPI minus 1.778%, we've secured a great level of value -- a greater level of value even if we have left the bond fixed, provided CPI average is below 3% over the entire 9-year life of the swap, a breakeven point significantly higher than the Bank of England inflation target of 2%. So in summary, our approach has maximized the expected level of financing outperformance, locking in a guaranteed GBP 40 million and contributing to a sustainable financing structure that delivers long-term shareholder value. On this slide, we show our regulatory CapEx profile for AMP7 and how we've accelerated our investment program compared with the original CapEx profile in our business plan. This delivers operational improvements earlier than would otherwise have been the case and brings forward significant capital investment into this current year and next year, but is eligible for the super deductibility of capital allowances, a benefit we expect to retain. The dark blue bars on the chart show the extent of the capital program, but we've already contracted with our delivery partners. This represents around 80% of our total AMP7 program. Having a secured delivery route for such a high proportion of our capital program means we've significantly derisked sourcing in a construction market that is increasingly showing signs of overheating. As is common on large delivery projects, our contracts are subject to a target price mechanism, aligning interest and incentivizing our partners to deliver as efficiently as possible. This slide bridges the net debt from March '21 to September '21. Net debt of GBP 7.4 billion has increased by GBP 95 million since March '21, with the usual underlying movements shown in the bridge. Our net debt position results in RCV gearing of 62% and therefore, within our target range of 55% to 65% and supporting a stable A3 credit rating with Moody's. The credit rating agency is also making adjustment for any IFRS pension deficit, which is not relevant for United Utilities given our IFRS pension surplus position. This slide sets out our outlook for the year to March '22. Much of the outlook remains unchanged from the guidance we gave at the full year results in May, with the exception of revenue. As I discussed earlier, we now expect revenue for the full year to be around 2% higher year-on-year and with overall consumption as many customers continue to work from home and consumption and businesses return to pre-COVID levels. This is only partly offset by a regulatory revenue decrease. We're likely to see continuing inflation pressures in the second half of the year and therefore, we expect underlying costs to be higher year-on-year. The greatest impact is on costs such as chemicals and power. And although having hedged 95% of our power commodity price for the current year and being well hedged for the remainder of the AMP, we are minimizing the impact of the most recent energy price rises. Higher inflation will also impact our index-linked debt, and we expect the underlying finance expense to be higher. As I mentioned earlier, the inflation linkage in our debt portfolio delivers shareholder value, adding to our financing outperformance while mitigating risk for the longer term. And so to conclude, we've delivered another strong financial performance in the first half of the year. We continue to raise debt efficiently, locking in debt at low rates compared to the price of your assumptions and adding to our financing outperformance. Our hedging policies deliver sustainable performance, mitigating risk and securing shareholder value. And finally, we benefit from having one of the strongest balance sheets in the sector with an appropriate level of gearing and a low level of customer debtor risk. So thank you, and I'll now hand back to Steve.

Thanks very much, Phil. We confirm that the full year results in May that we're confident in delivering the scope of our AMP7 final determination within our totex allowance, and that remains the case. We also introduced GBP 300 million of additional spend that has since been increased by a further GBP 65 million in relation to our green recovery allowance. And I just want to unpack the details behind that. GBP 150 million of the total is for approved extensions to our investment program, which allows for schemes at Bolton and Vyrnwy in Wales. These schemes and our green recovery allowance are fully funded through the regulatory mechanisms we have in place. In addition, we've elected to spend a further GBP 100 million on Dynamic Network Management and GBP 50 million on other projects, which are driving ODI performance. And that expenditure is subject to the totex sharing mechanism with around 50% company funded, but that's more than compensated for improved ODIs in AMP7 and future periods. A proportion of the expenditure, as Phil has mentioned, is eligible for the super deductibility of capital allowances in this year and next, which provides further benefit retained by the company. And as a result of our financial strength and balance sheet headroom, we're able to fund our investment now, improving performance for customers in the environment today while also generating value for shareholders. I just want to provide more detail as well on that GBP 100 million for DNM. As we told you in May, we're investing in a state-of-the-art network of sensors in our sewers and wastewater pumping stations with artificial intelligence that analyzes the sensor data across the complete connected system. And this information allows us to proactively manage our sewer network and take action before issues such as blockages or flooding incidents arise. And I mentioned earlier the sensors that we've got on our water network, that through DNM, we've installed another 4,500 sensors in our wastewater network with enhanced monitoring at around 600 sites. So that artificial intelligence now is learning how our wastewater system behaves, sending information to automated dashboards in our integrated control center and alerts if there's a deviation from the norm. And this allows dedicated alert response teams to be directed to the right place at the right time, helping to reduce the impact on customers and on the environment. Across all of the live areas we've installed to date, we've achieved a significant improvement in performance, with already over 400 operational issues have been detected and resolved, and we're on track to roll out the remainder of the 20,000 sensors and enhanced telemetry at over 3,000 sites by the summer of next year. Working with Jacobs, the global engineering company, we're first in the world to be implementing this technology at this scale and with artificial intelligence being applied for full network system learning. We believe the work we're doing is truly transformational and will deliver a step change in wastewater performance. So in summary, we've continued with the great start that we've made to AMP7. We're benefiting from the investment we made at the end of AMP6 and the acceleration of our AMP7 program. This investment, together with our systems thinking approach, is delivering operational excellence for the benefit of customers and the environment. And as a result, we're delivering regulatory outperformance, enabling us to drive further value for shareholders. We're leading the way on the critical issue of climate change demonstrating resilience and contributing to the efforts that need to be made globally. And we have a unique opportunity as the U.K.'s largest corporate landowner to deliver our targets whilst also enhancing biodiversity. So thanks for listening, and we'll now take questions.

So I have one question that's actually coming from Lidia Panarello, which that's coming on the system, and it says, what kind of unforeseen circumstances affected the postponement of today's presentation. Well, I apologize for the delay. I mean, as you know, we were scheduled to start at 9 today, but there was a huge smash on the motorway network, which effectively stopped a large part of the team from actually getting here on time. So Phil and I did debate whether we'd film each other on our iPhones and play it back to you on YouTube, but we thought that wouldn't be very professional. So we delayed, so please accept my apologies and your forbearance for actually joining us later in the morning. I'll go to Martin Young at Investec first, please, Martin?

Given that it looks like it's just myself and my good colleague, Mr. Freshney asking questions, maybe I can particularly run with 3, please. The first relates to the investigation that's been launched by the Environment Agency and Ofwat into river spills, just wondered if you could say a few words. Firstly, about where you feel you are positioned on that in respect of the investigation, but also what it might mean longer term for the water sector because I have a feeling that ultimately, if there is a task at hand here, it could lead to more investment somewhat near -- down the line. So a few words on that. And in terms of inflation. If I think about something like power prices, which are obviously considerably elevated relative to where they have been historically, that ultimately all feeds through to inflation. So are you, in a way, positively exposed to higher power prices because you make more on the revenue line than you might incur in the cost line. And then the final question is just a point of clarification around the innovation fund. That cost that you borne in the first half of the year, would I be right in concluding that, that is operational profit neutral in so much that you appear to have suggested that you have indeed collected revenue for that. So it's in through the front door and on through the back door, so to speak?

Yes. Okay. Thanks, Martin. Just pick up -- I'll pick up a couple of those, and then perhaps Phil can expand on inflation and the impact that has with us. I think first on the EA investigation. Obviously, we're just days into that. We -- as a sector, we heard about it last week. So as you can imagine, we're currently working through the questions and the detail associated with that. I think -- I mean, for us, you'll know we're 4-star. We've been 4-star for a number of years in terms of the way the Environment Agency measures the sector. And we're also very transparent. I think we're transparent in all aspects of our business, but certainly transparent in terms of regulatory performance and how we operate there. So I think a lot to work with the EA and Ofwat through their investigations and we'll see where that goes. But I think at this point, we'll work with the agencies. But as I say, we feel we're very transparent. We're an organization that has very high levels of self-reporting of performance. And we're also one of the leaders in the sector, certainly in terms of serious pollution incidents where we've had none for a couple of years and have been improving on other, like, less serious pollution. So I think we go into the investigation with all that behind us, but we'll see where it goes. As far as the innovation fund is concerned, yes, there's a -- if you like, there's a credit and a debit going on there in sense that we actually contribute to the fund of what effectively calls for contributions from the companies in accordance with their sort of prescribed share. And then you compete for money from the fund. And as Phil said, at the moment, we are a net positive in the sense that we've been winning competitions valued at sort of 3x what we're contributing. And for me, that it was important that we engaged fully in those innovation competitions. And I think our whole focus on innovation and pushing the frontiers for the sector, I think, is reflected in the success that we've had in those competitions. On inflation, Phil, so we get a different voice. Do you want to talk to that one?

Yes, of course, Steve. Martin, I think in terms of the power price inflation, you're right to ask the question, I think sort of power prices today, probably about 3x what they were in terms of the commodity element. So it's a huge risk to be being managed. As you know, our hedging policies have served us well here. We're over 95% hedged in the current year, sort of over 80% hedged next year and circa 75% plus hedged for AMP. So we're in a strong position from a hedging position. I think really pleasing in this first half year as well because power prices are flat half year on half year, reflecting not only the hedging policy, but also the active management the teams put into sort of mitigating power consumption where we can. So a lot of focus and a lot of effort. In terms of your more general point about sort of correlation of inflation, I guess, power prices do feed into the overall basket. But clearly, power price inflation in the last sort of 6 months or so has probably been 200% sort of way outstripping the CPI piece.

Just before I go to Mark, I've got a couple of other questions coming through on the pad here. The first is from Verity Mitchell. And Verity's question is, do you think the focus on CSOs, which effectively are out 4 points, spill out 4 points on sewers could be an opportunity for an increased investment in unpaid given you have a large number of permitted discharges. It's certainly true that our wastewater system is characterized by having a higher proportion than the rest of the sector for what we call combined sewers. So those are sewer that take foul flows as well as surface water flows from highways, streets, et cetera. And so when you look at that, combined with the high rainfall, our sewer system is -- does have a large number of CSOs associated with it. I think the issue that we've been doing is a huge amount of work to essentially install sensors around the system, this is in addition to the work that we've done on Dynamic Network Management. And we have a whole series of studies that we've committed to do with our regulators during this particular 5-year cycle and additional studies that were committed to under the green recovery program to effectively understand what's driving that. Clearly, we are very supportive of the government's drive to progressively reduce spills coming through CSOs. And so I think those investigations will tell us what we've got to do. I think fundamentally, though, and this is, I think, a characteristic of the whole sector. The thing we've really got to do is to get surface water out of the sewers. At the moment, by law, people have the right to connect to sewers. It means there's a huge amount of rainwater that gets into the sewer systems and really rather than necessarily building more storage or building bigger sewers, which is literally billions of pounds, I think we'd be far more sensible in the way we use money in terms of getting surface water out of sewers. And I think that's the general sense that you find right across the sector. So will these investigations identify things that we could do in our systems? I'm sure they will. But I think the prime driver for the sector and for us will be to essentially try and stop rainwater and other surface water getting into the sewers, which means working with partners in diverting that water away from our sewer systems. Dominic, you've obviously got a huge question, which you might want to ask because you've said, can we have more than 160 in characters in our questions. So I suggest probably not. So you might want to ask one online. You've also asked Dominic a question about the national social tariff. And will it lead to subsidies between different regions or could a tax solution be a better solution. I think at the moment, the way the social tariffs work in each region is they are essentially something of a postcode lottery. So if you've got a relatively affluent area, those areas -- those customers in those areas are inclined to support a higher tariff for those who are struggling to pay. Clearly, you find in areas where there is more socioeconomic deprivation, there isn't the money to support the tariffs. And so it is something of a postcode lottery as to where you live as to how much support you might get. And I think the thing that the Consumer Council for Water and government are currently looking at is how can they level up as far as social tariffs is concerned. So it doesn't really matter where you live as to how much support you'll get. And the formula that we're looking for is how we might approach that. Do we do it by redistribution of tariffs that are collected, so that we get a fairer distribution across the country. We've yet to see the full solution for that. There's quite a lot of work being done by government on it. But I think it's a great initiative to actually look at how we help those who are struggling in the more deprived areas as part of this whole leveling up agenda. So more questions coming in from Dominic. We'll deal with those in a moment, Dominic, if we can. But Mark Freshney from Credit Suisse, we have a question from you.

Steve and Phil, so I've got a question for each of you. Steve, to try and pin you down on this Ofwat investigation, I mean how confident are you that the internal controls you have are picking up all of the storm outflows and that you have reported the data appropriately in the past? And Phil, just on the super deduction. My understanding is that there's a reopener on PR19 price review for changes in capital allowances and changes in the tax rate or there's a true-up mechanism. But you seem to think that the actual benefit can be kept by UU. So would you first of all be able to quantify that? And secondly, talk about why it would be shareholders' money or UU's money and not going back to customers?

Mark, I'll pick up the first point. I mean, clearly, we're now in the midst of an investigation. So to an extent, I'm limited on detail. But I think I can certainly say that we believe as a company where we've been very transparent. We believe as a company that we put a lot of effort into that and into behaving appropriately and responsibly. And we'll see how that runs through as we go into the detail with the investigation, but it'd be inappropriate to go any further really. Do you want to pick up that point?

Okay. Yes. So Mark, on the tax sort of adjustment, you're right, there is a tax adjustment mechanism as part of the next sort of price control process. Broadly the way that works is when Ofwat sets prices they run their models and calculate the overall tax allowance that companies are allowed in prices. And at the end of the AMP period, what they will do again is rerun that model using the revised capital allowance rates and revised corporation tax rates and calculate the overall amount of tax that companies should have had and compare that to what they allowed in the first instance. And that will be the amount of the true-up that effectively gets taken forward into the PR24 discussions. So that's how the mechanism works. So as you say, it picks up changes in capital allowances and corporation tax rates. The key issue here though is that the company is free to make decisions about profiling of that spend. So we front-end loaded profile of our spend into these 2 years with the super deductibility of capital allowances. And also, Steve and I have made decisions to improve operational performance and we talked about DNM in May and the extra money we're investing there. And that's a sort of company-made decision to invest that extra money. And as a consequence, that's extra benefit from the tax sort of capital allowances, but we will get to keep through that process because the Ofwat model will look at the original profile of the overall CapEx spend in the determination. So that was part of our thinking in terms of accelerating the DNM activity because it made perfect sense from the improved operational performance and the ODIs, it was going to help support and deliver but actually getting on with it quickly in these 2 years allowed us to maximize the super deductibility of capital allowance is benefiting all stakeholders, ultimately with better performance.

Okay. Got a question, another one from Dominic. So you're obviously breaking up your 160 characters, Dominic, into several questions. This one is says, are your enhanced monitoring systems picking up more pollution incidents and potentially picking up a legal activity reflow to full discharge? I think the sensors that we've been installing across the network effectively, as far as Dynamic Network Management is concerned, is allowing us to understand the pattern of life better in our sewer system right back up to customer level. What you often find in the way that your sewer system performs is that you'll get a blockage, which occurs or a collapse, you will go and fix it. You won't necessarily see that ever again in that area. And so actually understanding how your sewer system is working and dealing with appropriately is a bit like pin the tail on the donkey. What the sensor system is allowing us to do is effectively to understand how the system is performing and where issues are developing rather than responding to an issue like a blockage or a collapse or something of that sort or inundation with river water instead of responding to a problem once it's occurred, you start to see it develop and get to it ahead. So that's effectively what the sensors are doing for us. We've got a question from James Brand of Deutsche.

Two questions for me. The first question is on your inflation-linked debt, given how big the swings are in inflation this year, maybe you could just remind us the various delays on your inflation in debt. I think from memory, some of the inflation-linked debt is based on 3 months inflation from the end of the year, some has lagged a bit more given that it's going up very sharply, it would be useful to know just have a reminder of how those work. And if you could also remind us the inflation, I guess, RPO inflation, I know you have some CPI-linked debt now, but the vast majority is RPI, what the RPO inflation number was in last year's cost of debt. I think it was slightly less in previous plan. And then secondly, on the direct procurement, I was just interested, are there any risks for you in how that goes? Do you kind of procure that out and as long as you follow the guidelines then it's totally the responsibility of whoever it is that wins the contracts? Or do you retain some responsibilities while how that project is implemented or managed?

Okay. All right. I'll deal with DPC before that, James. And just before I answer the question, just congratulations, I understand you're a dad of not many weeks and I have to say see you on the picture, you look as you're getting some sleep actually. So have you learned the age-old trick of the fella just pretending that they don't wake up or either that or you are extremely resilient. Anyway, just quickly touching on DPC. Yes, you're correct. The way the DPC works essentially is that the program is funded and then effectively delivered by a third party. We act essentially as a payment agent and the client for the project. When it comes to risk, performance risk sits with the contractor for delivery of the project. Clearly, if there are what you might consider compensation events, which you see any construction program, then one would expect those events to be scrutinized, negotiated, but normally, they would be for customer account if they're valid. The areas of risk that we have is where we fail to perform as a client. So for example, if we have to provide information, we have to provide our own assets. So for example, there are many connections between the Haweswater Aqueduct and our system. And so we have to deliver there. So essentially, we have to do what we are responsible for delivering as part of the program. But other than that, largely, the responsibility sits with a contractor. Yes, you're correct in that regard. Do you want to pick up on the inflation element, Phil?

Yes. James, I guess on the inflation-linked debt, so you're right, there's some inflation-linked debt has a 3-month lag and some has a 6-month lag -- sorry, 8-month lag. The majority of the debt actually has a 3-month lag. So that's what's going to drive the interest cost. So January 2022 will be the key sort of inflation point for the index-linked debt. I think your question about where was it this time last year in terms of Jan '21, I think it's around about 1.4%. And clearly, in the current inflation environment, we're expecting sort of RPI to be up sort of probably around about 6% in January next year. Probably just worth sort of highlighting that we have half of our debt in index-linked form. And that's about 1/3 of our capital structure. So we benefit from the whole of the RCV going up with the inflation profile and 1/3 of the capital structure incurring that cost on the index-linked debt.

Okay. Thanks, Phil. We have a question on the screen from Pavan Mahbubani from JPMorgan.

I just have one question, please, on inflation and the impact on bills. Some of your peers have been talking about potentially smoothing bills and being unable to fully pass through inflation sort of when it's supposed to be mechanically. I understand it's an NPV-neutral issue. But from a P&L perspective, is that a challenge you're facing as well? Or should we expect that you're able to pass through the higher inflation from now into your bills in '22, '23?

Yes. I think what we tend to do each year as we're looking at bill impact is we do look at where the sort of some effect of all of the factors affecting billing that year. Do they have exceptional impacts on particular elements of the customer community or more generally on customers. And yes, you're correct that the degree of smoothing goes on in order to ensure that bill shock isn't particularly significant across the customer base or with any particular segment of the customer base. So that's something that we do continuously as we go through annual revisions. I think there is precedent where we've seen very high uplifts as a sector year-on-year for there to be some bill smoothing. But I think, again, it tends to be company by company, and it's a factor of what is the sum impact either of revenue correction mechanisms, annual uplifts, which could be positive or negative, depends on the formula that you have through your final determination, whether you've got ODIs applying penalties or rewards applying in that year. There's a whole series of factors. And I think where you start to see high inflation. Historically, we have had some bill smoothing. As you say, it tends to be NPV neutral in the way that we do it. But I think it's too soon really to say what we think the impact might be on '22, '23. I think we've yet to see that roll out in terms of all the factors that will apply. And then we've got Verity. Verity Mitchell, HSBC.

Just a couple of questions. I was just curious if, Phil, sorry, could explain the inflation slide, Slide 19, I think, about the GBP 40 million of locked-in financing outperformance. And then the risk whether or not CPI is over 3% over 9 years. And then just another quick question. I mean your hired and contracted costs are up 9%. I mean is that temporary? Or is there anything you can do to perhaps mitigate those?

Okay. I'll take both of those. So dealing with the last one first, Verity, hired and contracted costs are up, in the slide, when we talked about the bridge, I talked about the sort of driving performance in terms of ODI costs, in terms of ODI benefits, in terms of operational performance and some of the hired and contracted costs reflect the extra work being done in that area to drive our performance and earn those ODI benefits. On the inflation side, what I was highlighting there was the 2 key points. In terms of the Ofwat allowed cost of debt is a real cost of debt. So consequently, if you walk in inflation cost of debt, then you're matching the regulatory assumption and you're, therefore, locking in guaranteed outperformance. So that's a GBP 40 million guaranteed outperformance as a consequence of keeping it an inflation format. And then as I said on the slide, if inflation has to average over 3% over the whole 9 years of that instrument for that to have been the wrong decision. Now clearly, we don't take a view on where inflation is going to outturn. And we have a balanced hedging policy that keeps half of our debt in nominal format. And the advantage of doing that means that when you model through a whole range of sensitivities and scenarios in terms of what might happen, you get the best optimal answer in terms of financing outperformance over the long term. So it's all about driving and delivering long-term sustainable performance.

Okay. Thank you. Right. I have no other questions. Dominic's obviously used all his 160 plus characters that he wanted. We've got no other questions coming up on the screen. Just before we close, I'd just like to thank many of you for the expressions of condolence that I received in recent weeks following the sudden unexpected loss of my wife. It was very nice and very comforting at the time to have those expressions of support. And I thank you very, very sincerely. Thank you. Okay. So without any other questions, thanks very much for attending. Thanks for bearing with us to deal with the motorway issues, and look forward to seeing each of you in the weeks and months ahead. Thank you very much.