Pennon Group Plc (PEGRF) CEO Susan Davy on Q3 2020 Results - Earnings Call Transcript

Pennon Group Plc (OTCPK:PEGRF) Q3 2020 Earnings Conference Call November 24, 2020 3:00 AM ET

Company Participants

Susan Davy - Chief Executive Officer

Paul Boote - Group Finance Director

Conference Call Participants

Susan Davy

Good morning. I'm Susan. I'm delighted to be here today in my role as Pennon's CEO. I'm joined by my colleague Paul, our Group Finance Director. And together we will walk you through the key elements of our 2020 half year results in a socially distanced and safe way.

I believe today's results demonstrate Pennon's ongoing resilience and ability to deliver sustained performance responsibly. This is all the more reassuring in a world dominated by the uncertainty of COVID where the devastation on businesses and societies is being felt every day in so many ways and continues to do so.

I really want to pay tribute to the extraordinary commitment and resilience of our colleagues at this time, allowing us to continue to deliver for our customers and communities.

Before looking at the half year results, I wanted to talk about our new vision and purpose. Our reshaping of the group with a focus on U.K. water together with the impact of COVID on society and communities has been a catalyst for us in reviewing our purpose and considering the widest social contract or New Deal we should have with our customers and the communities we serve.

We all know that water companies have a vital role today and every day providing customers with safe and clean drinking water and in our region clean bathing waters with the importance that has on health and hygiene bringing water to life. So that might be a given.

At Pennon we also believe we have a unique role to play in supporting the lives of people and the places they love for generations to come. For us it is not just about what we do, but how we do it and that's why we strive to live our core values daily and operate in the public interest.

That brings us on to our sustainable future focus areas. For example, our responsibility for natural capital stewardship and the public interest commitment to come net zero by 2030 influences the way we operate now and I will touch on some of those examples today whether it's leading the way with our working catchments, nurturing biodiversity on our sites or ensuring our investments like our new Mayflower treatment works operate in a much more sustainable and renewable way.

Affordability and water poverty is one of the strategic priorities to address for our business. Our bills are lower today than they were over 10 years ago. And we have a good track record of providing innovative solutions to address affordability and vulnerability in our communities but there is still more to do.

Finally in supporting Build Back Better and the green recovery, we have an opportunity to make a bigger and more societal contribution whether that's through promoting social mobility, addressing racial and gender inequality or in providing secure jobs where all employees are paid fairly for their work they do.

I believe by focusing on all these things, it builds ongoing trust and confidence in us as a business whether you're a shareholder a customer or an employee. At Pennon, we'd like to call it profit with purpose guided by our values.

So turning to the half year results. I'm pleased to report that we have had a good start to the K7 regulatory periods, delivering on our plans and continuing to demonstrate financial discipline. At the headline position, equity returns as measured by the WaterShare return on regulated equity are 8% at the half year, double the base return in Ofwat's final determination. We are on track or ahead of 80% of our outcome delivery commitments. And we have continued our efficiency momentum delivering £30 million of totex outperformance this half year and have locked in efficiency.

Our effective interest rate of 2.5% for this half year is 90 basis points lower compared to the last half year. The sale of Viridor completed in July has resulted in a profit to the income statement in the half year of £1.7 billion. In line with our values we've adopted a responsible approach to the use of proceeds by repaying debt at the Pennon level and paying into our pension scheme considering the needs of all our stakeholders.

In terms of deploying the remaining proceeds, we continue with our highly disciplined approach in assessing potential investment opportunities. We have worked extensively to narrow these down and they've been benchmarked against the return of capital to shareholders. If a compelling value-creating acquisition is not available, capital will be returned to shareholders.

Speaking of shareholders, we have been developing our shareholder base and we've established a unique new relationship with shareholders customers and I'm pleased to report we have shared £20 million of returns with our customers either as a credit on their bill or as Pennon shares, one in 16 households across the regions are now shareholders in Pennon. Importantly this means that both customers and shareholders alike can benefit from our sector-leading dividend policy, which is growing the dividend by 2% plus inflation measured by CPIH.

I will now hand over to Paul to talk in more detail about the half year financial performance.

Paul Boote

Thank you Susan and good morning everyone. I'm Paul, Pennon's Group Finance Director. Whilst we're all living through challenging times, I'm pleased to be able to report that Pennon's financial results for the half year have been resilient. They're in line with management's expectations.

For those of you who have followed Pennon closely, you'll appreciate that this has been a landmark year for the Group, in which we've crystallized significant value for shareholders through the sale of Viridor for £4.2 billion. The sale completed on the 8th of July and has resulted in a profit on disposal of £1.7 billion.

Throughout this presentation, we will focus on the underlying results of the Continuing Group with comparatives for the prior period being restated accordingly. The appendices to these slides contain full reconciliations to the statutory results and provide details on non-underlying items, including the substantial profit recognized in connection with the sale of Viridor.

For the Continuing Group, South West Water and Pennon Water Services highlights for the half year include a resilient profit before tax performance of £86.7 million in the period. This includes the impact of the K7 reset reflecting a lower weighted average cost of capital and the limited financial impact from COVID. Both these factors have outturned broadly in line with our initial expectations.

Another notable feature of our results is the 90 basis points reduction in our effective interest rate to 2.5% for the period. With our current year current tax effective rate of 14% consistent with the prior period, this all results in earnings per share for the Continuing Group of 17.9p in H1. This underpins our sector-leading dividend policy of CPIH plus 2%, which based on September's inflation rate of 0.7% gives an interim dividend per share of 6.77p.

Focusing on the Group's revenues period-on-period, I'm pleased to report that overall these have remained robust even with the K7 revenue reset to around £320 million for the half year. There have been a number of moving parts this period in particular the impact of COVID, which overall has lowered revenue by around £10 million.

COVID has resulted in circa 20% lower demand from our non-household business customers, which is mostly offset by additional demand of circa 5% from household residential customers. Both movements are primarily due to the impacts of lockdown and restrictions. The impact of this is broadly even as around 80% of South West Water's revenues are from household residential customers.

In addition, we have seen a reduction of new connections from developers, particularly through the first lockdown, although this activity has now picked up again and we've not yet seen any significant impact in this area from the second lockdown in England. It is also very pleasing to see Pennon Water Services making a number of large contract wins with sustainable national businesses, which has resulted in around £10 million of additional revenue this period.

Profit before tax for the Group period-on-period is in line with expectations at £86.7 million. The chart sets out the movements from last half year with the largest factor being the £10 million anticipated impact from the K7 revenue reset. The profit before tax impact from COVID of around £5 million is lower than the revenue impact I noted earlier, as lower demand from business customers in non-South West Water regions of the country results in a lower associated operating cost charge.

The benefit of our lower effective interest rate increases profit before tax by £2.5 million period-on-period. Other movements include operating costs net of continued operational efficiencies.

Cost increases include for example higher power costs this year, which were hedged out in prior periods when power prices were higher. We expect the benefit of the current lower spot power prices to flow through in future financial years. Cash collections from both business and residential customers have remained robust in the half year at comparable levels to past years with the Group recording an expected credit loss charge of £2.3 million in the period again consistent with prior periods. The vast majority of the £7.8 million expected credit loss provision recognized at the end of last year remains in place.

Looking ahead to the second half of the financial year, I would note that demand is typically H1 weighted, whilst K7 revenue reset will continue through the financial year. The impact of COVID appears limited, but is of course highly dependent on the extent of the pandemic and on continued government support for our customers both business and residential.

Turning to the Group's financial position and cash flows in the period. You can see in the first shade of block, the continuing group recorded an overall net cash inflow whilst continuing to invest in our K7 capital program. This includes the delivery of our innovative Mayflower treatment works which is designed to be more sustainable than traditional water treatment works through the use of cutting-edge treatment processes and is now supplying drinking water to our customers in Plymouth.

The disposal of Viridor has resulted in the group moving to a net cash position at the 30th of September. Taking each bar in this second shade of block in turn, the group received net cash proceeds of around £3.7 billion on completion and £200 million of net debt was transferred with Viridor at that time.

Following the sale announcement in March 2020, Pennon made the decision to repay its £300 million perpetual capital securities at the first call date in May 2020. This instrument was solely issued to fund part of Viridor's investment program. We have also made an extra £36 million contribution into Pennon's principal pension scheme.

The other cash flows noted include Viridor's operational and investment cash flows up to disposal as well as make-whole payments made on payments to repay Pennon's company borrowings.

I'd like to spend a few moments on South West Water's financing position which as a regulated company is financially ring-fenced from the wider group. On the 30th of September South West Water had £2.2 billion of net debt with over 50% on fixed rates, 25% index-linked, and with the remaining net debt of floating rates.

The majority of the fixed-rate net debt is achieved through our agile hedging strategy which the new debt issued in the K7 period is now fixed through hedges of up to 10 years duration. This approach mirrors Ofwat's cost of debt methodology.

Our pioneering sustainable financing framework now in its third year continues to be a source of new funding for South West Water and I'm pleased to report a further £30 million green lease has been signed in the period. We are very grateful to our banking group for their continued support of Pennon and our sustainable financing objectives.

South West Water's net debt to RCV gearing is currently at 65.2%. Aligned with our sustainable approach to financing we expect this ratio to reduce over K7 towards Ofwat's notional level of 60%. Through our agile financing strategy, we have delivered a 90 basis points reduction in South West Water's effective interest rate to 2.5% compared to the same period last year. This reflects new hedging for the K7 period at lower rates compared to those in place through K6 and lower inflation rates in the first half of this financial year compared to the same period last year.

We continue to demonstrate a disciplined approach to the use of the £3.7 billion net cash proceeds we received from the Viridor sale. Having carried out a detailed review of Pennon's company borrowings, we have made good progress and we paid circa £0.75 billion so far and are on track to deliver the £0.9 billion the group previously announced it would seek to retire.

In determining the facilities to be repaid, we considered the ongoing sustainability of the financing held at the Pennon company level and we paid certain fixed-rate facilities where the make-whole cost of doing so were value accretive.

Assuming we retain £0.3 billion of debt at the Pennon company level and after taking into account associated expenditure for the reshaping of the group which includes the Viridor sale transaction costs, pension contributions, and make-whole costs on retired debt, this leaves £2.7 billion available for possible future investments and for returning funds to our shareholders.

As Susan noted earlier, we will act responsibly in considering any use of capital to pursue an investment opportunity by benchmarking it against returning that capital to shareholders thereby ensuring our strong focus on financial discipline is maintained.

In summary, today's results demonstrate Pennon's ongoing resilience and ability to deliver sustainable financial performance coupled with an excellent financial position that leaves Pennon well-placed for future challenges and opportunities.

And with that, I'm now going to hand you back to Susan who will pick up our operational performance and plans. Thank you.

Susan Davy

Thanks Paul. The focus for our delivery plan for K7 is characterized by our new deal. In building a new relationship with customers, we are also committed to delivering a step change in environmental performance and creating a great place to work for our loyal and dedicated employees. Our relationships with business customers through our business-to-business retailer Pennon Water Services is also thriving. Our goal is to focus on the right things in the right way, enabling us to outperform our business plan and deliver sustainable returns, double the base allowed in the final determination. We are demonstrating we have a great platform for growth.

So starting first, with the changing nature of our relationship with customers. Building a deeper relationship with customers through our pioneering WaterShare+ Scheme giving customers both a stake and a say in the business has been a very important, and unique step in advancing a new type of social contract with business, and one we're really proud of.

Shaped by customers for customers, its origins are in the largest-ever customer consultation exercise South West Water has undertaken. Customers have been able to choose whether they wanted to show in our outperformance by either getting a credit on their account or by becoming shareholders. We're really pleased with the outcome, especially as no one else has ever done anything like this before. We've more than tripled Pennon's share register and now one in 16 households are shareholders, as well as customers and we're heralding a new era in customer ownership. And it doesn't stop there.

We're also introducing a WaterShare+ Advisory Panel, which will meet quarterly in public championing the customer view and holding us to account. We will also be holding a dedicated customer AGM. So at the heart of any great business are the people who work in it. With over 2,000 employees our people strategy is centered around talented people doing great things for customers and each other.

I'd like to take a moment to recognize the exceptional commitment and resilience of all our people during this time. Since taking on the role as CEO, I have spent time out and about in our sites and in field locations, and have been humbled by their dedication and commitment that has allowed us to continue to deliver for customers and communities.

Like any responsible employer, our priority has been on protecting the health and safety and wellbeing of all our employees, from ensuring all our sites and operations have remained COVID secure, and we've had almost 1,800 employees having undergone mental health training, and we're currently expanding our mental health first aider program and continue to offer all employees 24/7 access to confidential assistance.

I talked earlier about the role responsible businesses should play in promoting social mobility, addressing racial and gender inequality, and providing secure jobs and we're doing exactly that. We're one of the first businesses to sign up to the Kickstart scheme, providing work placements for 16 to 24 year olds on universal credit, and adverts for those roles are out now.

We're also focused on bringing in the people capability for the future investing in 500 apprenticeships over the next five years, and we'll be offering a new grad scheme in 2021. And in addition to championing gender diversity as one of only three top FTSE 100 businesses to have a female Chair and CEO, and have a lower-than-average gender pay gap, we're also the first water company to become a signatory of the Change the Race:Ratio helping society to advance asset diversity at all levels.

As I said before, over time, we want to change the nature of our relationship with customers with WaterShare+. At the transactional level, we start the beginning of this new regulatory K7 period in a really good position. Customers are already seeing the difference as we have tailored solutions prioritizing issues that matter most to them, and focusing on first-time resolution.

As a result, written complaints have reduced by 5% this half year compared to last half year, with a cumulative reduction since the start of the last regulatory period of circa 58%, reflecting our focus on first-time resolution. And in response to COVID, South West Water was one of the first companies to proactively expand our priority services register, helping to identify customers shielding, adding over 21,000 customers to that register.

During lockdown, our WaterCare+ advisers have completed over 2,700 virtual home visits, realizing nearly £1 million of financial support as a result of our innovative affordability and WaterCare+ program supporting customers to ensure they are all receiving eligible benefits.

South West Water continues to expand its customer toolkit. We have a 17% increase in customers now benefiting from our social tariff compared to the last half year. And cumulatively since the start of the last regulatory period K6, the number of customers on our social tariff has increased by 76%.

Over 28,000 customers now receive support through reduced tariff with more than 36,000 customers supported through one or more of our affordability schemes. Importantly, as well our digital improvements to our website have seen more than 42% of our customers now using us online.

What matters most to our customers is getting the basics right. I started at the -- I talked at the start about the availability of clean and safe drinking water and that being a given. Minimizing supply interruptions to customers is always a priority. And with the increased use of network sensors and business intelligence, we have been predicting and proactively mitigating network issues and targeting reductions for those customers who have an outage for more than three hours.

For this measure, in this half year we have achieved our lowest-ever level per customer outcome of 2 minutes, 57 seconds, a 51% reduction on the last half year time of 5 minutes, 59 seconds. And since the start of the previous regulatory period, we have delivered a 65% improvement in the average duration of water supply interruptions. And this has been achieved through use of network sensors and our fleet of state-of-the-art rapid response vehicles.

We also continue to invest significantly in preventing and managing leaks on our network and continue to achieve our leakage target every single year. We are delivering a step change in performance with innovative techniques such as acoustic logging technology to help identify and fix leaks and bursts.

In this half year, we've had a 40% increase in detection and 25% reduction in leakage running time. By upgrading several of our treatment works and utilizing better treatment processes, we have also successfully reduced the number of contacts received about the taste and smell of water. These contacts have reduced by 18% in this half year compared to last half year, with a 38% reduction since the start of the last regulatory period.

We have maintained our good performance this half year compared to last, which is ahead of our commitment. And since the start of the last regulatory period the number of flooding incidents have also improved by 35% with a range of measures including enhanced sewer cleansing and monitoring and our unique educational campaigns aimed at influencing customer behavior, so that they can do their bit too. All of these are key customer priorities and we're targeting even more improvement over the remainder of K7.

So moving on to the environment. We take our role as custodians of the environment very seriously and are committed to helping people across the South West and Bournemouth enjoy the places they love. We continue to make improved and sustained bathing water benefits with our current investments two years ahead of plan and we're working proactively with partner organizations across the region to tackle bathing quality issues in a sustainable way.

We've also been driving environmental improvements and our award-winning catchment management plans have delivered benefits in 80% of our supply areas with over 14,000 hectares improved this half year. We have accelerated biosecurity invasive species work and have delivered measures at 23 sites already against our full year plan of 21 and we expect to double our original target by the end of the year. This will include a U.K.-first biosecurity wash down facility at Roadford Lake, which is used extensively for related facilities. And we have planted over 50,000 trees towards our planned 100,000 trees target by 2025.

As the only water company to have been fast-tracked by Ofwat for the second consecutive time, we are on track or ahead with 80% of our outcome delivery incentives this half year. 33 of the outcomes have financial incentives attached and all are grounded in customer priorities and those are the most financial incentives I've touched on in the previous slides.

For those that are specific to our region or bespoke, we have delivered a GBP 3.5 million benefit in this half year. For those that are common to water companies, such as leakage and water quality, we are delivering a net gain. And for both where we will be measured comparatively, internal sewer flooding and supply interruptions, both are on track or ahead of the target.

Pollution's performance is behind, but we have a step change targeted incident reduction plan in place. This includes a dedicated task force, strengthening our incident response capacity and a cultural training and employee engagement program. It's early days, but in the last three months we have seen a consistent step-change reduction in a number of pollutions, although there is much more to do.

We are delivering on our commitments, but we're doing this in an efficient way. We accelerated expenditure last year to enable a fast start to this year and have also accelerated investment this half year to ensure we're making a really good start to this K7 delivery period.

We've already delivered GBP 34 million of efficiencies in the first half and are on track to consistently deliver at this rate over the period to 2025. This is where we see innovation coming to the fore, not just in the technology we deploy, but also with how we are working with the broader supply chain across the region to deliver efficient and improved services. For example, we're currently working with the University of Exeter establish an industry-first Centre for Resilience in Environment Water and Waste. We are also increasing the use of robotics to increase efficiency and automating more of our network inspections.

Paul has talked earlier about our diversified financing portfolio with a 2.5% effective interest rate, which is lower than Ofwat's 4.2% allowance, we have an optimally hedged portfolio. And we have locked in a significant proportion of our efficient financing outperformance for K7. Comparatively, against the water sector, we compare favorably in this area. So I talked at the start about the role of a responsible and sustainable business delivering against our commitments whilst delivering sustainable returns.

In summary, we are delivering strong outperformance in totex and financing and this run rate is locked in predominantly for the K7 period. Compared with Ofwat's return on regulated equity, FD assumption South West Water of 8.5%, at 8% we have made a really good start to K7. Whilst 8% of ODIs are on track or ahead of plan, we have more to do to improve our environmental pollutions performance and deliver a positive financial outcome, but we have accelerated our plans to achieve that. So in summary, it's a really good start to K7.

So turning to Pennon Water Services our business-to-business retailer. We are seeing customer growth despite a challenging environment. As we are all aware, COVID has affected all businesses. And in the regions that PWS serves, we've seen a 20% reduction in demand, as the number of businesses have not been able to operate for several months. It is ever pleasing to see PWS performing robustly in this half year and driving growth in new customers as well as reporting a positive EBITDA. Cash collections have remained stable. Importantly, there has been no requirement so far to use industry support mechanisms.

In summary Pennon Water Services is well positioned for the future in what has been a really tough market. So we have started the regulated delivery period in a good position. We've extended our license area and taken on the Isles of Scilly from the beginning of this financial year and we've got operational teams and key supply contracts and essential investments underway. And in line with our passion for the environment and doing what's right, we're committed to supporting Build Back Better and the green recovery. We're therefore looking at bringing forward planned investment from future K periods for the benefit of our customers communities and the economy using the most appropriate funding mechanisms to do so. PWS is in a good place to continue sector growth. Pennon has significant investment headroom. And with the Board's highly disciplined approach to assessing all opportunities, we are focused on delivering value creation for shareholders.

So in summary, our new deal is all about building a new relationship with customers delivering a step change in environmental performance and creating a great place to work for our employees. We have performed well in the first half of the 2020/2021 financial year and have locked in delivery to achieve a doubling of base returns over the K7 period. Pennon is well placed to continue to drive a sustainable business and has created a platform for future growth. Thank you for listening.

Question-and-Answer Session

End of Q&A