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United Utilities Group PLC (ADR) (OTCPK:UUGRY)

Q2 2013 Earnings Call

November 27, 2013 04:00 AM ET

Executives

Darren Johnson - IR

Steve Mogford - CEO

Russ Houlden - CFO

Analysts

James Brand - Deutsche Bank

Edmund Reid - JPMorgan

Darren Jameson

Good morning everybody. Welcome to United Utilities Half Year Results presentation. And it's good to see many familiar faces here. I think most of you know me, but for those who don't, I am Darren Jameson and I look after the investor relations at United Utilities. So, just a few usual housekeeping duties to run through before we start, please. There is a fire drill time for this morning. So of course it’s the fire alarm sound, it's for real, so if you could make a way out of the doors in the corner of the auditorium. And as usual if you could switch off mobiles, BlackBerry's et cetera. And today's presentation as always is considered in the context of the cautionary statement towards the back of the presentation, perhaps you have. So I'd now like to hand over to our Chief Executive.

Steve Mogford

Thanks a lot Darren. Good morning ladies and gentlemen. This morning Russ and I will provide you with a brief overview of our progress over the last six months. It’s been another good period for the business with making progress against the strategy on all fronts. You will see that customer satisfaction is continuing to improve, asset performance is delivering stable or improving serviceability, costs are firmly under control and our capital program is on track. We are also pleased with our early success in the Scottish business retail market.

We recognize affordability is a key issue and have decided to use tax refunds to discount customer bills and to help those struggling to pay. We are delivering for all our stakeholders and have increased our interim dividend in line with our policy. Our hard work over AMP5 has put us in a good place as we approach AMP6. We are now only days away from releasing our business plan for AMP6. We can’t provide you with a full summary before all companies have released their plans, but this morning I will give you a sense of its key features.

This is the agenda for this morning’s presentation.

Two years ago, we adopted a customer centric strategy focused on delivering class leading customer satisfaction. We have made good progress and, as you will see in a few moments, we are no longer the sector laggard. In fact, we are the most improved water and waste water company in the sector. We know that we have more to do to be consistently one of the best in our sector and delivery of our plans will achieve this. However, AMP6 and the sector evolution contemplated by the UK Government’s Water Bill will re-define what it means to be the best.

Change in the water sector is much more likely to be evolutionary than revolutionary but AMP6 marks a departure from the last 20 plus years of water regulation. Two of the big changes featuring in AMP6 are separate binding price caps and retail competition for business customers. We are preparing to thrive in AMP6 and beyond and to exploit the opportunity presented by sector reform. In April this year we brought about functional separation of our three key business areas into Domestic Retail or household; Business Retail or non-household; and Wholesale, subdivided into water and waste water.

Against the backdrop of our 25 year Strategic Direction Statement, each of these business areas has created a delivery plan for AMP6 focused on meeting the needs of customers, regulators and other stakeholders for its area of operation. Each team is also focused on delivering the best outcome for customers and shareholders as competition is progressively introduced into the sector. So, starting with our domestic retail business.

The Ofwat Service Incentive Mechanism, or SIM, has provided us with a great litmus test of how well we are delivering. Over the last two years of SIM measurement we have progressed from last, among the ten water and sewerage companies, to joint fifth last year. This is the third and last year of SIM measurement for use by Ofwat in calculating companies’ eligibility for an AMP5 penalty or reward. I thought you would be interested to see the performance trend lines based upon available results to date.

This chart shows the exponential trend lines of water and sewerage companies’ quantitative SIM scores, using performance to date. You will recall that quantitative SIM measures the avoidable contacts companies receive from customers. As you can see, all companies have improved with us improving the most. The best improving companies are on a converging path and we have worked hard to be among this group. The qualitative SIM trend lines show a similar picture.

You will recall that the qualitative SIM score measures customers’ satisfaction with how their contact with a company was handled. Again, we are one of the most improved companies and on a convergence path with the best. High performing companies are now clustered with very few SIM points between them. Just few dissatisfied customers out of a population of millions can make the difference between first and second quartile performance.

What is important, however, is that customer satisfaction has significantly improved over AMP5 and this is important for the legitimacy of the sector. The final outcome will not be known until the summer of 2014 when the full three year SIM results are published. Nothing is certain but based on current progress we are on track to achieve our aim of not receiving a SIM penalty, based on Ofwat’s penalty/reward methodology. This would represent a significant achievement given our starting position as an outlier.

Since 2010, every year we have continued to improve the customer experience. Customers dissatisfied with our handling of their complaint can refer the matter to the Consumer Council for Water or CCW. It is testimony to our improved handling arrangements that the number of such referrals has reduced significantly over the last two years and none were considered by the CCW to warrant investigation last year. This remains the case for the first half of 2013/14.

Our customer centric strategy recognizes that customers’ expectations of us are also conditioned by their experience of non-water companies. So each quarter we benchmark our performance against other leading service providers in our region. In the last results, we scored over 90 percent for customer satisfaction and customers ranked us third behind John Lewis and Marks and Spencer.

Cross-sector recognition for our efforts, evidenced by our recent contact centre and House Builders Federation awards, tells us that our work is delivering results. In 2011, we undertook a detailed study into the implications of opening the business retail market to wider competition. This led to the recruitment of a team experienced in retail competition in the utility and other sectors to deliver our strategy for this area.

Over this period the UK Government reduced the threshold at which companies in England can compete for their water retailer as a next step toward full opening of the English retail market for business customers in 2017.

Today we can see only a small number of incumbents and new entrants active in the English market. We assume that this is because the discount available to customers is too small to be of interest until new pricing arrangements take effect in AMP6.

However, the Scottish business retail market has been open for a number of years and whilst there has been limited switching away from the Scottish incumbent, there is an attractive margin available in this market.

In October 2012, we were granted a license to trade in Scotland and have since won customers with over 1,500 sites representing an annual revenue of around 6 million.

In this short period, we have become the second largest water retailer in Scotland after the incumbent, Business Stream, and we continue to pursue a significant pipeline of opportunities.

Our retail service is underpinned by a range of value-added services, such as on-site engineering solutions and water efficiency advice. This, combined with our strong focus on delivering high levels of customer satisfaction, is winning business.

Competing in the Scottish market is also helping us to learn about the propositions, processes and systems needed to acquire out of area customers and this is important in the run up to the English market opening in 2017.

Now, onto our wholesale business, this table shows Ofwat’s latest KPI assessment for the ten water and sewerage companies. Once again we have delivered an above average performance and the best among the listed companies.

In the previous year, we had four amber scores and no reds. In 2012/13, we halved our amber scores, but we did have one red assessment on internal sewer flooding incidents. This was an industry wide issue as the exceptionally intense rainfall in the year led to many companies seeing higher levels of sewer flooding.

Our plans for AMP6 are to reduce the risk of internal sewer flooding by a further 40 percent. The Environment Agency has yet to publish its latest KPIs for water and sewerage companies. In its draft report, it congratulates UU for becoming one of the two leading water and sewerage companies for environmental performance, alongside Wessex, so good progress, with more to do, but a good platform for AMP6.

I’ll briefly cover capital delivery and Russ will talk in more detail about our OpEx performance later in the presentation. In previous presentations, I have talked about how we use our Time, Cost and Quality index, or TCQi, to measure how well we are delivering our capital program. We have made good progress, achieving a score of around 90 percent last year, compared with our score of around 50 percent for the first year of this regulatory period.

We are pleased to have improved again in the first half of the year, with a TCQi score now in excess of 90 percent. This performance was key in enabling us to accelerate our capital program last year, when we invested 787 million, an increase of around 100 million compared with the prior year. It has also underpinned our ability to re-invest around 200 million of savings in projects that will deliver benefits to customer service or the environment.

We have maintained momentum this year, investing 407 million in the first half, an increase of around 15 percent on the first half of last year. This puts us well on track to invest at least 800 million in 2013/14. Management of private sewers continues to progress well, with expenditure remaining within our cost estimates. Accelerating investment has enabled us to complete a number of projects early, reducing risk in the last year of this regulatory period.

Our cumulative investment across the first three and a half years of AMP5 is now 2.4 billion, and we remain on track to deliver the five-year CapEx program within the AMP5 allowance of around 3.5 billion.

Overall, we have significantly improved our performance in delivering regulatory commitments compared with AMP4, when our poor performance led us to receiving short-falling revenue penalty of over 80 million, and our much improved performance should significantly reduce the penalty risk at PR14.

Our wholesale business has seen a lot of change over the last two years. The fact that we have delivered significant improvement in performance whilst undergoing considerable change in process, technology, and organization and people is testament to the commitment of our wholesale team. We’ve delivered new target operating model for our business, integrating best practice and experience from our sector and others. Our goal is to achieve optimization of our system in real time to deliver customer service, efficiency and statutory compliance.

During AMP5, we’ve taken a number of steps to establish the foundations of this new way of working and we intend to continue the program into AMP6. A recent project to survey the Haweswater Aqueduct presented us with an opportunity to test our approach. The aqueduct is a critical asset which supplies water to around 2 million people on its route from Cumbria to Manchester. We closed the aqueduct for three weeks while we surveyed the tunnel and carried out small repairs. We took water from around 40 alternative treatment works around our region and reconfigured our network in real time to keep the customers supplied. And all this was achieved without our customers noticing any change to the quality or reliability of supply, including the Prime Minister who was in Manchester at the time attending the Conservative Party Conference, and never have to miss [indiscernible].

Before passing over to Russ, I would like to touch on how we’re sharing benefits with our customers. We previously announced 240 million of CapEx and financing outperformance reinvestment for the benefit of customers and the environment. In addition to this, there has been a recent development in the sector in respect of taxation. HMRC and water companies have recently reached an agreement regarding credits of prior years’ tax, and Russ will touch on this in a little more detail in his presentation.

We have carefully considered what is the right thing to do with our cash tax refund and we’ve decided that we should share a 75 million net cash benefit with customers. Our final determination for AMP5 allows us to increase 2014, ’15 prices by an average of 1.2% over inflation, and we’ll use around 20 million of tax refunds as a special discount to offset this factor, so that, on average, customer bills rise by no more than inflation. Across AMP5 customers in our region will have seen prices rise by less than inflation.

Our trust fund, which we established the number of years ago, helps customers struggling to pay their bills and around 70% of customers receiving assistance from the fund return to regular payments. We intend to use 17 million of tax refunds to provide further funding to the trust. This will help customers struggling to pay and reduce indebtedness. The balance of 38 million of the cash tax refund is to be used for future sharing with customers. We will decide upon precise arrangements once we understand our AMP6 final determination and could identify how the refunds can be used to best effect.

We believe we are achieving a good balance in sharing our success between customers and shareholders. Going forward, we’ve also assumed that revised tax arrangements will apply in AMP6, saving customers a further 90 million over the 2015 to ’20 period.

Now, over to Russ to present the financials.

Russ Houlden

Thank you, Steve, and good morning, everybody. This is another good set of results in a tough economic climate. An increase in revenue, and tight cost control and lower tax rate combined to increase underlying operating profit by 9%, underlying profit before tax by 14%, and underlying EPS by 19%. We have responsible financing policies with RCV gearing comfortably within Ofwat’s AMP5 range, and our dividend policy, targeting growth of RPI to 2% each year, keeps dividends growing in line with the RCV.

For the half year, we have declared an interim dividend of 12.01 pennies per share, up 5%. This comprises RPI inflation of 3% for the year to November 2012, which is the rate included in our price limit for 2013-’14 plus 2% in line with our stated dividend policy.

As usual we’ve made some adjustments to reported profit to get to underlying profit, which we believe gives a more representative view of underlying performance. We had a 100 million fair value gain in the half year, largely due to gains on the regulatory swap portfolio, resulting from a significant increase in sterling interest rates during the period. This compares with a fair value loss of 49 million in the first half of last year.

Our tax charge in the first half of this year benefited from a 159 million deferred tax credit, reflecting the substantive enactment of changes to reduce the corporation tax rate from 23% to 20% by 2015 and this compares with a 53 million credit in the first half of last year, which reflected a 1% reduction in that period. We also benefited from a tax credit of 125 million following the agreement with HMRC, which Steve mentioned earlier and which I’ll discuss in a little bit more detail with the next slide. As a result, reported profit after tax was up significantly but the more meaningful underlying measure was also up with an increase of 27 million to 168 million for the first half.

Now, we’re really pleased to reached agreement along with the rest of the industry with the HMRC on historical tax matters covering for us over a 10 year period. The agreement principally relates to the revised tax treatment in respect of capital expenditure, particularly regarding the abolition of industrial buildings allowances, or IBAs, in 2008. The total tax credit to the income statement of 125 million includes deferred tax and the release of an accounting accrual, which are non-cash items. We expect to receive a cash tax benefit of around 90 million over the next two years relating to the revised IBAs tax treatment, of which 15 million was the cost borne by shareholders in the latter part of the previous regulatory period. We are therefore proposing share of 75 million net cash benefit with customers, as Steve outlined earlier.

In addition, our agreement with HMRC on CapEx tax treatment is expected to reduce future tax charges. We estimate that there will be tax savings of around 90 million in the 2015 to '20 period, all of which will flow through to customers through our PR14 pricing proposals. So this provides benefits to customers both today and in the long-term.

Now moving on to income statement. This is a summary of the underlying income statement after making the adjustments shown on the earlier slide. Revenue for the half year of 853 million was up 30 million, or 3.7%, which is similar to the allowed regulated price increase of 4% nominal, 3% RPI plus a 1% real increase. Underlying operating profit was up 29 million, to 343 million, as a result of the increase in revenue and tight cost control.

Underlying profit before tax was 216 million, 27 million higher than the first half of last year, due to the 29 million increase in underlying operating profit partly offset by a 2 million increase in underlying net finance expense. The underlying tax charge of 47 million was similar to the first half of last year, as the tax impact from higher profit was largely offset by a fall in the total tax rate. This rate reduction was partly due to the 1% reduction in the mainstream rate of corporation tax from 24% to 23%.

On to our cost performance; our cost performance in this period has been good. Employee costs have decreased by 5 million, mainly reflecting an increased proportion of CapEx activity, supported by a tightly controlled pay award. Power costs have increased by 1 million and rates and bad debts were similar to the first half of last year. Regulatory fees increased by 2 million and other expenses also increased by 2 million. Overall, our tight cost control measures have helped us keep operating costs flat at 269 million.

IRE was similar to the first half of last year, as our maintenance program continues to progress well and depreciation was 3 million higher, as expected, mainly as a result of an increase in the commissioned asset base. And so our total operating cost, including IRE and depreciation, increased by less than 1%.

On to our bad debt performance. We recognized the financial difficulties facing many of our customers and provide a range of options to help those who are struggling to pay their bills. However, we continue with our robust approach to those customers who can afford to pay but choose not to. We have delivered another good performance, maintaining bad debts at 2.2% of regulated business revenue for the first half of 2013, '14 despite the tough economic conditions, and we remain strongly focused on this important area given the potential impact from the Government’s recent benefit changes.

Turning now to the statement of financial position. Property, plant and equipment was up 185 million in the first half of the year to just over 9 billion, as we continue to make good progress on our CapEx program. Cash and short term deposits of 53 million were 149 million lower than the position at March, mainly as a result of CapEx spend.

Total derivative assets have decreased by 141 million, to 580 million, mainly due to a significant increase in market interest rates during the period. This has been partly offset by a decrease of 73 million in derivative liabilities, to 127 million, for the same reason. As at September, the group had an IAS 19 pension deficit of 184 million, compared with a net pension surplus of 15 million at March 2013. This 199 million adverse movement reflects the movement of market rates during the period, particularly the significant reduction in corporate credit spreads.

In contrast, the scheme specific funding basis does not suffer from volatility due to credit spread movements as it uses a conservative, fixed credit spread assumption. Therefore, the recent credit spread movements have not had a material impact on the scheme specific funding and the level of deficit repair contributions. The triennial actuarial valuations of the group’s DB pension schemes were carried out as at 31 March 2013 and the overall funding position in those valuations have actually improved since March 2010.

Retained earnings have increased by 227 million, mainly as a result of the impact of the tax credits and fair value gains, partly offset by actuarial losses on our DB pension schemes.

Net debt was only 34 million higher than last year end, despite the increase in capital expenditure, as we benefited from fair value gains on our debt and derivative instruments.

So this chart shows our RCV and gearing level. The blue bars, representing RCV, have been adjusted to reflect actual capital expenditure to date, consistent with the regulatory treatment expected at the next price review. These bars show our steady growth in RCV. The green line shows the movement in RCV gearing since the start of this regulatory period and our gearing remains fairly stable at 59%. If we were to include the IAS 19 pension deficit, treating it as though it were debt, gearing would be 61%. Our gearing remains comfortably within Ofwat’s range of 55% to 65% and supporting a solid A3 credit rating.

Moving on to cash flow, net cash generated from operating activities is GBP383 million, up a GBP118 million compared with the first half of last year. This increase was mainly as a result of lower pension contributions and an increase in operating profit. Cash used in investing activities increased mainly because of the planned increase in our capital investment program. The GBP179 million net cash outflow from financing activities mainly reflects dividend payments. Following our agreement with HMRC, we expect to receive a refund of around GBP75 million in this financial year or next.

And finally, an update on our performance against our key regulatory financial targets and how our good performance is benefiting customers. We have now delivered cumulative OpEx outperformance of over GBP50 million in the first three and a half years of this regulatory period. In respect of CapEx, we are delivering significant efficiencies and expect to meet Ofwat’s revised allowance, as adjusted for COPI, and are reinvesting around GBP200 million of savings for the benefit of customers and the environment. As previously reported, we are also reinvesting around GBP40 million of our financing outperformance in unfunded private sewers costs. Our strong performance across these areas has added value for shareholders and at the same time enabled us to propose below inflation average household bills for our customers in AMP6.

Now, back to Steve.

Steve Mogford

Thanks Russ. Companies are due to release their AMP6 business plans by Monday, the 2nd of December. In building our plan we have taken account of the views of over 27,000 customers and other stakeholders to understand their priorities. An overriding message that came back from customers is that they are content with existing service levels and they are generally prepared to pay for a small number of improvements, such as sewer flooding. In respect of the environment, customers do care but they expressed the need to balance the cost of improvements against affordability.

This is important in respect of new European environmental legislation on river and bathing water quality under which the implications for the North West are significant. We have worked with the Environment Agency and other stakeholders to devise a phased approach to compliance with new legislation that sees us delivering improvements over the next three AMP periods. Recognizing that we alone cannot deliver the outcomes required under new legislation, our plans are founded on partnership working with other interested parties. The net result is that our CapEx plan is heavily influenced by expenditure in meeting environmental legislation and results in a substantial investment program.

Affordability has been the principal concern for customers and the overriding driver for our plans. 86% of domestic customers surveyed expressed support for a plan in which prices increased by no more than inflation over AMP6. And three quarters of business customers support a plan where average bills increased by no more than 2.5% above inflation by 2020. This recognizes that environmental legislation has a greater impact on prices to high users of wastewater services than for domestic customers.

Deprivation in the North West is another key driver in our plan. The region is home to more of the most deprived households than any other in the country by a considerable margin and this is a significant driver of our cost to serve. Our plan builds on the processes and practices we have developed to help customers struggling to pay, always with the objective of assisting them to return to regular payment. However, after savings delivered in AMP5 and planned for AMP6, the Ofwat methodology around average cost to serve does not reflect our situation and our plan assumes an additional cost allowance to deal with deprivation.

We are confident that our plan reflects the views of customers and other stakeholders. It achieves an affordable pace of implementation of environmental legislation, restricting bill increases during AMP6. Our plan means that customers would benefit from below inflation average household bills for the decade to 2020. We will be pleased to provide you with more detail following release of the plan on Monday.

So in summary, we have delivered another good financial performance and are on track to deliver our objectives for AMP5. We said that we would significantly improve customer satisfaction and we are the most improved water and waste water company, with opportunity to do more. We said that we would improve operational performance and we are the best performing listed company as measured by Ofwat’s KPIs, and one of the two leading companies in the sector as measured by the Environment Agency.

We are managing operating and capital expenditure well and delivering our outperformance targets. We are well placed to deliver benefit from sector reform and the most successful new entrant in the Scottish business retail market, paving the way for English market opening in 2017. We are taking a responsible approach to sharing our success between customers and shareholders in a difficult economic period. We have established a strong platform for AMP6. On Monday, we will release a plan which builds on these strong foundations.

That concludes our results presentation. Thank you very much for listening. We’ll now be pleased to take questions.

Question-and-Answer Session

Unidentified Analyst

[Indiscernible] just few questions, first question is on today’s tax refund sharing. You’ve 38 million from today’s net cash benefit that you’re sharing with future customers and then yet another 90 million to be shared before an entire AMP6. My question is, are both these amounts included in your commitment to keep AMP6 do increases by no more than inflation or this stay top of over and above that commitment? And the second question is on the 20 million that you’re sharing today in terms of special customer discounts, and another 17 million that will support struggling households. Just could you share with us whether or not you’ve spoken about these two schemes and what your feedback is on these two business? Thank you.

Steven Mogford

Yes, happy to do that. I think starting with the media activities. As Russ said, the tax refund we don’t receive immediately so we get that over the next couple of years. So what we’ve looked at is our first measure which is provide a special discount to customers I think you know that our real price increase for next year is 1.2% positive. And so the 20 million essentially gives customers around GBP 4 of their bill, which will bring prices, average prices in line with inflation for next year, so that moved.

But yet other aspect which was the 17 million into the trust fund. We very much recognized that in our region we’ve got a lot of struggling customers. The trust fund is a very successful way of helping people get back into payment, so about three quarters of people go into the trust fund, get back into regular payments. So we felt that that was an appropriate move and a benefit actually to both customers and shareholders because you see a reduction and that is just a consequence.

And the balance, the 38, we effectively chosen because we haven’t received that cash. So as I say over the next couple of years what we’re looking to do is decide at the time and how we best use that, how we best share that, so there are a number of options available to us. As far as the 90 million is concerned that Russ mentioned so that actually is the revised tax arrangement rolling through into AMP6 and we’ve taken that into account in our pricing for AMP6. We’ll work forward, okay.

James Brand - Deutsche Bank

Thank you. James Brand from Deutsche Bank, three question each on slight different topics. First on retail in Scotland, the success you’ve had there in capturing customers. I was wondering if you could give a bit more detail on what profitability of those customers is like and what do you have [indiscernible] Scottish rules (Ph) significantly to gain those customers? Second question is on bad debt there has obviously been a big focus for us as indicated and you’ve obviously deliver the significant improvements.

I was wondering whether you are all the way through in terms of managing your plans to improve performance whether that was scale and scope for more progress come through over the next couple of years in terms of bad debts. And thirdly, in terms of CapEx you’ve built into your business plan, you may want to leave this question for Monday certainly in terms of the specifics. But I was wondering if you could give a broad guidance in terms of what substantial CapEx program means?

Russ Houlden

Yes, I’ll pick Scotland and then debt just to take that up. And as far as Scotland is concerned and the margin available in Scottish market varies very significantly, both from services being provided but I can’t confirm that and revenues from Scottish market relatively smaller as talked about, 6 million. But the margin itself is healthy so it’s profitable business for us and you’re talking margins that can be up to double-digit. So it’s in that sense it’s a market that’s worth having to go at. Clearly, it’s competitive. And so we’ll compete against the incumbent business stream but also wanted to the other plays but it’s a good market to be in and it’s a more mature market as well.

Steve Mogford

Yes, and I think we’ve got a good performance here with 2.2% of regulated business revenue doing [assets] bad debt particularly when you consider that we’ve got and more than two times the number of the prior customers in any other region. So if you compare that with similar number you see at some other companies as particularly go to in the likes of that. And is there more to come, well, I think yes there is plenty more that we’re doing in terms of driving buyback performance and plenty seeing should therefore continue to improve our buyback performance if it [indiscernible] so environment huge changing about how [indiscernible] is from the government.

And we believe that those benefit changes will affect 800,000 of our customers there because we have a declined customer base those benefit changes will be quite sever in our region and therefore I suspect we’ll be planning very hard to stand still, we are running very hard to improve just a little bit.

Russ Houlden

Yes, I mean on CapEx I mean this time we'll be delivering for the regulated allowance and adjusted security, plus transitional investments and I don't know if you all have picked up from transition investments, we're hoping we're moving from one end to the next Ofwat will allow us to spend money we keep it to the next time.

And in terms of next time we’re expecting CapEx to be broadly similar to this downturn as we just mentioned, but we can't get the numbers today and we will be giving the number on next week.

Unidentified Analyst

[indiscernible] from Barclays. Couple of questions, firstly could you just remind us of your situation your adjustments your exposure to that provision over the next, I think you have given guidance before including the effects of the [indiscernible] so can you just remind us what you think your exposure is and where do you think there might be an impact of any changes that government might be considering to your ability to recover bad debts , there have been press reports that they might change your ability to recover bad debts from tenants.

And then secondly could you give a bit more color in your pension, I think there has been about a GBP200 million swing due to the increase in rates. Is there a rule of thumb we can use to give us the sense as to how your pension might move in the future and continue to move?

Russ Houlden

One of the things we have been pushing forward and I think you will see water industry issue, is that we're seeing a lot of movements between properties including one of the key thing we're ask in terms of the recovery of debt, we are understanding who the tenant is in line with properties and so what we have been doing is working with the government on developing manual portals. I think we preferred for landlords to obliged legally to complete that course, essentially we have scheme that we have developed in conjunction with government and the landlords, which allows landlords to work with the [indiscernible] to identify who the tenants are, I think that will be a big help in moving forward associated with debt recovery. So that's the key issue that we have been looking around in landlords and tenants.

Steve Mogford

A few comments first of all on the depravation average cost of service [indiscernible] or that sort of stuff. I think when you would have analyzed this a year ago you would have said that we had a pretty much gap to average cost of service 300 million. If you have looked at '12, '13 results it would seem that our cost has came down and therefore that reduces debt quite a bit. And top of that the costs have reduced quite a bit, so you could well be below 100 once you adjust those two factors. In terms of what we're actually doing in our business plan proposal we will be making a proposal for an adjustments the average cost of depravation we have shared with you many of the fact points that support that would seem incredibly strong correlation between depravation and the bad debts, and you will see a very strong correlation between depravation and the cost of chasing customers for that bad debt. And we'll be building that into a very well argued case for an adjustments we have a [indiscernible] in our business plan.

And on the pension item I think the point to make here is that we manage pension essentially on a funding basis, and I recognize that's actually quite a difficult conversation because in funding basis that's the time what it goes, you can't see the funding basis such as the [indiscernible] all depend on they are not in the public domain but we manage to scheme funding deficits and we have been driving down the bar of that investment.

So we believe we have a much less exposed pension schemes than many other companies as a result of that initiatives to drive them. And what you are seeing here today in terms of the IS19 deficit reflects the fact that that is not the same funding and it is quite volatile because of credit spreads. And main factor behind the 200 million of the 99 million change is the [indiscernible] credit spreads of about 4%.

I was just trying to give you a rule of thumb, I think it's very difficult because we actually need to work through the interest rate effects, we need to work through the credit spreads effect within the interest rate effect, we need to understand what happens to the assets as well. And so I think it's one of those things where you just got to recognize the [indiscernible] in the IS19 not in funding deficit and we'll report to you as we go along as to how the IS19 deficit is moving the way it's moving.

Unidentified Analyst

[indiscernible] from Credit Suisse. Couple of questions, firstly I think you said a statement that you are expecting the prices you gave that 2015, 2020 to be I guess some inflation price increases over the next regulatory period. I think previously we talked about five prices in real terms, I was wondering whether it’s key driver behind that with reduced taxes 90 million of the next regulatory period or any other variables effecting that. Secondly, the 75 million net cash benefit that you’re getting, can you just confirm whether that something also would club back annually to the regulatory mechanism at 2015 and near back we giving back to customers sooner the new otherwise with, and finally the 3.5 billion CapEx guidance is pretty consistent couple of years, but I guess if you look at the Ofwat published RAB value sort of suggest number in the 4 billion or 4.1 billion range, so I guess you got the RAB is just consuming up in the next with you. I was wondering something that we’re going to see in your business plan that you’re publishing on next week.

Steve Mogford

Okay and just picking up the position on the plan going forward and for M6, you’re right. We are looking at pricing of that five years which will be below inflation increases through domestic household customers, and I think the issue there for us is driven principal [Indiscernible] closely and what you see there is a very strong driver across the region to invest the high level of deprivation [Indiscernible] and customers and so whilst the tax element does contribute, does help, what you also seeing there is a big deficiency drive within the organization as well or actually taking cost out of the organization to deliver that sub-inflation pricing. And just want to pick the otherwise –

Russ Houlden

And Ofwat has no regulatory mechanism callback 75 million, that we’re getting, the 90 million the next period should be built into the proposals, and we have built into the proposals and we have built it in, and therefore equally be built in by another company we are benefitting from the capital (Ph). For this period, there is no regulatory pull back mechanism as such.

Steve Mogford

As far as CapEx has been concerned, I think we have lost touch on that -- we have been driving to deliver that CapEx program for essentially our SD number and so which is around 3.5 and as Russ said there are areas outside of that, one is the private series that we talked back previously and the other one is what is called transition funding and transition funding essentially is a mechanism, that is agreed with Ofwat for no need to have six which is essentially allowed us to do early work to be able to de-risk activity during six and that is actually in line of the cost (Ph) , as I am concerned so that’s a very positive move. And being able to smooth the profile, smooth the risk profile between the two. So essentially out of that we all driving the CapEx with four our adjusted number.

Unidentified Analyst

Just the final question there with given that -- I’m not sure if you give any guidance on Ofwat transitional investment figure is that even including the private sewers cost, I guess, its lower than the non-COPI adjusted figure that sort of consistently been published by Ofwat. I was wondering those added values in the forecast you published as part of business plan next week?

Steve Mogford

I don’t think [Indiscernible].

Russ Houlden

I mean, if you do a COPI adjusted forecast, you can come out about 3.5, probably about 3.6 with disclosed private sales as 120, transitional investment, it’s going to be in the range of 40 million, we think, but it’s not something as a fixed number because as we get through that program, we decide how much percent transitional investment and that will give you a rough idea we’re heading.

Unidentified Analyst

Okay, two questions please. Firstly on EU, and EU hedging strategy, I think and [Indiscernible] is that possibly going through a sharing mechanism with consumers on cost effect going forward and could you give some colors to why you adopted tracker. And secondly on IFRS accounting versus regulatory accounting, if you have sub-inflation rising revenues and suppressing IFRS earnings, how you going to looking at cash and regulatory earnings dividend cover going forward?

Steve Mogford

I think both of those are for Russ.

Russ Houlden

And right on the first question about the debt and the fact that we now have rolling 10 years and hedging strategy, I don’t think that is in anyways to customer point which I think is linked to the [Indiscernible] what we’re doing with the hedging strategy on this nearly trying to take the position which is least likely to be too far adrift (Ph) the next five to ten years that’s the only focus of that and we will be able to know when we got final determination how [Indiscernible] hedging on that. On the issue about regulatory campaigning, our press earning dividend cover and I think you also will be working your way into the dividend question and which obviously we can't comment on 2015 dividend until we get upon determination, we’ve set the dividend policy for this period and it’s a pretty [indiscernible] even if it is not going up [indiscernible] still we’ve have been paying it out making no reason why we wouldn’t continue to pay that out. So we will have to take a range that could almost the right dividend policy when we got final determination. As to dividend cover and how important is dividend cover in that judgment, I think it is one of a numbers important metric. There are, one [indiscernible], miss him, not in the room today. He thinks this is completely irrelevant metric. And but I think most of our investors sees the dividend cover rightly or wrongly has been pulling metric, so we look at it. But there are other important constraint on the dividend including the metrics relevant to S&P and Moody’s and credit facilities, that may be, position is very comfortable to [indiscernible] long way away from that [indiscernible] very much price constraint and that I think just that surrounds your question of how we will be thinking about dividend policy. I think dividend cover and S&P [indiscernible] that ultimately key numbers, I think that the Moody’s [indiscernible] debt will be non-constraining, hopefully [indiscernible] and might be the sustaining factor.

Steve Mogford

Too long, so large, how good is the question, you ask to anyone.

Unidentified Analyst

First half good advance, again have a bad debt, in the Thames Water [indiscernible] Ofwat used the Pricewaterhouse kind of bad debt that crushed it, as a way of denying Thames price rise. I just wonder whether you’d look that how you will practice bad debt against with the Ofwat’s benchmark. I [indiscernible] told you were against with that practice. And secondly whether you would, in terms of your business term, whether you would still [indiscernible] if there was scope to argue over the denomination.

Steve Mogford

I think, two points, there as far as bad debt is concerned, yes obviously we’ve looked at the dialogue that’s been published between Thames and Ofwat. I think the important point to pick here is, the cash we were making is practically around socio-economic deprivation. And I think when you look at the evidence for the North West then we have over half of the most deprived communities which is basically double the closest of the area in any region in the country. And essentially when you look at that the transaction cost associated we’re dealing, with customers in that financial situation is much-much higher. So you’re not sending out a bill and perhaps the chaser when you are dealing with those individuals on many-many occasions through the year.

You’re taking them through debt management polls and you’ve got debt collection arrangements, you’ve got co-carings and whole host of things. So I think the key issue here is not just to look at bad debt, but you look at the impact of deprivation on transaction. And I think what you see in the business plan when that’s published, it’s those of an awful lot of evidence that’s rusted which looks associated in the economic deprivation. Understand situation in the North West as very different from Thames because Thames has actually a very small proportion of the most deprived communities in their area. You then come to how do you deal with that, then clearly we over the years had to develop a whole series of measure for being able to deal with customer struggling to pay.

Our principal action clearly where we thought customer who can pay but don’t, then we deal with that appropriately. Well if our customers are struggling to pay with their whole range of schemes so I mentioned the trust found earlier, we go through matching schemes – we are helping something like 76,000 customers work through this situation. Again nobody wants to be in debt. It’s about getting them out of debt and how do we work through that. If you look at that against the earlier guidance that our folk produced then we meet that guidance and more. And one of the things that we’ve done clearly is benchmark households against what we do in our region against what other companies do. But we will also look outside our sectors for what’s best practice in management of the situation, and we standout extremely well to all of those different measures and the things we do. So I think we have a very caviared argument, a very facts based argument, we hopes to go into this forthcoming discussion with Ofwat.

Russ Houlden

Just a follow up on the [indiscernible] denominator and as you know Ofwat sort of started the denomination 1, and we said well why not 2. They came out with 1.3. We said we will have a 1.7, so it’s still in the long journey of discussion on this. I think our bottom line position is we believe that 1.7 gives the best answer because it is 1.7 that puts water and energy (ph) companies and water and sewerage companies on a level [indiscernible] basis. There is no evidence that water and energy companies are apparently more efficient than water and sewerage companies. And it is the only thing that makes you – think they might be more efficient because you could get the denominator along. So when you accept there is no efficiency gap endemic in that comparison and the only rationale way to set the nominator is to equalize those two groups and that gives you the 1.7. And so how we deal with that in the business plan I’m afraid [indiscernible] I can say.

Edmund Reid - JPMorgan

Edmund Reid from JPMorgan, two questions the first one is on OpEx outperformance. You set a target of 50 million over the repeat period and from the statement in fact you’ve reached there during the half year and you willing set a new target or give us some ideas on how much [indiscernible]? My second question I guess is slightly tricky but back to the dividend question. I understand that you can’t comment because you don’t know what the final termination is, but is your business plan consistent with maintaining the great dividend?

Russ Houlden

Okay, I’ll take those so I think first on OpEx you’re right we’ve done really well on OpEx and we effectively achieved that target within the 3.5 years. And we’re going into last year the cycle and what we’ll be doing we have a number of significant cost challenges in that last year. What we’ll be doing is going through a budgeting process setting budgets for ’14-’15 once we get past Christmas. I mean our intention there would be look at last see what we think we can do and then to give you a revised forecast when we come to full year for the following year. But we recognize we’ve done very well and we just want to have another close look at the final year before we update our final forecast for the end. And on dividend, yes, you’re very tricky, and I’m not going to answer it.

Okay, well thanks very much for coming along. Thanks for the questions. Thank you.

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