National Grid Executive Insights: Balance Sheet & Tax, U.S. Returns
On Thursday, National Grid PLC ADR (NYSE:NGG) reported its fourth quarter earnings and discussed the following topics in its earnings conference call. Take a look.
Balance Sheet & Tax
Steve Holliday – Chief Executive: We can do three, I can that’s okay, but let’s do in the sequence. We have just filed those rate plans in the U.S. literally in the last few weeks. We set out very clearly, why we believe these are the right plans with customers and for ourselves. It’s all about what we need to deliver. I think the communications, the openness between ourselves and many stakeholders in New York in the past year has been a very big step-change for us. So try and make sure people understand what it is that we need to run this business well. It is the beginning of a process, so it will be completely wrong to speculate on where you believe the outcome would be, but what we do need to do is to get an arrangement in place. It allows us to run these businesses safely and reliably and deliver the allowed returns. That’s the key we have to be able to do. Tom, do you want to add a couple of points to that?
Tom King – Executive Director: I do. Specifically to address the issue on, (can you) give us a limitation of where we are in relationships in terms of history of other filings. We have had significant outcomes in New York and Rhode Island this year as a result of final input and as a result of the time and effort that we are putting into both the commissions and stakeholders involved in the Group to deliver some transparency. So let me take Rhode Island as an example. On the heels of the last regulatory outcomes in Rhode Island, we ended up with some legislation that gave the ability to ensure that the integrity of the networks was being invested in and that the commission was required to help us move forward within Rhode Island on a strong delivery of both the gas and electric networks, and we ended up with an investment recovery plan. Both gas and electric were represented this year and we got unanimous approval on both gas and electric for everything that was presented to them through those discussions. So we’ve got a very good track record early into Rhode Island. We took that and leveraged the communications and customer outreach and the commission outreach prior to filing the Rhode Island rate case that Steve mentioned two weeks ago. So I think the recent recovery and recent decisions out of Rhode Island give us a good indication of where we stand within Rhode Island. Then if you move over to New York, we’ve filed the deferral filing based upon the Commission’s requirement in August. We’ve got a decision in December that deferral filing sought to recover $236 million of deferred cost that were allowed for previous time periods. The outcome of that was we were able to achieve 211 of the 236. We got an advanced storm recovery of $25 million in the Commission decision in December, and we were able to pick up about $4 million of some deferred pension cost, so it resulted in a $240 million decision that is in rates today. So I think again it’s another example of the quality of the data that we’re presenting to the commission, the integrity of the story and the need for the recovery and where the relationships are to build on that trust where we’re able to walk out of that filing with a very good outcome of $240 million cost recovery. Then again we built on top of that going into the rate case filing, significant outreach. The data has been audited by a third-party auditor and we’ve done a significant amount of outreach with both customers, regulators and there isn’t any surprise in either the Narragansett filings or the new work filings, both regulated environments understand line by line the issues and the reason for the filings prior to the filings going out. So, I think we are building on the experience we’ve had this year to give us a good opportunity to get those costs recovered as we stepped into the rate filings.
Steve Holliday – Chief Executive: Thanks Tom. It has been about as Tom was describing creating transparency and confidence. Andrew, you want to pick up the question on balance sheet and tax.
Andrew Bonfield – Finance Director: Balance sheet and tax, first of all, will there be a change in balance sheet strategy as far as credit ratings are concerned, I don’t expect us to think about any change. We’ll maintain or aim to maintain A ratings in the operating companies, BBB+ at the holding company level. As we look out, obviously the biggest signals that we have been waiting for is the impact of RIIO until we have that. We have to then look at our longer term financing plans and we are ready to do that as soon as we get the final proposals from Ofgem and we can talk to you about that how that fits into longer term dividend payment structures and so forth, so that’s something we will be ready to talk about, probably in the either the first quarter next year or at the time of the results that Steve indicated, a moment ago. As for as the tax rate is concerned for next year, a couple of things just one the tax rate this year was slightly lower than we were expecting. Part of that was, there were some capital taxes in the U.S. state taxes, which I actually allocated to operating profit and not tax. So, again part of the reason why we beat the guidance we gave you on the tax line. So those aren’t anticipated to recur, so that will drive the rate up slightly. Secondly tax rate volatility is really dependent on two things mix of profits between the U.S. and the U.K. U.S. rates aren’t declining and it depends on the mix profitability and then the second part is around whether you’ve finished ordered cycles and so forth which then sometimes require some small release of provisions. We aren’t expecting those to go through this year. Is the guidance conservative? Malcolm is sitting there in the room you can be sure he has a target to beat it as we do with any of our budgets and targets, but I think we think it’s fair guidance for the moment, and that’s where you probably should use for modeling purposes.
Bobby Chada – Morgan Stanley: Bobby Chada from Morgan Stanley. I think this is the fairly obvious one. The regulated assets that are not in rate base in the U.S. which you’ve kind of mentioned a little bit before but this is the first time we’ve this level of disclosure and it’s a big number. Can you break it down as to what it comprises, what return you get on it and why you are confident it’s worth a dollar and the dollar?
Steve Holliday – Chief Executive: Andrew gave the break out. I think the point I want to make is this is about us trying to show you more transparency and of course you will remember that’s sort of unusual situation as a U.K. listed entity here if we were in the U.S., those assets would be in the balance sheet as regulatory asset. Under IFRS, you cannot hold that as a regulatory asset, but it’s clearly (indiscernible) of money over time, we absolutely will get back. Do you want to break it into component parts, Andrew?
Andrew Bonfield – Finance Director: We receive an interest return on about 65% to 70% of the amount that we talked about Bobby, so that would be ones where we get an interest return rather an regulatory return, so that’s why we took out of rate base as we did at the half year. The split, really the three buckets about one-third of the amount is working capital, which is outside rate base working capital where you don’t either – where the regulators doesn’t allow within rate base or where it’s actually above the cap. But probably we think about a third of it is capital work in progress. So it’s related to things where you got assets which were in the process being built but that hadn’t been included in the rate base yet, so definitely will get into rate base in due course. About a third of it is deferrals. Things like environmental costs, storm costs, which is the biggest single increase in the year, which are basically held in deferral accounts and then will be recovered through regulatory filings in due course.
Bobby Chada – Morgan Stanley: So in terms of the timing of getting this back, the capital work-in-progress goes into the rate base through normal rate cases I guess? The deferrals is recovered – through the next time you ask for deferral recovery in each jurisdiction, how does the working capital get treated?
Andrew Bonfield – Finance Director: The working capital probably is (indiscernible) from a one-to-one basis as an economic value and that you’ll get cash flow associated with it but probably from a valuation perspective it won’t get into value and rate. It’s basically just having to manage working capital balances as you go forward.
Steve Holliday – Chief Executive: That was very cheeky, I was going to Dominic. Would you mind? I like the initiative.
Dominic Nash – Liberum Capital: Dominic Nash, Liberum Capital. Couple of questions on the RIIO transmission process if I may please. Firstly, how confident are you that the positive read across from the fast track process to the Scottish networks can go into you? Secondly, on the less positive angles, is there anything in this transmission review that keeps you awake at night that you think might go against you? So, that’s why on the gas transmission, I see you are over earning against allowed some returns by over 2%. Do you think that spread will come in significantly in the first year of the next transmission review?
Steve Holliday – Chief Executive: Very fair questions, other than – in fact I can assure you I sleep like a baby every night of the week, so don’t worry about that, which is not the same as do you worry about RIIO. We have to. We have to I think from a business and we actually have to in the U.K. These investments are crucially important as I said. So the need for us to get the balance right to get the returns that we need for investors and make sure the impact on to (build this constraint) is there. It’s very clear as well from the transparency around the investments we put out. Electricity transmission for example, There is a GBP 1 a year on the build, GBP 18 this year going out by GBP 1 a year thereafter is to fund essential investment, so there is a degree there for compensate. We really ought to get this right, we really do. We will know at the end of July, so there is no point this morning in speculating, and we are very confident with the resubmission of the plan as I conferred, huge engagement with stakeholders. We look very carefully at the balance between the cost of equity, the gearing ratio, the transition measures, when you’re changing the depreciation, we believe we’ve got a sensible balance that makes sense for all parties there. We’ve been asking a lot of questions for Ofgem and they will come back with their proposals in July. Nick, I am sure there are a couple of comments you can add to that there?
Nick Winser – Executive Director: I think at a high level to make sure the process that we have had is (something) the fact that we have got the opportunity to put our plans in front of the stakeholders, had intensive discussions with stakeholders, so this is a fully formed plan which is completely known and discussed with stakeholders, I think that’s – congratulations to Ofgem for it and excellent process. There I think is substantial agreement not just in terms of the discussion with Ofgem, but across the industry about the critical challenges that are ahead which I think is a good foundation for the process. That’s been very good. You asked a specific question on the gas outperformance, that’s been strong because we’ve had a change in gas transmission system. Those changes will continue because of the decline of U.K, sales and over a period connecting out new source of gas and enhancing the network to bring in new flexibility, to bring in new sources, so where we’ve really made money is on doing a great job of earning of (indiscernible) in an environment of very significant network change. That network change is going to continue over the next eight years just because of changing source of gas, so we will seek to continue to outturn and deliver for customers because it’s really valuable customers to have that flexible system to have it delivered on time to have the flexibility in the network to be able to transport gas from all of those new points.
Dominic Nash – Liberum Capital: On the Scottish (indiscernible) why do you think that your return on equity should be higher than the two Scotts?
Steve Holliday – Chief Executive: I said I guess in my remarks what we believe it’s the right structuring of the plant. If you look at the risks in our business the size and complexity of our capital program versus the two smaller Scottish businesses, it is a very different order of magnitude. We always talk about the CapEx and used to us delivering actually, there is huge execution risk in delivering the capital program that we believe is required that (was in) thousands of projects. We believe that justifies the high return on equity.
Unidentified Analyst: (indiscernible) from Exane. So, just three key questions on the U.S. returns and the rate base over there. First of all the GBP 400 million impact of working capital this year do you think that it could reverse next year and secondly can you give an indication of where you believe that the returns would be past the restructuring impact and then finally in terms of getting them to converse with the U.K. returns would you mainly wait for the impact of the rate filings or you are seeing that are still significantly more cost improvements that can be done?
Steve Holliday – Chief Executive: Well, let me give do the back-end and then Andrew can answer your question on the rate base here. We absolutely expect the return on equity in our U.S. business to continue to increase that is what we are doing. You’ll see the benefits of some of the cost savings flowing some of the things were offset by inflation of the base next year as well. We actually are targeting to continue to increase those returns so that we can earn our allowed returns. There have to be the target. It is not a target by asking regulators. It’s more about self-help. What we are doing ourselves in the business, but there are one or two jurisdictions that are clearly not recovering their costs. We are talking about those this morning. Those are the ones that are filing and if the benefit of those come through then clearly (we will return) and the U.S. will continue to increase as well.
Andrew Bonfield – Finance Director: On rate base and working capital, the working capital, a lot of significant reduction in working capital year-on-year in the U.S. was due to volume-related activities in the gas business, because in effect customer bills were lower. There were some days of reduction improvements as well. The working capital element it really does depend on volume and so it is going to be volume driven. It’s hard to predict where it’s going to be in the final quarter next year. This year it was a particularly mild winter by U.S. standards, so there probably will be some reversal next year. Second thing on restructuring and the benefits of that as we indicated this year, the run rate of savings was about $100 million in the fiscal year results. Obviously some of that benefitted the amount of U.S. returns on a calendar year basis. There will be further improvement on costs base this year as a result of the second part of the savings from the U.S. restructuring. There will be inflationary offset as Steve indicated and there are some other things as well going the other way, for example, property taxes continues to rise above the rate of inflation. We have some in U.S. implementation of systems for getting down to a single SAP platform. There are some one-time costs associated with that. So, year-on-year we have indicated in the technical guidance, we expect U.S. costs to be broadly flattish and cost pressure probably more in the U.K. rather than U.S.