United Utilities Group Exec Insights: Operational Improvments, Cost & Debt
On Thursday, United Utilities Group PLC (OTC:UUGRY.PK) reported its fourth quarter earnings and discussed the following topics in its earnings conference call. Here’s what the C-suite revealed.
Steve Mogford – CEO: I’ll pick up the license change and then let Russ answer the question for him. I think on license changes, certainly there is a strong degree of consensus amongst the industry, the income that’s in the sector on the fact that what we need to do is essentially look at the core license amendments that are required to implement the changes to PR14. So I think there is a general degree of consensus on what the material issues are. In truth, I don’t think we are mile away from Ofwat in a sense of what needs to be done now in the context of facilitating competition, for example. I think there is more of a discussion to be had around longer term change and the pace of that change and what it delivers, the rationale for it, because many of the longer term ideas are simply in concept at the moment and we haven’t been able to work them through. So I think my sense is that there is developing understanding now of what needs to be done. I think there is also a sense that’s developed over recent months of everybody just wanted to get this sorted and move on. I think that the license – the principles paper that Ofwat put out 10 days ago was extremely useful in that context and sort of confirming some of the things that we’d understood earlier, but the earlier license amendment perhaps haven’t been firmed or reflected.
Russ Houlden – CFO: On index linked debt, we are obviously pleased that we have got a high proportion of index linked debt. About 50% of our debt is index linked and we think that is an appropriate hedge of our RCV. We look at it on an economic basis. So we think that is appropriate hedging. As to whether we should somehow hedge the profit and loss account, we are not inclined to do that at this stage, but obviously we’ll keep that under review if there were a demand from Shell just to do it, but we think the economic hedge that we have in place is the appropriate one.
James Brand – Deutsche Bank: James Brand from Deutsche Bank, just want to ask question on operational improvements. Clearly, you’ve made well looks like a lot of progress over the last year or so, operationally and particularly in terms with your SIM scores, you did mentioned that you aimed over the last year and the next years to be above average on the SIM measurements. But, do you have any other kind of mid-to-long term ambitions operationally and how much more do you think has left to go for?
Unidentified Analyst – Credit Suisse: (indiscernible), Credit Suisse. Just a couple of questions. Firstly on the non-household retail. I think the consumption threshold for your competition was reduced from 50 megalitres per year to 5 megalitres per year in December granted it’s a small market, a small part of your overall profits. But I was just wondering if you’re seeing anything to date in terms of switching your churn or if you expect to see more of the threshold that is eliminated altogether. Secondly, just to come back quickly to license modifications, I understand that Ofwat is now meeting individually with each of the companies to, I guess, negotiate. I was wondering if you’d met with them yet. If so, if you expect this issue to be resolved or if you expect it to go to the CC, and if so, what kind of an outcome you’d expect from there?
Steve Mogford – CEO: Okay. What I’ll do is with second question first and let Russ pick on the revenue issue and churn. We’ll do with it, so I’ll share it out. I think as far as our license modification, yes we have met with Ofwat. John and I met a few days ago. I think a general sense was very positive engagement with Ofwat, very constructive. I think it’s fair to say nobody wants to go to CC, the Competition Commission, that would be a sad outcome for all parties. I think as I said earlier, I think there is a developing degree of consensus about what needs to be done in order to facilitate things like increasing competition for PR14, and as I say, the principles paper that Ofwat put out, I think clarified some of the ambiguity that we’ve seen with the proposed license amendments, because in price consultation we heard things like detection of RCV, retention of RPI link, retention of five years, those sorts of things. When we saw license amendments, we didn’t see that reflected and I think what Ofwat has done recently is extremely useful in reconfirming the core intent. So I think what I can see here is a general convergence, The Devil’s in the Details, so things like the retail pricing issues and average cost to serve; and what’s also very positive, I think, from Ofwat and the sector is a declaration to say let’s get into that detail, let’s work it through and let’s understand how it would work, because there is a recognition that for those on what might be seeing is the wrong side of average cost to serve they have a problem, but there is also a problem for those on the right side, because potentially you have the opportunity to put out customer prices for no good reason. So, I think we’ve got to work through this in some detail now and I think The Devil’s in the Details.
Russ Houlden – CFO: On the competition point, as you rightly say the threshold was reduced from 50 megalitres to 5 megalitres in December. At the moment it applies to water only, it doesn’t apply to (storage), that’s just the water service that is open to competition. When we had the 50 megalitre open to competition, there were no switches about 50 megalitres and since we’ve moved to 5 megalitres we’ve so far had no switches above 5 megalitres either.
Steve Mogford – CEO: But I think the point you make is correct. The impact of switching for perhaps was relatively small from a – even if everybody switched you’re talking about a handful of a single digit millions impact on revenue, it’s actually very small.
Cost & Debt
Dominic Nash – Liberum Capital: Hi, it’s Dominic Nash, Liberum Capital. Two questions, please. Firstly, on your cost of debt, it seems you’re raising debt. So 1% really seems quite attractive at the moment and quite big spread between cost of debt and cost of equity. Is there any headroom available to you to increase the cost of – your level of gearing about 59% to RCV and replace expensive equity? Secondly, on the average cost to serve pulling up from that, obviously I think you on the wrong side of the average, is I don’t understand that you will be – it would be unacceptable to you on the introduction of competition?
Steve Mogford – CEO: I’ll pick up cost to serve and to the debt issue Russ. On cost to serve, I think the issue we’ve got is that the average cost to serve calculation as presented today is relatively simplistic. We’ve identified in the dialog with Ofwat a number of areas, where, for example, using an average cost where you’ve got somebody that might have a wastewater provider separate from the water provider, and are we talking about that customer paying two average cost to serve, (we don’t say) we’d only have one, does that make sense. We’ve always, as we’ve gone through pricing, been able to look at socioeconomic conditions in regions, and I think all the factors, it’s been relatively simple in the context of company reporting when you’re dealing with a single price all costs sits within that single price. I think now as we moved to break that single price down into possibly two price caps, you’ve got to be pretty clear that you’re working to the same rules when you allocate costs and you’re actually calculating pricing. So I think those are the types of issue which cost principle doesn’t cover. To be fair, we have had a positive engagement with Ofwat on this and the conversations that John and I had last week indicate a willingness to engage on that and try to get this right. As I say, it is difficult for us and what we would see as unfair and unreasonable, for others it would be unreasonable, unfair on customers if we simply use that methodology. So we got to solve this down.
Russ Houlden – CFO: On the question, Ted, I mean you are right to point out that we’ve got a very good rate there with 0.9% rate on the latest EIB loan and partly EIB is generally cheap because they’re financing environmentally-friendly projects, (it’s better) but partly the timing was particularly good and I think that since then their loans to other companies have not been as cheap as that. Your question about whether we should increase gearing rather assumes a limitless part of money at the EIB which I think doesn’t exist and I think 400 is a very good achievement so early in the period. If we could get a little bit more that will be great, but we shouldn’t assume a bottom (indiscernible) funding that’s not what exists. We do think that the 55 to 65 range on gearing is the right range and it supports the A3 credit rating and it is the Ofwat target and it is our target. So we wouldn’t intend to go out and borrow money, which would not be as cheap as the EIB, let’s be honest. If you would go out and borrow a lot of money it wouldn’t be that cheap and we don’t intend to do it.
Lakis Athanasiou – Independent Analyst: Lakis Athanasiou, independent analyst. I have three questions. First, one thing you mentioned the tariff adjustment to the next review. Has there been any indication yet of what Ofwat minded to do, whether there will be a revenue adjustment or a rev adjustment? Is it likely to end up, if it’s a positive, it will be up RAV adjustment and if it’s a negative, it will be a revenue adjustment. Second on finance…
Steve Mogford – CEO: Can you just explain that in context?
Lakis Athanasiou – Independent Analyst: You mentioned your revenue reductions versus the DFP, you’ll get compensate for the next two years. Just wondering how that mechanism will work, whether Ofwat has given indication, whether it’s revenue or RAV, because I don’t think it was agreed at the last (year). Second on financeability, has there been any indication on whether Ofwat will improve the competitive segment in the financeability test. I think it is going to be important in the next review given that probably financeability will be how they’ll back into the (indiscernible) return given the industry. Third on debt rating, is it still the case for the S&P, FFO to debt measure, is it constraining metric rather than the Moody’s debt to RAV or adjusted interest cover?
Steve Mogford – CEO: Tariff adjustment next review, how does the (indiscernible) work? I think you’re right. I mean you were all over the detail, Lakis and I think it isn’t 100% clear, but our assumption is they would probably come through revenue, but that’s an assumption rather than we could prove it to you in black and white. One financeability, have Ofwat made any statements about whether the competitive segment would be in the test? I don’t think they are 100% clear on that, but I think we should push them to do that. Then on debt rating, you’re right, there is a significant difference in methodology as between Moody’s and S&P. S&P do still look at FFO and that means that our rating with them is one notch lower than is with Moody’s. We comfortably engage with S&P to talk to them about the methodology, but so far it remains focused on FFO.
Lakis Athanasiou – Independent Analyst: (Question Inaudible)
Russ Houlden – CFO: It doesn’t really constrain us, because I think most people see the Moody’s rating as the more balanced approach to the sector. So it doesn’t really have a big effect on our financing capability.
Ian Gordon – Exane BNP Paribas: (Ian Gordon) from Exane BNP Paribas. Can I just ask about the infrastructure renewal expenditure, which was up year-on-year as expected? What’s driving that and how do you see that coming out for next year and the rest of the AMP? Then on the EIB debt, I think you’ve now got about – a total of about GBP1 billion of that, which is a relatively short duration compared with the rest in your balance sheet. Not trying to be a so glass half empty person, but do you worry about how you’re going to be refinancing that over the next five to sort of 10-year period?
Russ Houlden – CFO: I think you’ll find that along with the rest of capital program, it normally is higher (indiscernible) and so as we renew into the network, so I think that’s not an unusual feature. On the EIB, you said shorter duration, but I think the average length of the debt that we’ve just taken on is about 11 years, that’s not likely short. Do I worry about it? Not particularly, and I think the next thing in my sight really is the 2015 maturities where we’ve got about GBP450 million maturity coming up in 2015. That will be the next financing task. Can I address that task now? No, not really because of the cost to (carry) if I was into it right now, but we keep looking at that every six months and we will probably do something before we get to 2015.