United Utilities Group PLC

This year has seen both a continuation of a challenging macroeconomic environment, but also the realisation of significant inflation alongside higher interest rates. While both of these factors have a material impact on our reported and underlying results, the economic performance of the business, reflecting the regulatory model, remains robust, with the company on track to deliver an improved rate of return on equity, or RORI, this year. In today's presentation, I will focus on how we're managing our cost base, our strong balance sheet, and our resilient pensions position. And to finish, I'll provide some updated guidance for the full year to March 23. Here are the key financial highlights for the half year. Revenue is down 1% at $919 million as a result of consumption being lower than expected. Household bad debt has remained stable at 1.8% of regulated revenue. Underlying operating profit of 259 million has been impacted primarily by inflationary increases on core costs. As a result of higher inflation, and in particular its impact on finance expense, we have a small underlying net loss for the first half of the year and an EPS of minus 1.8 pence per share. In contrast, our reported EPS is 51.8 pence per share, reflecting the significant fair value gains arising from higher interest rates. The interim dividend per share is 15.17 pence in line with our policy. Inflation on core costs has been actively managed and we're well positioned with a current pay deal agreed at 4.75%, virtually all our base capital programme on contract and 96% of power costs fixed for the year. We continue to have one of the strongest balance sheets in the sector with RCV gearing of 60% and a pension scheme that is fully funded on a low dependency basis and which has been resilient to the recent market challenges. And finally, we have a strong liquidity position, having raised debt early in the AMP at attractive rates. I'll now consider these points in further detail. So let's look first at our household cash collection and bad debt performance. We're driving continual growth in customers on direct debit. This provides us with a strong starting position for our collections activity, which has continued to be robust in the first half of the year. At 81%, we have one of the highest proportions of customers on direct debit or repayment plans within the sector, providing a high level of collection certainty for a significant proportion of our revenue. We're very conscious of the difficult times that customers may face over this winter and are utilising data and technology efficiently, allowing us to act early and swiftly to support customers. Good examples of this are our nudge activity if customer behaviour changes and open banking which helps customers to efficiently access support tariffs and reduces our cost to serve for these customers. This all supports our lowest ever level of household bad debt at 1.8% of regulated revenue. Underlying operating profit of £259 million is down £74 million. This principally reflects the decrease in revenue, inflationary increases in our core costs, investments in driving ODI performance and costs associated with incidents resulting from dry weather over the summer. Revenue is £13 million lower than the first half of last year. Our over-recovery in the prior half year broadly offsets the allowed inflationary increases in the current half year. The remaining reduction in revenue is driven by lower consumption as we focus on reducing per capita consumption, which supports our water resilience position and benefits our PCC ODI. The £19 million impact of lower consumption in the first half of the year will be recovered in revenue in the financial year ending March 25. We're not immune to the global inflationary pressures, and as a result, we've experienced inflationary pressures on input costs with the largest impact to power and chemical costs, resulting in a 36 million increase in the first half of the year. We've invested an additional 9 million in infrastructure renewals expenditure associated with dynamic network management and water quality, and which is targeted at improving ODI performance. And during the exceptionally dry summer, we experienced three atypically large bursts in our water network, resulting in around 8 million pounds of cost associated with network repairs, customer support, and compensation. As these were core operational incidents, they have not been excluded as adjusted items in our underlying measure of performance. As we noted at the full year, the accounting change towards the end of last year in respect of software as a service now results in costs of 3 million being treated as OpEx rather than CapEx. So we're very focused on the action we can take to mitigate the impact of higher inflation. And while we're not immune to the macroeconomic challenges we all face, we are well positioned. Let's first look at how we're managing the near-term impact of inflation. We agreed our pay deal for the current year at 4.75%. Our decision to accelerate AMP7 investment means our base capital program is already 98% let under target pricing arrangements, providing confidence of supply chain resource in a challenging environment and incentivizing efficient and effective cost management. We've already delivered around 65% of the program, only halfway through the AMP, giving an increased level of certainty on costs. On power, we're in a strong position having increased our hedge to 96% for the current year. And as we look forward, we continue to focus on tightly controlling our cost base, although it's also important to understand how the regulatory mechanisms mitigate this impact. We expect a higher non-cash indexation charge in our inflation-linked debt this year. Inflation-linked debt equates to around 30% of our RCV. with a full RCV benefit therefore being around three times the non-cash indexation charge, although as you know, the RCV benefit is not reflected in the income statement. The regulatory contract also allows for inflation indexation of the Totex allowance, providing mitigation to inflation on core costs. Each 1% increase in CPIH over the AMP will result in around 600 million increase to the RCV and around 150 million increase in the Totex allowance. At our full year results in May, I gave a lot of detail on our power position and hedging policy. We came into the year in a strong position and now have 96% of our consumption locked in on contracted rates for the current year. This has helped us control power costs at an average rate of £85 per MWh, which compares favourably to the energy price cap of £211 per MWh through the second half of the year. Our hedging policy has created significant value as without the benefit of the hedge, our power costs would have been around 75 million higher for the full year. As a result of our hedging strategy, we're also focused on driving energy efficiency across the organisation, minimising usage and maximising benefits from time of usage. We continue to benefit from 25% of our power needs being sourced from self-generation and long-term power purchase agreements. The sale of our energy business, which completed in September, has unlocked capital that we will recycle back into projects to support our journey towards net zero. At the same time, we've locked in the price of the energy from those assets sold through long-term power purchase agreements or PPAs. Lastly, our long-term power hedging policy is demonstrating its effectiveness. We're in a strong position for the rest of the AMP and have locked in a large proportion of our energy needs at favourable prices. So let's now focus on finance expense. Our underlying net finance expense for the first half of the year is 267 million. This is 132 million increase on the prior half year, largely reflecting a significantly higher inflation applied to the non-cash indexation of our index-linked debt. Our reported net finance income includes a significant fair value gain of £403 million. This reflects the benefit we will receive in our underlying cash interest expense in future periods from having fixed rates on our nominal debt. Turning to our forecasts for FY23, we now expect underlying net finance expense to be around £165 million higher than the previous year. This increase relates to the non-cash indexation on our index-linked debt due to the higher inflation, but importantly, our cash interest for FY23 is expected to be broadly the same as FY22. We have provided our current forecast along with the main components of our finance expense for FY22 and the first half of FY23 in the appendix to this presentation. Let's now look at how well we're positioned on financing. First, we're ahead of where we need to be, having raised a significant financing in the first half of the AMP. We have a strong liquidity position with over 1 billion of liquidity, enough to take us through to almost the end of the AMP 7 period. This means we have flexibility to choose when and how we issue to maximise best value. Second, we have a strong track record of outperforming the debt index for new debt, typically by between 50 and 100 basis points, as illustrated on the chart in the appendix. This, together with the acceleration of our financing, means we benefit from the debt indexation mechanism in a rising interest rate environment. Third, we're also benefiting from having issued debt earlier in the AMP, which locked in historically low long-term yields, all of which puts us in a robust position from which to navigate the second half of the AMP. Now turning to our strong balance sheet. To the left of this slide, we have a bridge of our net debt position from March 22 to September 22. Net debt of 7.8 billion has increased by 259 million since March 22, with the usual underlying movements shown in the bridge. High levels of inflation have impacted both net debt and our RCV, and therefore RCV gearing has reduced slightly to 60%. At the full year, I provided a view of how the investments we're making in AMP7, together with the expectations of inflation, were expected to drive higher RCV growth through this five-year period. To the right of this slide, I've provided an update to this, reflecting our current expectations of inflation. Our nominal RCV growth over the five-year period is now anticipated to be 27.5%. This means we expect to exit AMP7 with an RCV of 15.1 billion, and gearing trending towards the lower end of our 55% to 65% target range, which comfortably supports a stable A3 credit rating with Moody's. Now to touch on pensions, as it's been a challenging time for many pension schemes over the last few months. As at September 22, we had an IFRS pension surplus of 824 million and remained fully funded on a low dependency basis with no ongoing pension scheme deficit contributions payable. Our clear and effective risk management policies enabled our schemes to successfully navigate the recent challenging market conditions. And as I mentioned at the fall year, we're now exploring with our trustees further de-risking options and this process remains ongoing. This slide sets out our update for the outlook for year to March 23. We expect revenue to be around 1% lower year on year with the consumption trend we've seen in the first half of the year expected to continue into the second half. The 34 million expected impact from lower consumption will be recovered through increased revenue in FY25. Underlying operating costs are expected to increase by around 130 million. Around 80 million reflects inflationary pressures on operating costs, principally power, chemicals, labour and other contract costs. Around 30 million reflects the increased scope and includes the FY23 element of incremental infrastructure renewals expenditure in relation to the investment we previously announced. The remaining 20 million reflects atypical costs, including the dry weather costs incurred in the first half. As I've already mentioned, higher inflation materially impacts our index-linked debt, and as a consequence we expect our underlying finance expense to be around £165 million higher. Further details of the assumptions are set out in the appendix to this presentation. We expect an underlying tax charge of between £5 and £10 million for the full year, as we continue to optimise capital allowance super-deductions and efficiently manage the Group's tax position. CapEx for the year is expected to be in the range of 660 to 715 million, a small increase on the guidance given in May as a result of revised phasing. And this includes the FY23 elements of incremental CapEx in relation to the additional 765 million investment we previously announced. We're targeting a customer ODI reward of around 30 million, consistent with our investment plans and our AMP7 guidance on ODIs. And with higher expected financing performance alongside our improved ODI performance this year, Rory is expected to be higher than the 7.9% reported last year. Finally, our dividend policy remains unchanged and we expect dividends in FY23 to be in line with our AMP7 dividend policy of growth year on year by CPIH. And so to conclude, we're in a robust financial position. We're actively managing the near-term impacts of inflation driven by wider macroeconomic challenges, and we benefit from higher Totex allowances and RCV growth. Despite the cost of living challenges, our focus on supporting customers and our approach to debt management means that household cash collection has remained robust, with our bad debt position stable at 1.8%. And finally, we have a strong balance sheet with a sustainable level of gearing and a leading pension position, enabling us to capture the opportunities for future investment.