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UTILITY Week 5th September 2014

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20 | 5TH - 11TH SEPTEMBER 2014 | UTILITY WEEK Finance & Investment Analysis O fwat's long-awaited dra determina- tion announcement was overshad- owed in the national business press by a second Tesco profit warning but, in truth, there were few real surprises in its reams of published documents. Based on a move to "upper quartile" rather than "average efficiency" bench- marking and an assumed weighted average cost of capital (Wacc) of 3.7 per cent, retail water bills are expected to fall on average by 1 per cent in real terms per year until 2020, although the average 2.1 per cent cut for Anglian looks challenging. Nonetheless, much sector focus will be directed towards the three largest companies. In Severn Trent's case, the dra determi- nations were overall positive, especially with its submitted wastewater costs being mark- edly lower than Ofwat's figures. Severn Trent's average bill should fall from £315 currently to £297 by 2019/20 (before inflation). Despite its wafer thin divi- dend cover, these numbers may enable Sev- ern Trent to avoid a dividend cut – and even reinvigorate last year's bid interest. By contrast, United Utilities still has con- siderable unfinished business with Ofwat, especially on its wastewater operations. There is a massive £773 million of projected wastewater expenditure that has not been accepted by the regulator. Closing this formidable gap will not be easy. Investors will be anxiously assessing the robustness of its future dividend projec- tions and the underlying 2013/14 dividend cover ratio was just 1.2x. Thames, while satisfying Ofwat on its clean water operations, still faces many uncertainties on the wastewater front as Ofwat's exhaustive company-specific 203- page appendix confirmed. In particular, the financing details of its controversial £4.2 billion Thames Tideway Tunnel scheme still have to be resolved. Ofwat has consistently argued that this scheme is outside its regulatory asset value (Rav)-based financial model. Elsewhere in the proposals the benefits for the two original fast-trackers – South West and Affinity – were reaffirmed, along with some minor concessions for Welsh Water and Northumbrian. These companies were given their dra determinations in May. United Utilities was alone in receiving financial compensation for its high bad debt level – other water companies may wonder why they failed to meet Ofwat's materiality test. At last, too, Ofwat has imposed a more rigorous obligation to reduce leakage levels, which – in many areas – remain excessive aer 25 years of privatisation. Among the water-only companies, Bris- Draft deal Ofwat has published its draft determinations on water company prices for the next five years, and the pressure is on companies to find savings. Nigel Hawkins crunches the numbers. Following Ofwat's announcement Mike Wolgar, managing director, environment and water management at Atkins: "Customers now shape the priorities for companies. The customer may not be in the driving seat but they are in the front passenger seat with the map of where to go." Andrew Reeks, head of the water sec- tor at Siemens Industry: "The critical part [of Ofwat's] announcement is the planned investment – £43 billion invest- ment in today's technology will enhance UK water companies' operations, reducing chemical and labour costs and allowing these operational savings to be passed on to their customers." Neil Dhot, head of corporate affairs at Water UK: "To keep bills down for water company customers over this period, returns to investors will be reduced. Our recent investor survey revealed that despite Ofwat's pressure on companies, investors still see water as less risky than other sectors, including energy and rail." WHO SAID WHAT THE GAP BETWEEN WATER COMPANY BUSINESS PLANS AND THE PRICING REGIME SET OUT BY OFWAT FOR AMP6 Company Water % gap Water gap in £m Waste Water % gap Waste water gap in £m Anglian 5 86 -1 -36 Severn Trent 5 136 -5 -133 Southern 6 45 6 110 Thames (excluding Tideway) -5 -162 1 353 Thames (including Tideway) 10 NA 9 22 United Utilities 4 217 29 773 Wessex -5 25 7 72 Yorkshire 57 -74 0 6 Bristol 12 209 NA NA Dee Valley -3 11 NA NA Portsmouth 3 -5 NA NA Sembcorp Bournemouth 3 5 NA NA South East 5 36 NA NA South Staffordshire 3 12 NA NA Sutton & East Surrey 3 7 NA NA What happens next? Water companies have until 3 October to respond to Ofwat's proposals. Final determinations will be issued on 12 December and AMP6 will officially begin in April 2015.

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