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UTILITY Week 4th March 2016

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Operations & Assets UTILITY WEEK | 4TH - 10TH MARCH 2016 | 19 "There are opportunities to drive value by bringing SWW and Bournemouth a little closer" Q: What was the rationale behind the strategy review and the group restructure? A: We have a strategy review process every year – and it is not surprising we've done it in more detail. This is the first year of this asset management plan period, Viridor is moving from investment to delivery phase with its energy recovery facilities and we have a new chairman – so it is a natural time for reflection. Q: Is the restructure making steps towards bringing Viridor and South West Water closer? A: Following the strategic review we did over the summer, we real- ised that there is more commonality between SWW and Viridor than we might have imagined and therefore synergistic benefits to be had. If you look at Veolia and Suez, for example, although they're inter- national, they are seen as water and waste companies, and nobody sees that combination as strange. There are a lot of similarities between the two, so we see oppor- tunities to drive value by bringing SWW and Viridor a little closer together. However, water is a regulated market, while Viridor is regu- lated by the Environment Agency, but not regulated economically, so we must not force them together too closely. Q: What is new in the restructure and the updated strategy? A: It isn't a particularly new strategy, but there are some new nuances. There is more commonality between waste and water business than we gave ourselves credit for. The new strategy aims to capitalise on the group's strengths and capabilities and is looking for opportunities to share best practice and synergistic benefits. Increasingly we're looking at strengthening the shared services within Pennon group: procurement, HR, IT, those sort of things. We will do this on a case-by-case basis but must not destroy what makes SWW and Viridor great companies. Q: How do SWW/Pennon's preparations for competition in the non-domestic water market, and for the potential domestic water market, fit into the restructure? A: In terms of structure, companies have the option of doing some internal segregation or opting for full legal separation. Some compa- nies, although not many, have gone for full legal separation. That's the route we've decided to take, by bringing SWW and Bournemouth Water customers together and creating a legally separate non-house- hold business. For household retail, that will remain a part of the combined SWW and Bournemouth Water business. Q&A Chris Loughlin, Chief executive, Pennon Group L ast week, Pennon hosted a capital markets day, which sought to reassure investors about its longer-term prospects. Given that it was awarded Ofwat's coveted enhanced status (only Affinity Water managed to do likewise) and that its dividend policy is a 4 per cent year-on-year increase over RPI until 2019/20, outsiders may wonder where reassurance was needed. Unlike the other two quoted privatised water companies – Severn Trent and United Utilities – Pennon has built up a sizeable waste business, Viridor. Recently, Viridor has stumbled somewhat, to the detriment of Pennon's share price. Over the past year, shares in Severn Trent have risen by c4 per cent whilst Pennon's shares have fallen by c5 per cent. In the lead presentation, Pennon's new chair- man, Sir John Parker, confirmed a more centralised board structure (see main article, le). In terms of the regulated water business, Pennon's focus will be on delivering major cost savings over the five-year period until March 2020. This will be crucial if Pen- non is to grow its underlying earnings at a sufficient rate to enable its aggressive dividend policy to be implemented. More specifically, it confirmed last week that the integration of Bournemouth, whose regulatory asset value (RAV) is just 5 per cent of Pennon's c£3 billion RAV, is proceeding well. The Viridor business is more of a challenge. However, one underlying message in Pennon's presentations was the belief that the near complete build-out of the energy recovery facilities (ERFs) has de-risked its operations. Eight of the 11 ERFs are now operational, with the two plants at Runcorn being key components. Importantly, too, Pennon has confirmed that 80 per cent of its projected ERF revenues are hedged. Of the other waste-related activities, landfill gas sites are being cut back – from 17 to three by 2020 – while the recycling continues to face head winds. Importantly, too, in its presentations, Pennon drew attention to its low borrowing cost – just 3.2 per cent on net debt, which has an average maturity of 23 years. This borrowing rate is the lowest in the sector. All Pennon needs now is for all these posi- tive messages to get through to potential buyers of its shares. Nigel Hawkins, director, Nigel Hawkins Associates Comment Nigel Hawkins Delivering major cost savings over the next five years will be crucial if Pennon is to realise its aggressive dividend policy.

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