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Edited Transcript of AST.AX earnings conference call or presentation 12-Nov-19 11:00pm GMT

Half Year 2020 AusNet Services Ltd Earnings Call

Southbank, Victoria Nov 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Ausnet Services Ltd earnings conference call or presentation Tuesday, November 12, 2019 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alistair Parker

AusNet Services Ltd - Executive General Manager of Regulated Energy Services

* Chad Hymas

AusNet Services Ltd - Executive General Manager of Mondo

* John Nicolopoulos

AusNet Services Ltd - Head of Tax & IR

* Mark Ellul

AusNet Services Ltd - Acting EGM & CFO

* Tony Narvaez

AusNet Services Ltd - MD & Director

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Conference Call Participants

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* Ian Myles

Macquarie Research - Analyst

* James Nevin

RBC Capital Markets, Research Division - Analyst

* Nathan Lead

Morgans Financial Limited, Research Division - Senior Analyst

* Peter Wilson

Crédit Suisse AG, Research Division - Associate

* Robert Koh

Morgan Stanley, Research Division - VP

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Presentation

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John Nicolopoulos, AusNet Services Ltd - Head of Tax & IR [1]

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Well, good morning, everyone. Welcome to the AusNet Services Half Year '20 Results Presentation. Thank you all for making the time to join us this morning. My name is John Nicolopoulos and I head up the Investor Relations function here at AusNet Services.

I'd like to kick off today with a few introductions and outline today's agenda. We have 4 members of the executive team presenting today, including 2 new presenters. As most of you are aware, Tony Narvaez commenced as Managing Director on the 1st of November this year, following the retirement of Nino Ficca. Tony brings with him extensive leadership experience from senior executive roles that span strategy, business development, commercial, operations, major projects and joint ventures in Australia, New Zealand and throughout Asia.

Prior to joining AusNet Services, Tony was Chief Executive Officer of Endeavour Energy in New South Wales. And prior to Endeavour, Tony was CEO of United Energy and Multinet Gas here in Victoria. We're very fortunate to have Tony join and to be able to leverage off his deep experiences in the Australian energy sector, and I welcome Tony to his first results presentation.

Tony will shortly kick off with some introductory comments around safety performance, our key strategies and the AusNet Services' investment proposition. Tony will be followed by Mark Ellul, acting Chief Financial Officer. Mark will provide an update on financial performance for the half and discuss capital management and financial settings more broadly. This is also Mark's first result release as a presenter. But Mark is no stranger to the financials or the business. Mark has been with AusNet Services for 9.5 years in various senior finance roles, including Group Financial Controller; and most recently, as General Manager, Finance for our regulated business. Mark has been acting CFO since September 20 this year. So Mark, welcome to your first presentation as well.

Alistair Parker, General Executive -- Executive General Manager of our Regulated Energy Services business will then provide an update on network operations and regulatory developments. And Chad Hymas, Executive General Manager of our Mondo business, will provide an update on our unregulated commercial portfolio. And Tony will conclude today's presentation with some outlook comments and then hand over to some Q&A, which will be facilitated by the operator.

So that's enough for me. Thanks again for joining us today, and I'll hand over to Tony.

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Tony Narvaez, AusNet Services Ltd - MD & Director [2]

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Thanks, John. Good morning, everyone. My name is Tony Narvaez, Managing Director of AusNet Services, and I'd like to welcome you to our half year 2020 results presentation.

As John mentioned, I joined the organization just under 2 weeks ago, following the retirement of Nino Ficca, and I'd like to acknowledge Nino's incredible contribution to the company and the industry as a whole, spanning some 38 years, the last 14 years as Managing Director. I have known Nino for many years, and it's of no surprise to observe, even in my short time here, the strong legacy he leaves behind. AusNet Services has an enviable culture of passionate, driven and capable people who are focused on doing what's right and getting on with the challenge of transitioning to a new energy future.

The company is in great shape, and I'd like to thank Nino for his tremendous contribution. Prior to joining, I viewed AusNet Services as the benchmark in many respects from its network expertise to the manner in which it participates in policy and industry consultation. And of course, I feel very privileged and very excited to join the team. I believe there are great opportunities and upside outcomes ahead for our customers, for our communities and for our shareholders, and I very much look forward to driving the business forward in these exciting times.

Now moving on to the results presentation proper. So turning to safety on Slide 4. Since joining, I have observed a great safety culture with a strong focus on continuous improvement. I'm very pleased to join an organization which makes safety its #1 priority, and our goal is to have 0 injuries, but we're not quite there yet. Energy delivery, as we know, is a hazardous business. And although injuries are good, we have had no serious incident involving any of our people or delivery partners in the last 12 months, resulting in a permanent injury.

In the last 12 months to 30 September 2019, we have seen a 26% reduction in recordable injury frequency rate, which is the lowest on record. And whilst this is a pleasing trend, we need to do more to eliminate injuries in our workplace. We are continuing to energize the safety focus in our business, and we are empowering our people to be at the center of the solution, looking for positive outcomes and learnings and making safety a matter of integrity.

Now turning to Slide 5 on strategy. We have a very focused strategy in place, which responds to the shift towards renewables, new technologies and changing customer expectations. Our strategy comprises of 5 key strategic objectives, all with specific targeted outcomes. The focus on customers is resonating really well throughout the organization, and the strategy also retains a strong emphasis on efficiency.

During the period, we transferred certain electricity distribution field workforce functions to Downer EDI to better support our electricity distribution network. And this will allow us to better align to our cost base, with volumes of works whilst delivering lower costs for our customers. And is the case, as you'd expect in a changing environment and under new leadership, we intend to dive into the initiatives that underpin the strategy itself to better understand if they remain appropriate if they require fine tuning or if the leaders themselves need adjusting.

Over to the investment proposition on Slide 6. So whilst the industry is undergoing tremendous change, stability remains at the core of AusNet Services' investment proposition. Our diversified asset base and staggered regulatory resets allow us to reduce price risk review. And our current low interest rates are not impacting our regulated revenues until full year 2022. On growth, the transition to renewables is opening up many avenues for investment, particularly in Mondo, and I've already had the chance to spend some time with Chad, who you'll hear from shortly, and my personal view is that Mondo's potential projects appear in great shape.

We've made strong progress on a number of renewable connections, and we expect to see them completed and operational in the second half. And we also continue to perform well in terms of benchmarking for gas and electricity transmission. And as mentioned on the previous slide, we've taken further steps to improve performance in terms of electricity distribution.

I'll now hand over to Mark Ellul for a review on financial performance.

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [3]

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Thanks, Tony. Hi, everyone, and thank you for joining the call. Before I get into the presentation, I'd just like to say how excited I am to continue the work of driving performance, and I see a lot of upside and growth at AusNet Services.

As John mentioned, I've been with AusNet for 9.5 years now, and so I have a great understanding of the business and its key drivers. I'm also looking forward to meeting some of you and having a further conversation about the business. In terms of the financial performance, though, there are 3 things that I'd like to touch on today. The first is in relation to our financial and cash flow performance for the half. Secondly, I'll give a bit of an overview with regards to our capital investment profile and our funding mix. And finally, I'll touch on some of our capital management parameters and dividend profile considerations.

But if we have a look at the financial summary for the half and looking at Slide 8, revenue and costs were impacted by pass-through increases, easement tax and an inventory sale from our transfer of O&M services to Downer. Overall, EBITDA declined 0.9% to $626 million. This was impacted by higher vegetation management costs from an earlier program execution and an increase in our TUOS costs, which are recovered in calendar year '20. Pleasingly, we have continued to deliver on cost efficiency. Now it's a little hard to see in the numbers, so I'll take you through that shortly. As guided at the full year, our interim dividend is up 5% to $0.051 per share, franking is at 50%, and we continue our DRP with a 2% discount.

Now looking at our cash flow performance. And on Slide 9, cash flow from operations remained strong in absolute terms, although period-on-period, we did see a 13% decline due to 3 main reasons. Firstly, we have higher tax payments due to a $28 million payment relating to the FY '19 final tax position, along with a higher installment rate this year. Secondly, we paid down $20 million for employee entitlement transfers and mobilization costs. In the second half, this will be somewhat offset by remaining proceeds from inventory and motor vehicle sales.

And finally, interest is higher because of a $7 million settlement of a swap transaction, which was accrued over previous periods. When you look through these one-off cash impacts, the business continues to generate strong cash flow to support growth and returns to shareholders.

Now just in terms of some of the details of our NPAT performance and looking at Slide 10, we have excluded the impact of easement tax and Downer inventory sale. These are pass-through items impacting both revenue and costs equally. After adjusting for these items, revenue was down $3 million for the half. In gas distribution, revenue was down $9 million due to price rebalancing, which is expected to reverse in the second half, along with the prior year, including some contributions for our energy for the Regions program. Mondo experienced a $17 million decline in revenues as a result of one-off contracts in the prior year as well as the flow on impact of last year's strategic refocus. In addition, there's been a $6 million reclass associated with the new lease accounting standard, which has been offset by a $6 million increase from the completion of several wind farm connections. We're expecting completion of 2 larger wind farm connections in the second half, and this will see a further uptick in Mondo's revenues.

Offsetting these declines has been a $22 million increase in electricity distribution revenue on the back of regulated price increases, higher incentive revenues and higher customer contributions. Operating costs after the adjustments were up $3 million for the half. This is due to a combination of the $10 million reduction in Mondo tied to the revenues that I spoke of earlier and a $13 million increase in regulated OpEx. The key drivers for the regulated OpEx increase include $13 million of higher vegetation management and TUOS costs, as I covered earlier, along with a $2 million increase to implement our efficiency program.

Looking through these items, highlights our continued cost efficiency performance. This continues to be an ongoing focus of management, highlighted by the recent transfer of O&M services to Downer. In summary, the revenue decline for the half was in line with expectations, and we continue to manage our cost base through the ongoing delivery of efficiency initiatives.

Now looking at our capital expenditure performance for the half. And on Slide 11, capital expenditure for the half was consistent with the prior period, both in total and across each of the businesses. Electricity distribution CapEx was up $4 million, largely due to our safety program spend, in particular, our REFCL program. Electricity transmission CapEx was down $9 million as spend on our transmission upgrades was lower due to the completion of Richmond Terminal Station in FY 2019. Second half CapEx is expected to be higher than first half, largely across our transmission connections, Mondo infrastructure and REFCL programs.

Now having a look at our dividend and capital expenditure funding, and Slide 12 highlights the source and use of cash and how we have funded our CapEx and dividend. Maintenance CapEx and a portion of growth CapEx were funded by operating cash flows for the half, consistent with our dividend parameters. Despite the lower cash flows as well as dividend growth, we still had good cash flow coverage of our dividend. As is normally the case, given the seasonality of the business, the proportion of growth CapEx funded by cash flows is expected to be lower in the second half.

Now having a look at our dividend slide, and this is Slide 13. First off, I'd just like to reconfirm that our FY '20 full year guidance of $0.102 per share. We recognize that the rate of return guidelines and very low interest rates will likely impact regulated revenues over time. We're in a strong position to manage through this change, thanks to our staggered regulatory resets, continued efficiency focus, strong balance sheet and the other items listed on the slide. The Board has always taken a long-term view when setting dividends and looking beyond a particular reset period, ensuring that we preserve our A-range credit rating. We also have a track record of moderating our growth profile as required, and we intend to do so going forward. All of these factors work to support our sustainable dividend growth objective.

And finally, just touching on some of our capital management parameters on Slide 14. Our balance sheet and credit metrics remain strong. Our capital management framework targets an A-range credit rating to provide us with financial flexibility and support the efficient funding of our capital requirements and growth objectives. Our policy remains to cover 100% of maintenance CapEx and a portion of growth from cash flow.

During the half, we also engaged with the rating agencies to reevaluate some of the relative risks and thresholds for maintaining our A-range credit rating. This has increased the headroom on some of the metrics, in particular, the FFO to debt and should provide us with additional funding capacity over the coming years.

In summary, despite the challenges of future revenue pressures, we remain fully focused on reducing costs in order to deliver improved customer outcomes. We continue to deliver strong cash flows to support both our capital expenditure programs and our objective of delivering sustainable dividend growth to shareholders. And finally, our balance sheet continues to support an A-range credit rating to deliver regulatory outperformance, whilst providing flexibility to fund future growth opportunities.

In conclusion, we have strong fundamentals and sufficient capacity and levers to support growth and provide attractive returns to shareholders. I'll now hand over to Alistair, who'll talk about the regulated business.

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [4]

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Thanks, Mark, and welcome, Tony. As Mark says, I'll provide an overview of the regulated businesses. So turning to the operational highlights on Slide 16.

So in transmission, our major projects to strengthen the network continue. As you know, the supply-demand balance is at risk for summer as forecast by AEMO, particularly if we see a run of hot days and generation outages. We are doing everything we can to ensure the network is well prepared and our operational processes are in good shape. But ultimately, customer outcomes will depend on the circumstances on the day. We're communicating even more with our customers and last year really extensively. So in electricity distribution, we've made good inroads on Tranche 1 of the REFCL program. We were granted time extensions for the remaining 2 zone substations and reapplied for further extensions until November 2020 and May 2021 to address harmonics and dumping issues and achieve full compliance. I'm pleased to say that we've got workable solutions, and that all 8 zone substations will be operational over summer.

As Tony mentioned, and as Mark mentioned, during the period, we signed a 5-year contract with Downer to expand operational and maintenance services. Previously, about 70% of electricity distribution services were provided by a number of contractors, where we've now consolidated our arrangements with Downer, who are now responsible for 100% of these services. In gas too, we've also extended Downer for another 5 years from April 2021. These have been relatively seamless transfers, been really pleased to transfer our experienced people across as we see a good alignment with Downer on safety and values that's developed over our long-term relationship. And lastly, on costs, as highlighted earlier by Mark and Tony, we're delivering on our efficiency journey. And you've seen that come out in the numbers over the last few years. And of course, Downer contract will contribute to that in future periods.

We continue to have discussions with the Australian energy regulator on its benchmarking methodology, in particular, how bushfire liability insurance is treated. We think it's not an apples-with-apples comparison with the other networks, and it puts us somewhat at a disadvantage. So absent this adjustment, we'd be knocking on the door at top quartile.

Turning to Slide 17 on wider industry developments. We've spoken to you in the past about the customer forum, and we're pleased with how that's tracking. It's been a really intensive process, but it's driving a culture change that puts the customer at the heart of the distribution business. You have seen on the previous slide, improvements in customer satisfaction in gas. We're also seeing that in electricity.

The forum provides a really different lens on some traditionally difficult areas with regulators, such as innovation, and we really welcome that. We're at the pointy end of the negotiations with the forum, and our ambition is to have an agreed proposal that we can then put to the Australian energy regulator.

There's a lot happening as ever in the longer-term reform landscape, and we are watching COAG on the 22nd of November very carefully. I'll highlight here a couple of reforms. The Australian Energy Market Commission is looking at distribution access, and that stayed with the efficient connection of distributed energy resources. We believe that is much needed and really happy to take questions on that after we finish.

The second reform to COAG is the so-called COGATI, cooptimization of generation and transmission investment, which would look to provide a firm transmission light regime, and that's intended to make access to the transmission network much more efficient. This provides some opportunities and risks for transmission sector. And I'd also note that a clean energy console is not supportive at this stage. We're really pleased to see the energy security Board making the integrated system plan actionable by integrating it into national strategic and regional transmission planning. That leads me into Slide 18.

I'd like to finish up by talking to some of the investment opportunities coming out of the ISP. The Insights Paper builds upon the 2018 ISP and attempts to provide a better understanding of the impact of proposed pump-hydro developments and the transmission infrastructure they will need. We welcomed the initial ISP in 2018, but had some reservations on the timing. So we're pleased to see AEMO, bringing forward some important projects to ensure that customers get the full benefits of the energy transition. We've highlighted here some great long-term investment opportunities for AusNet services, and we continue to engage strongly with the federal and particularly the state government and policymakers more generally. It's widely recognized now, and it seems to be bipartisan, that we must get cracking on long-term national transmission planning. Otherwise, we risk not being able to harness the benefits of renewables, which would be a terrible outcome for customers.

As but one example, AEMO has determined that the net benefits of the Western big project are around $300 million for consumers. So in summary, a good half, progress on cost efficiency, progress on REFCL and opportunities coming from the ISP.

Thanks for your time this morning. I'll now hand over to Chad.

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Chad Hymas, AusNet Services Ltd - Executive General Manager of Mondo [5]

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Thanks, Alistair, and good morning, everyone. Turning to Slide 20. I'm very pleased to communicate that Mondo has made excellent progress in the last 6 months in delivering commercial growth through building, owning and operating contracted infrastructure with credible strategic partners that deliver stable long-term returns. Some key business highlights include completing Murra Warra Stage 1 wind farm on time and on budget, constructing Stockyard Hill and Dundonnell wind farms, both to be completed in financial year 2020 and undertaking early works for various projects, including Project Marinus, the second interconnector between Victoria and Tasmania, Golden Plains wind farm in Southwest Victoria and Star of the South Wind farm, Australia's first proposed offshore wind farm.

Mondo is also taking an active role in our AEMO-led processes for network upgrades that both represent investment opportunities within our core skill set and also facilitates the continued growth of renewables. Mondo has a strong pipeline that supports our contracted asset base target of $1.5 billion by financial year 2024.

Turning to Slide 21. Mondo is leveraging mature business operations in energy data and technology solutions to enter new markets, disrupted by renewable energy and to be ready for a future with 45% of all electricity could be generated by customers. Key business highlights include: winning the Clean Energy Council National Award for Community Engagement and Innovation, constructing the Deakin University's smart energy microgrid system and leveraging this to partner more broadly into the Barwon regional community; innovating and partnering with Toyota, supporting their vision of a more renewable energy future; and developing the human project, partnering with ARENA and AEMO, to develop a marketplace for integration of distributed generation and storage assets across the national electricity markets. We're very excited by the opportunities that exist for Mondo, creating a sustainable new energy future for our customers and Australia.

With that, I'll hand back to Tony for some closing remarks.

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Tony Narvaez, AusNet Services Ltd - MD & Director [6]

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Thanks, Chad. So turning to the outlook on Slide 22, and we are pleased to reaffirm full year 2020 dividend guidance of $0.102 per share, up 5% on prior year, franked between 40% and 50%. And again, despite policy uncertainty, the pace of change, industry dynamics remain favorable, increasing penetration of large-scale renewables, distributed generation and battery storage will further underpin the essential nature of our networks. This will require capital investment in 3 key areas. Firstly, to strengthen the transmission network to support renewable targets; secondly, to facilitate a 2-way flow of electricity on our distribution network; and finally, to meet the growing requirements for unregulated connections to the grid.

In addition to facilitating the energy transition, our focus remains on accelerating our operational efficiency. And as we never go through the challenges and opportunities faced by our business, we'll continue to ensure that safety is always front of mind. Thanks again for listening in. I'll now hand over to the operator for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first telephone question is from Peter Wilson from Crédit Suisse.

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Peter Wilson, Crédit Suisse AG, Research Division - Associate [2]

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Just one on cash flow, if I could, firstly for Mark. I don’t see the noncash portion of EBITDA has significantly increased this first half. So about $25 million of noncash items this half versus $7 million in the first half last year.

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [3]

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Yes, thank you for the question, Peter. So in relation to that EBITDA noncash movement, it was impacted by our Downer transfer. As part of that transfer, we had a noncash gain on our -- some of our defined benefit liabilities, just based upon the way they are measured. So about a $12 million noncash gain in that number, which is unusual and one-off.

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Peter Wilson, Crédit Suisse AG, Research Division - Associate [4]

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Okay. So a $12 million benefit from the defined -- from the defined benefit. Was there some offsetting transition costs that you've called out on that related to Downer?

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [5]

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Sure. So in relation, when we look at the Downer transaction in its totality. The net impact on our income statement was minimal. While we had that curtailment gain on our defined benefit fund, we also incurred, obviously, mobilization and transition costs, which largely offset that. So the impact on the income statement was negligible. But obviously, from a cash flow perspective, given we also paid out the employee entitlement benefits, there was a $20 million cash outflow associated with that transaction.

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Peter Wilson, Crédit Suisse AG, Research Division - Associate [6]

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Okay, understood. And then a couple on the Mondo business. In terms of the revenue outlook, so you mentioned that the second half is likely to be a little bit higher because you've got some wind farm connections to be completed. I'm just wondering on how that looks into next year, what's your workbook of connections looks like? And what proportion of that segment EBITDA actually comes from connection-based revenue?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [7]

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Thanks, Peter. I'll start with the first part of the answer and then maybe hand to Mark, if required. We won't give any forecast around revenue for the second half around those projects. But what I will say is about -- we do have 2 or 3 significant projects coming to construction completion in the second half. They represent about 70% of our growth over the last 2 years in that infrastructure projects. So they will come, first of all, we'll see the full year results of that revenue and those results in FY 2021.

In terms of pipeline, we're very positive about the pipeline that Mondo has created and worked towards. As I had on the slide, there's been about 8,100 megawatt hours of construction and energy projects that we're working on, some early works developments. I will say that to keep in mind that it sort of takes 12 to 18 months to develop those projects, wait for financial close and then construct. So you may see a bit of a lag in some of those next projects coming on to the growth in revenue the following year, but we have a very healthy pipeline to hit our target of $1.5 billion of contracted asset base by 2024.

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [8]

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And I guess the only point I'd kind of add to that is in relation to -- obviously, the infrastructure part of the Mondo business is a high-margin business. So that contributes a lot to the EBITDA performance. And as I highlighted during the call that the revenues in relation to that area of the business are up $6 million half-on-half.

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Peter Wilson, Crédit Suisse AG, Research Division - Associate [9]

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Okay. And then if I could just go to Alistair's comment. Apologies, I missed a little bit, but you made a comment around -- aside from an adjustment to spend that you think you'd be in the top quartile. Just hoping you could elaborate on that. And on his views, whether that's something that will be taken into account in the upcoming reset?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [10]

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Yes, thanks for the question, Peter. So what I said was there used to be an exclusion of bushfire liability insurance, and we felt not reflected are different circumstances compared to most of the other distributors, the AER and the leaders doing the benchmarking, which hasn't been published yet, but will come out shortly, has just treated that as ordinary OpEx. So we don't think that gives us an apples for apples. And also, one of the things that we recognize is really difficult. By benchmarking is it doesn't cover outputs for bushfire safety. And again, that's something the AER really understands well. So we are reasonably confident about how they'll approach that at the EDPR price review, we feel in good shape where we are in efficiency from that pure regulatory lens. But just in terms of as a market, looking at efficiency, we just think it gives a slightly misleading impression.

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Peter Wilson, Crédit Suisse AG, Research Division - Associate [11]

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Okay. And can you tell us why the AER would take into account for the determination, but not taking into account for their benchmarking exercise?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [12]

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It's a good question. What they are really using the benchmarking processes for is a screening, too, so they want something that's relatively easy to calculate each year that they can get the information from the businesses, and it's relatively straightforward. And the way the process works is if you then kind of feel on the face of a test, you then go into a more determinative process where they look at all these factors. So our strategy, certainly, for this period, is to stay out of that second stage review. But if we went into that second stage review, they would look at those factors very carefully. One of the advantages of being involved in the customer forum process is that we have seen a number of practice notes come out of the AER. And so we have a good understanding of where they are in terms of our relative efficiency that we wouldn't otherwise have.

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Operator [13]

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(Operator Instructions) Our next question is from Rob Koh from Morgan Stanley.

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Robert Koh, Morgan Stanley, Research Division - VP [14]

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So first question is in relation to COGATI and the -- I'm just trying to understand where would those kind of financial transmission rate hedges sit within the business? Would they be within Mondo or within Alistair's regulated side? And I guess how do you guys think about managing kind of 5-minute price risk?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [15]

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Yes. Thanks, Rob. Really thoughtful question. Look, I think it would sit in the regulated business, there's obviously quite a question for how does the Victorian transmission arrangements [were] handle something like transmission hedges and so on. So I think there's a lot of water to go under the bridge. That question of risk management was really what I was alluding to in my comments, that's something we would need to work through. And I think we would really need to give investors a good understanding of it. And the other TNSPs have been handling the interregional settlement residue for some time, and that has quite an impact on earnings in any period. So I think we're reasonably confident about it. I don't think the proposals as we read them would be a sort of -- they would have a material impact, I think, on cash flows, but I don't think it would be beyond [the appeal] to manage them. But that's something, as we see more details, we'll work through and make sure we communicate.

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Robert Koh, Morgan Stanley, Research Division - VP [16]

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Yes. Okay. So I guess, probably a question for Mr. Ellul, about the levers for managing the moderating growth profile of dividends. So firstly, when we talk about that moderating growth profile, should we be thinking about that as the dividend, the cash dividend and the franking? And then also, I guess, in relation to debt. When we talk about that A- target credit rating, should we still be thinking about that in stand-alone credit rating terms? Or is there a kind of parental credit rating part of the lever.

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [17]

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Thanks a lot for the question. So I guess, in relation to dividends, obviously, franking is just a function of the tax that we pay. So that will flow through as we make tax payments each year. From a funding perspective with cash -- sorry, from a dividend point of view, and as we've reiterated, our policy is to fund our dividend through cash flow after servicing all of our debt, interest, tax and maintenance CapEx.

In terms of the rating agency -- I'm sorry, the A-range credit rating objective, we look to target that on a stand-alone basis, and I understand that's how it's measured.

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Robert Koh, Morgan Stanley, Research Division - VP [18]

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Yes. All right. I guess last question, I guess, trying to give Mr. Narvaez a chance to say something. Welcome back to Melbourne. Can you perhaps give us a view on the rate of return guideline 2018? And we've even started, I guess, process for the rate of return guideline 2022. Some of your peers, Mr. Narvaez have suggested that the current rate of return guideline is too low and outdated and I guess, just keen to understand if you agree with that. And then thinking about 2022, what kind of evidence can networks bring to the regulator to try and prove that. And I guess, we presume you don't want to under invest in the networks in any way.

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Tony Narvaez, AusNet Services Ltd - MD & Director [19]

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Thanks, Rob, and thanks for the welcome back to Melbourne and nice to reconnect and part of your question will be answered through Mark, if it's okay, and through Alistair. What we'll say is that, clearly, we're in a fairly tight market at the moment when it comes to WACC and rate of return guidelines. Of course, it's not ideal for us, and we have constant communication with the regulators and with government to ensure that we can continue to invest in our assets and deliver safe and reliable outcomes for our customers. So that's what I'll say first and foremost. Having said that, of course, not only we got license obligations to do the right thing in terms of our investments. But also, if that's the parameters that we've been given, and we've proven historically to be able to manage the business efficiently given a number of circumstances, and I think this is going to be no different in this particular case, where we can still outperform, and we can still roll our lease-up and still provide the outcomes that I think our investors and our customers demand from us. Anything you want to add to that?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [20]

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I'd just add, and I think you put it well, Tony, it's our job -- now we've got the rate of return guidelines settled, it's our job to make it work. We think there's still attractive investments to be made. But it will then be our job in terms of the 2022 guidelines to make sure we put clear evidence to the Australian energy regulator, where we believe the rate of return is inadequate and so on, and we will do that. And we'll obviously get ready for it. Great question, Rob.

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Operator [21]

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Our next question is from Ian Myles from Macquarie.

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Ian Myles, Macquarie Research - Analyst [22]

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Maybe first, Tony, you've just got your feet under the gas. Can you maybe tell us what your 100-day plan is and what -- when you might be able to update the market of going through the business?

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Tony Narvaez, AusNet Services Ltd - MD & Director [23]

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Thanks. And I know I’ll catch up, so apologies. We look forward to catching up shortly. I'll have a better view of the 100-day plan as we get closer, I think, to the 100 days. But what I can tell you is in terms of my impressions of the business today. And I ran through the strategy in an earlier slide, my personal view is directionally it feels about right. Of course, I made mention as well of the fact that you expect to get under the hood. I've only been here, this is my eighth day now. I've already had a couple of conversations. And of course, a number of data points. I need to continue that journey, of course, in terms of listening to the organization and validating those data points. But what I can tell you is that the business is in really good shape. So they've spent 2 or 3 years, shaking it sources up through a transformational process. A couple of the areas that I've noticed straightaway is that they've invested very heavily in terms of their IT platform, and that certainly helps you for the next phase, but also areas of the business where are far more commercial than I thought they'd be, such as procurement and so on. And that's really going to help again with Phase 2. In terms of probably what I'd expect for a business like this one here is that it starts to, I guess, narrow its focus in terms of 4 or 5 key elements that we want to take the business moving forward. We talked about growth, and we've got a wonderful outlook in terms of that. And so of course, if we're successful in a number of projects, your focus will move towards execution and move towards the capabilities of the organization. So that will be one key focus. We're not going to take our foot off when it comes to, of course, efficient outcomes. And you heard from the earlier question there around how do we cope in a tightening market. So of course, efficiency plays a key role.

One of the other things that comes out in our strategic slide as well, is just ensuring that we develop our people skills and their capabilities as well, too. So really looking forward to making that really clear for the organization. But early days, Ian, I'll get closer to being able to answer that question in more detail. Now that as I get closer to the 100 days.

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Ian Myles, Macquarie Research - Analyst [24]

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No, it's okay. A couple of others more technical things. Transmission, how much was the steepest revenue this period?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [25]

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I don't have it in front of me at the moment. Let me pick it out and I'll get back to you on that.

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Ian Myles, Macquarie Research - Analyst [26]

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That would be great. All the accounting changes with AASB16 and Mondo. Even if I look at the bottom line, EBITDA or EBITDA of IL, went backwards a little. Can you just explain, maybe run through why it actually went backwards, given you had some momentum in the infrastructure side of the business?

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John Nicolopoulos, AusNet Services Ltd - Head of Tax & IR [27]

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Yes, Ian, it's John here. Well, we're still -- half year on half year, we're still seeing the impacts of getting out of some of the low-margin field services work, that sort of accounts for somewhere in the order of -- in EBITDA [sense], $2 million to $3 million, which is a fair chunk. And some of that's volume related, but mostly it's contracts that we didn't want to pursue going forward. We've had some work -- one-off work in the geospatial area that was happened in the first -- last 6 months last year versus now, which hasn't re-eventuated because we finished those jobs, the geospatial business within Mondo's very project driven, and we're actually directing a lot of our resources and efforts now to support the regulated business on a LiDAR project, which is our internal development time at the moment. So you get that offset of infrastructure coming up, offset by things that are no longer in this half versus the first half of last year.

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Ian Myles, Macquarie Research - Analyst [28]

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Okay. That's great. On the financial side, FFO to debt, you suggested you've been -- the rating agencies are starting to look a little bit more generously on the ratio. I was just wondering what you see is now the standard AA ratio that you'd be targeting or wanting to exceed. I mean, not AAA.

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [29]

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So Ian I guess, in relation to our metrics and what we target. Obviously, as I mentioned before, we obviously target a little bit of a buffer in our metrics, and that gives us the flexibility to kind of measure the business and explore opportunities going forward. In relation to the metrics specifically around FFO to debt that I referred to earlier, Moody's have dropped their rating down from 11% to 9%. S&P remains at 9.5%. But I would note, though, that the credit rating -- for the rating agencies when they look at those metrics, they look at it over a multi years, they don't just look at it at a point in time.

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Ian Myles, Macquarie Research - Analyst [30]

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I appreciate that. And finally, on distribution, you pointed out the cost increases of TUOS and obviously, vegetation, which I presume will unwind over time. There's other comment in there about over-collection of revenue, does that also unwind over the next 12 months?

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [31]

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So the other question of revenue that we referenced, my understanding is it only about $4 million. And yes, that will reverse over time.

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Operator [32]

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Our next question is from Nathan Lead from Morgans Financial.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [33]

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I guess, just a couple of questions from me. The first one is just with the EDPR coming through. Could you give a bit of an estimate of what you think the incentive revenue might be coming out of that from EBSS, your CESS, et cetera?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [34]

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I don't have that to hand, we can come back to you on that.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [35]

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Will it likely be significant? I mean the draft proposal certainly had some pretty chunky numbers coming through. But I just wondered whether you'd revise your thinking there?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [36]

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Yes. No, like I say, I'll need to dig it out.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [37]

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And just second one, obviously, with the impacts coming through from lower interest rates and lower regulated revenues coming through, is it fair to say you're likely to keep that DRP running just to keep those credit metrics in check through into the next regulatory cycles?

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [38]

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Yes. So I guess, Nathan, in relation to our capital management framework, and it's kind of detailed there on Slide 14 and as I kind of touched on in the presentation. We like to keep a number of options open available to us, and we continue to look at our funding parameters prudently, part of that mix is obviously a DRP program. We obviously announced it as part of this interim dividend, and we'll continue to look at it going forward.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [39]

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So what about the hybrid? Just obviously, a 50% equity credit disappears in coming years? What's the thinking on that?

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [40]

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So I guess, in relation to the hybrid, and as you highlighted, it does give us some equity credit, which gives us some good flexibility. We'd obviously be looking to roll that forward. I think the first reset is in 2021. And we'd be looking to try and maintain that equity credit going forward.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [41]

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Okay. And any discussions with the rating agencies, business plan, I suppose, that you spoke through with them, did it include ongoing growth in the distribution? Or is there a contemplation potentially distribution going down?

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [42]

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So I guess, in relation to our distributions and kind of referring back to Slide 13. I mean, as you're aware, our long-standing policy has only been to provide 1-year worth of guidance. So that's what we'll be -- I'm saying at this point in time. Obviously, as is noted on Slide 13, we have a number of options and levers available to us to help us manage through the dynamic of lower regulated revenues going forward.

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Operator [43]

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Our next telephone question is from James Nevin from RBC.

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James Nevin, RBC Capital Markets, Research Division - Analyst [44]

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Just a first quick question on benchmark efficiency. Are you still targeting the distribution business kind of top quartile by end 2021? And then just also related to that, how does the outsourcing to Downer impact that? Do you get kind of visibility on your kind of OpEx over the next few years? And do you see that you're going to be achieving that target by 2021?

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [45]

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So perhaps -- James, it's Mark. I'll start and then maybe Alistair can jump in if he's got any further comments. I think it's kind of Alistair highlighted, we don't think that the benchmarking is kind of an apples-to-apples comparison, but we continue to focus from a cost efficiency perspective, and we continue to target being top quartile against our OpEx efficiencies. In relation to the Downer transaction specifically, yes, we expect that to provide us benefits going forward. Obviously, it's early days. We've only just recently undertaken that transfer. As I kind of highlighted as well, we still have some further kind of mobilization and transition to work through in the second half. But yes, we do expect to provide us with longer-term benefit.

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James Nevin, RBC Capital Markets, Research Division - Analyst [46]

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Okay. And then I just wanted to pick up, I think you talked about bushfire risks and liability insurance in the report. Just -- what are the impacts that you're seeing on that? Like if premiums are higher, do you have to alter the level of -- and cover that you take out. And just what are the impacts from that then, I think you talked about -- does your [alone] maybe in some certain circumstances pass-through some costs -- you recover some cost to the AER process. Just wondering kind of what type of costs you could potentially recover there?

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Mark Ellul, AusNet Services Ltd - Acting EGM & CFO [47]

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So perhaps, James, it's Mark. I might touch a little bit on the insurance and how we set, and then I'll hand over to Alistair for the regulatory mechanism and the pass-through. I guess as we kind of disclosed in that note that you referred to, the insurance markets are getting tighter, and it is more difficult to manage through. We continue to undertake an annual program, and we continue to review our level of insurance cover to make sure that it is efficient and prudent. And we will continue to do so. Obviously, also, too, as part of our broader risk mitigation activities, we undertake a lot of investment in the network each year to support that network and make sure that we -- we're dealing with our bushfire mitigation regulations and requirements. I'll hand over to Alistair to talk about the pass-through mechanism.

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [48]

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Yes. Thanks, Mark. Thanks for the question, James. And of course, we are struck by the bushfires we're seeing at the moment in New South Wales and, of course, in California as well. So this pass-through mechanism has been around for quite a long time, and it's an important part of our liability management. As it stands, it provides coverage to us where we take our bushfire insurance that's prudent and efficient. And there will naturally be a cap to that coverage. And where we have that prudent and efficient insurance, if we have a series of claims that means we exceed that cap, then there is a pass-through mechanism to recover that exceeded in mind from customers. There's a number of steps in the mechanism for the AER to look at, but the kind of central premise over this is, if the insurer pays out, then the cap pass-through is live as it were. So the AER will rely on the insurer, to make sure that we have met our duties to the insurer. And that's subject to that, they will look at passing through that to customers. It hasn't been used. It would clearly be a pretty controversial mechanism when it did get used we recognize that, that would be something we would have to handle very respectfully, but it is there to provide some sort of assurance. And it's a very customer-focused pass-through because the intention of it is to prevent us from taking out ever greater levels of insurance simply to protect shareholders. So we think it's a good balance of managing the risk allocation between shareholders and customers over the long term, really happy to take detailed questions on that. And we think it's an important piece of the framework.

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James Nevin, RBC Capital Markets, Research Division - Analyst [49]

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Yes, just able to comment on -- obviously, you want to be efficient and prudent in the -- what you actually pay in insurance every year. Just -- is there something -- are you having to make a trade-off at the moment to maybe to between the amount of coverage you have and the claim or the -- your actual insurance cost every year at the moment?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [50]

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Yes. So we won't get into the detail of our coverage, of course. But every year, we would have some sort of discussion with the AER that we are getting that balance right. And so you'd expect we're doing that at the minute.

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Operator [51]

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And our next telephone question is from Rob Koh from Morgan Stanley.

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Robert Koh, Morgan Stanley, Research Division - VP [52]

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Maybe a bit less field. I guess, there's a large customer of electricity in Victoria down in Portland, the big aluminum smelter, and that's under review. Could you perhaps just reconfirm with us what the transmission arrangements are there, what the impact of a smelter closure could be? And I guess, if -- because I presume everyone in the electricity system will need to contribute to keeping the smelter there. Could you be called upon to chip in?

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Alistair Parker, AusNet Services Ltd - Executive General Manager of Regulated Energy Services [53]

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It's a very detailed question, Rob, about a very specific customer. And so I'll see if I can help without betraying any confidences. Look, the current arrangements in Victoria are very clear. It's AEMO, actually, who holds those customer relationships and levies charges. If any large customer were to depart the network, then we are held whole. And in fact, this happened a couple of years ago when -- I just forgotten the name, but the other smaller [substation Anglo Seaway] closed and Pointe Henry, and everybody's transmission charges increased by 10%. And of course, the substantial part of the transmission there runs at the South Australia. It's just that they dined to Portland. And so that isn't something that's losing me a lot of sleep. Obviously, I hope the smelter stays open. It's a great source of employment there. But in terms of the risk of assets stranding, it's well-managed under the current framework.

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Operator [54]

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There's no more further questions at this time. I'd like to hand the call back to the speakers for any closing remarks. Please go ahead.

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Tony Narvaez, AusNet Services Ltd - MD & Director [55]

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Well, again, everybody, thank you for joining us this morning. Appreciate your time. Please feel free to reach out to the Investor Relations team if you have any further questions, and we'll see you next time. Thank you.

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Operator [56]

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Ladies and gentlemen that does conclude the call.