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Edited Transcript of PNN.L earnings conference call or presentation 27-Nov-18 9:00am GMT

Half Year 2019 Pennon Group PLC Earnings Presentation

London Dec 13, 2018 (Thomson StreetEvents) -- Edited Transcript of Pennon Group PLC earnings conference call or presentation Tuesday, November 27, 2018 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher Loughlin

Pennon Group Plc - CEO & Executive Director

* Susan Jane Davy

Pennon Group Plc - CFO & Executive Director

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Conference Call Participants

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* Christopher Robert Laybutt

JP Morgan Chase & Co, Research Division - Research Analyst

* Fraser Andrew McLaren

BofA Merrill Lynch, Research Division - Director

* Iain Stewart Turner

Exane BNP Paribas, Research Division - Analyst of Utilities

* James Brand

Deutsche Bank AG, Research Division - Research Analyst

* Jenny Ping

Citigroup Inc, Research Division - Director and Analyst

* John Musk

RBC Capital Markets, LLC, Research Division - Analyst

* Richard Alderman

* Verity Mitchell

HSBC, Research Division - Analyst

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Presentation

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [1]

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Well, good morning, everybody. I usually have to call everybody to order because everybody's gossiping and chatting, but suddenly, you all came to order without me saying anything. So thank you for doing that. You made my job easier, but welcome. Hopefully, that as for venue, you've managed to find it okay because it's slightly different venue and I hope the venue will be okay today. But obviously, thank you very much for giving up your time today. This is the half-year results for Pennon for the year 2018 to 2019, as you know.

So as usual, I'll go through some of the highlights, hand over to Susan to do the -- a little bit more detail on the financial results and then come back with a few operational things myself.

So just to start off them. So Pennon is delivering. It's delivering for its customers, delivering for its communities it serves and also delivering for its shareholders as well.

And as I said at the year-end, it's not just about delivering strong results for a company like Pennon. For a company like Pennon, it's how we deliver the results as well. So we're very pleased to say that these are strong results. So it's not just about the strong results, but these are strong results, but they're being delivered in a way that's true to our essential values of being trusted, collaborative, responsible and progressive. So that's how we're delivering those results and that's part of the social contract we have with the people that we serve.

So I'll just take you through some of the highlights of the results. As I say, just 1 or 2 of the main stories or the main messages in the results. And I said it's all about delivering and delivering for our customers. But it's also to maintain trust, it's essential that we deliver our promises that we made to our customers. And that's exactly what we've been doing.

And if I pick out some highlights in those -- in that sort of theme. South West Water, we made some promises and some pledges to our customers and the communities we serve back at PR14, so for the coming 5-year -- for the current 5-year period, and we're on track to deliver absolutely every single one of those promises and pledges. So that's good.

We also have a unique sharing mechanism in the South West Water called WaterShare, and of course, we promised that if we were outperforming at all in the regulatory contract, we would share that outperformance fairly with our customers, and that's exactly what we're doing and WaterShare has delivered so far GBP 100 million for our customers so far in this 5-year period.

So those are some of the results. We've had some operational challenges in the last year. You're all aware of the Beast from the East in March and then that was quickly followed by a very, very hot, dry summer, certainly down in our part of the world. And I'm very pleased to say that we've overcome those operational challenges of a resilient system and operations and have received praise from several independent sources as well. So overcome those extreme climatic changes and challenges.

Also this year, I might well be, to pick out another highlight, might be an important year in terms of customer service. So hand in hand with operational excellence comes good customer service, and you remember that Ofwat has a mechanism for assessing how well or otherwise you are serving your customers, Service Incentive Mechanism, that's the Service Incentive Mechanism they're using for the whole of this 5-year period. Well, that was an area of focus for us and I'll go through in a little bit more detail later in the presentation. But we're now ranked by Ofwat as second in the industry, so #2 in the industry, which is quite a turnaround from where we were. So that's the best ever score we had.

So that's delivering on our promises for the water business. And it's the same story in Viridor, the waste management business. As you know, one of the highlights of the last 6 months is bringing the next 3 Energy Recovery Facilities, ERFs, online and we're very pleased to say that Glasgow, Beddington and South London and Dunbar are all now receiving waste, burning waste and generating electricity and we're now moving into that operational ramp-up phase, as we did on the previous ones, over the next year or 18 months' time.

So that's good operational performance, delivering on our promises, as I said, and it's good, strong, sustainable financial performance as you've probably seen from the results. And I won't steal Susan's thunder, but she will go through that in a moment in a bit more detail.

But just picking out 2 or 3 things -- 3 or 4 things from those results from my point of view. RORE, South West Water's RORE, return on regulated equity, is a measure of whether or not you're outperforming on the regulatory contract. We continue to be, by some considerable margin, the sector leader in that regard, delivering a cumulative 11.8% over the period so far in the 5-year period. We're delivering year-on-year throughout the 5-year period, as I say, by some considerable margin outperforming the rest of the sector.

Viridor, turning to Viridor. I mean, the growth in Viridor, the growth in the financial results in Viridor is driven by that ERF build-out. But more than that, we're incrementally adding some extra capacity to the existing facilities. You've seen that investment and that continues. And we've just recently announced in the last few days increasing our shareholding in Runcorn I to 75%, as you've seen.

So that's good in the ERF, that's driving the financial results. And a good turnaround in recycling as well. We've overcome the difficulties and the challenges the whole industry had, the global challenges, in the back half of the second half of last year and we've seen that recovery coming through into this first half this year and we're expecting that to go through for the whole of the year as we meet our expectation there.

As ever, our financial results are driven by our focus on cost efficiency, both in the water, the waste, and of course, at group level and just that cost efficiency drive is continuing. We've previously put out there that we were aiming to get some consolidation -- some efficiencies from the consolidation of the group into about a GBP 17 million per annum. We've currently delivered about GBP 15 million per annum of that efficiency saving.

So that's the results. Just picking out something about the outlook and the outlook going forward. I think we're well placed in both businesses. Obviously, in terms of the water business, the PR19 process is under way. We submitted what we think is a top-quality plan to Ofwat and we wait to hear the results of their initial assessment of those plans at the end of January. We believe our plan have some elements or groundbreaking facilities -- facets to it. We've called it a New Deal because we do think it's putting more control into the hands of customers like never before, and I'll talk about that in a moment. I'm giving them a tangible stake in the business by aligning the interests of shareholders and customers together by giving them seed corn or some shares from our performance this year -- these 5 years and then the prospect of growing that in the coming 5 years and beyond.

But we're very confident in our plan and it's important to get off to a fast start. So we're very, very well prepared in those operational -- preparations for the fast start to the coming 5 years as well. So that's well underway now.

Similar story and outlook for Viridor as well. I mean, we're focused on, as you know, residual waste and recycling. Those are the 2 primary focus areas for us. We're focused particularly on the assets that underpin those operations and that's where we are at the moment and that's where we're focusing going forward. And we believe there are favorable market dynamics for both. So there's continuing to be an under capacity in terms of facilities to handle residual waste. We see that going through -- right through till 2030 and beyond.

And also driven by public perception, the interest in recycling, shortly to have the government's Resources & Waste Management Strategy be published soon, that will give a further stimulus to further stimulate the recycling business as well. So all of that means that we've got good outlooks for both the water business and the waste business.

So those are the highlights as I see them. I'll hand over to Susan who'll go through the results in a rather more detail.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [2]

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Yes, Chris. Thank you. Good morning, everybody. So just turning to the financial highlights for this half-year 2018/'19, I'm very pleased to say that we had a good, strong performance across all activities in the group. And looking at those key indicators of financial performance, all increasing period-on-period.

Underlying EBITDA is up some 8.1% and underlying earnings per share is up 18.6%. That's really reflecting our effective operations and our efficient financing that we have in place across the group. We have a strong balance sheet in place and that's supporting our continued significant capital investment across both Viridor and South West Water. And our dividend per share, I'm pleased to report, is increasing by 7.3% for the interim dividend for '18/'19.

So just unpacking those results in a little bit more detail and starting first with Pennon and looking at the underlying results for the first half year. I said EBITDA had increased by 8.1% to GBP 274 million.

In terms of 2 aspects, I'd like to just draw out from that performance. On the Viridor side, good, strong performance across all activities, but in particular, we said we're going to get growth coming through as we're building out that ERF portfolio and that's what you're seeing in the first half results for '18/'19 with Dunbar and Beddington coming through in terms of financial support for those.

On the water side, we have had some high revenue as a result of the hot, dry summer and we've had some extra costs to service the demands. But overall, we've had a net benefit, which, again, you'll see it coming through into the South West Water results.

That flows down -- if I just touch on net interest there, which, in absolute terms, has increased period-on-period. And if you look at effective rate, it's slightly lower compared to the prior half year at 3.6% as a rate.

So overall, our profit before tax on an underlying basis has increased by some 8.7%.

As is usual, we exclude items to give a better representation of our underlying results. For this half year, the nonunderlying items are associated with a small number of instruments what we have over one long-dated South West Water 2040 bond and it's the fair value movement in those that we have been pulling out for a number of periods now and that's the only adjustment that we have on in nonunderlying items for this half year.

You can see then our statutory profit before tax and profit after taxes increases. And if I touch on earnings per share, which has increased by 18.6% on an underlying basis and 17.4% on a statutory basis, again, this is really underlying our efficient financing that we've got in place. So what's causing the movement there, obviously, the profit falling through, but also the fact that we refinanced a hybrid last year. So we had a GBP 300 million hybrid at 6.75% coupon, which we refinanced at the 2.875% coupon. So that's really what's reflecting that pickup in the EPS.

So just moving on to subsidiary performance and starting first with South West Water. So this is the penultimate year of this regulated delivery period out of 2020. And I'm pleased to report that, financially, the outperformance for South West Water continues and that momentum continues.

Starting first with revenue and the tariff increases in this first half year of 1%, and as I just mentioned, because of the hot, dry period we had over the summer, Chris mentioned it at the beginning, we have had increased volumes from customers in terms of that demand, so we have had increased revenue and we have had costs associated with that, but you can see that coming through in the revenue as a result of that dry weather.

Having said that, we have a board pledge in place to make sure that customer bills do not increase by any more than inflation period-on-period and I have to say we're very pleased that we are maintaining that board pledge, and in fact, our bills today are lower than they were 9 years ago. So fair charging is very key for us. And actually, one of the aspects of achieving as lower bill as you can have is your focus on efficiency and cost base.

So just moving on to operational costs. You can see there the change in operational costs, an increase of 1.6%. That's much lower than the headline inflation rate of 3.3% for the half year and it takes into account some of those atypical costs that we've had because of the hot, dry weather over the summer. So good, strong focus on efficiency and momentum for those initiatives continuing.

One aspect that we've really been focusing on for South West Water in this regulatory delivery period is making sure our retail cost to serve and our bad debt costs are as low as they can be. I'm pleased to report that our bad debt charge has fallen to 0.6% of revenue from the 1.7% where we ended the last regulatory period. So good strong performance in terms of the cost base.

Looking at CapEx. CapEx is very much following the delivery of outcomes as we had in our business plan and that profile is reflective of that.

And if just turning to the return on regulated equity, there are 2 measures that we're showing there. One is the WaterShare measure, which is the measure we derived for sharing benefits with our customers; and the other one is the Ofwat measure. You can see there that momentum for delivery continues. Cumulatively, we stood at 11.8%. And if you look at either the WaterShare measure or the Ofwat measure, they're both set for leaving both strong returns.

So moving on to Viridor. As I said at the beginning, good set of results for Viridor across all activities. Very much the growth coming through being supported by build-out of the Energy Recovery Facility program.

Starting first with EBITDA, which is up 17.7% overall.

And starting with ERFs. As I said, we've got that build-out. In the prior results, we were getting some financial support from the Glasgow build-out, but what's incremental for this first half year is what we're getting through from Dunbar and from Beddington. You see that coming through into the results. So those are those assets that were under construction and are now operating. Those have been in operation for some time. The availability for those is, again, very strong and on track to meet over 90% availability before the year-end.

In terms of our maintenance cycle, we've been trying to focus those in H1 '18/'19. Why? Because we're unhedged on our energy pricing then we get some better benefits in H2 because the pricing is better. So we've been focusing our maintenance schedules for H1.

But putting that to one side, we've had a very good delivery on the ERFs for this first half-year period. And that's ERFs either in the top half of the P&L you can see there, all those that are under joint venture. And joint venture share of the JV profit after tax, you can see is pretty comparable period-on-period. Again, with Lakeside, we were focusing on maintenance in H1 so a slight reduction compared to prior period, but again, really just down to the maintenance scheduling on Lakeside. So good performance from ERFs.

Moving on to landfill and recycling and perhaps starting first with landfill. We've said for some time that we see an under capacity for dealing with residual waste in the U.K. And we had previously projected that the Landfill volumes we're going to drop more steeply. That's not been the case, and in fact, compared to prior periods, the landfill volumes are being sustained and the pricing is good in terms of the volumes that are coming in. So that's what you can see in the landfill line there period-on-period.

Landfill gas, we have been investing over the last 12 months in the asset base there to improve gas yields. Gas yields are -- previously, we've been forecasting gas yields reducing between 5% and 9% per annum. As what we've seen is a less of a decline for this first half in a roundabout 4% and that really reflects the investment we've been making in that asset base.

In terms of Recycling. So compared to the first half of last year, there is a reduction in Recycling EBITDA. In the second half of last year, we have the impact of the China restrictions for import quality into their country. And if you compared our GBP 7.4 million with the results for the second half of last year, then actually we've got a GBP 3 million betterment in that EBITDA. So we have recovered from that second half last year and you can see that in the numbers.

Quality is absolutely key on Recycling, and I'm pleased to report that we are achieving good pricing and pricing overall has increased and margins have increased compared to H2 last year.

Those results then flow down, just very quickly touching on indirect costs. Cost base across the group is something we've been focusing on for some time, although it's worth noting that, obviously, in absolute terms, costs have reduced period-on-period. But it's worth noting with some of the efficiency drives that we've been undertaking then since '15 and '16, we have got a 70% reduction in real terms on that cost base for Viridor. So good, strong set of results.

CapEx, you can see at the bottom there, again, very much reflecting the ERF program and where we are with that, and obviously, still significant.

And just touching on efficiencies. So across the group, thought it was worthwhile pulling together this slide shows our position in terms of our efficiency drive across the group. Starting first with the water side, GBP 209 million cumulative efficiencies in this regulatory delivery period that we have done to date, and we're on track for our GBP 300 million by the end of this regulatory period.

Now for us, we think we've hit the sweet spot in terms of delivering efficiencies, but also being on track to deliver all our commitments in our business plan as well and that means that both investors and customers benefit from that. Investors will receive returns, higher returns, and customers from the lower bills going forward. And we think that's the sweet spot to achieve and we're certainly on with doing that.

Bournemouth Water synergies, very much on track. GBP 27 million is what we forecast, and to date, we've delivered GBP 19 million. And the group efficiency initiatives that we put in place, by next year we had estimated GBP 7 million -- GBP 17 million per annum. To date, we've delivered and secured GBP 15 million per annum, about 70% of that falling within the Viridor activities. So good, strong delivery on efficiency.

Corporation tax, just touching on that for a moment. Probably the first thing to say before I get into corporation tax piece is early this year, we've published our tax strategy. We went out to customers to get their views on what they thought a responsible approach to tax was. Lots of interesting comments about that and some of that came through into our tax strategy that we approved with the board. It's probably worth noting that, as a group, we collect and bear around GBP 260 million of tax. Corporation tax is just one element of that, but it's something I'm going to focus on today. And so starting with the current year -- current tax, our effective rate, very -- well, because they're very similar -- the same as the first half last year at 10.9%, is lower than the headline corporation tax rate because of the significant investment that we're making across the group.

In terms of those adjustments from the prior year. As you might imagine, with a group the size of ours and a capital program the size of ours, we make some estimates when we put in our tax returns and then there are some true-ups that occur period-on-period once we've been through that process and those credits are really just reflective of that usual ongoing process that we have.

Overall, you can see our total tax charge then is very comparable with the first half last year.

Capital investment. We are past the peak in the investment in this regulatory period to 2020 for the group. However, it is still significant and you see that in the numbers for the capital investment that I'm showing for H1 '18/'19.

In terms of the profiling for this financial year, water is going to be H2 profiles and Viridor is H1 profiled.

And overall for the group, it's very much a H1 weighting for CapEx. There is still significant capital investment that we're making and you could see the change in GBP 1 million that we spent there for this half year.

The South West Water profile, as I said, really reflects the delivery in that business plan. And the ERF portfolio expenditure, we're still on track for just over GBP 1.5 billion. And we're spending cumulatively, we're just over the GBP 1.4 billion to date.

So turning to net debt. You can see the increase there from prior period. So just touching on a couple of the items. We've got the cash inflow, robust cash inflow. And then on the right-hand side of that bridge, you can see the capital payments that are going out. And so still significant CapEx, obviously, coming through in that cash flow.

Other aspects to note. We've got our usual payments for the pension scheme. Then we've got tax, corporation and other. And then we've got outflows to provide as a finance. We've got there the hybrid coupon, we've got the interest payments and the dividend. And it's worth noting for Pennon that we get both the interim and the final dividend landing in the first half. So if you're thinking about profiling on net debt, then both those land in the first half of the financial year for Pennon.

So just looking at that net debt position, just over GBP 3 billion. And looking at our financing and support that we've got there. If you look at the pie chart on the left-hand side of the screen, you can see there the mix between fixed, index-linked and floating-rate debt that we have left unhedged at this point in time. It is a diversified funding mix. Part of our strategy is matching the nature of our asset base. So longer-term financing with longer-term asset base and our average maturity of debt is around 20 years, which matches that asset-based life.

Just touching on index linking. For South West Water, we were at 25% of index linking in place and the Ofwat notional is around about 30%, 33%. We think we're in an advantageous position for that transition from RPI to CPIH in the new regulatory methodology. We know that, that CPIH market is developing. It is not yet mature. And at this point, we're not sure how its indices will fare in the future, so whether they might even converge in terms of RPI and CPIH. So at the moment, if you're entering into any CPIH financing, there is a bit of a risk that you're taking on there in terms of estimating that wedge between the two. We're keeping an eye on that market, and as we see opportunities coming through, then we may consider entering into some CPIH financing. But as I say, it's certainly a market that is beginning to develop and it's certainly not mature at this point.

Looking at gearing for the group and for the water business. Stable, as you might expect, and for the water business, very much aligned with Ofwat's notional levels.

Important for a group like ours, we've got headroom for investment of circa GBP 750 million.

So just touching on the financing that we've put in place for H1 '18/'19, some GBP 480 million. Again, something that I mentioned at the full year results, we put in place a sustainable financing framework. Sustainability is very much at the core of what we do as a business and we think it's an imperative for us that our activities are very much linked to delivery for the environment and for communities.

It was a U.K. first for us to have our sustainable financing framework in place. And I'm pleased to report of the GBP 480 million that we've raised this period, then GBP 350 million of that have been through these sustainability-linked financing instruments.

How do they work? Well, quite simply, given our performance on sustainability measured through ESG scores, then your interest rate improves, the better to score is. So as I said, a U.K. first as something that very much matches our values and delivery as a group and as a business.

Overall, we've just got over GBP 1 billion of cash and committed facilities, which I think is important as we're going into that Brexit period coming up for next year.

And a big thank you to many of you in the room who have supported us with our financing, and look forward to the financing that we need to do in preparation for the next regulatory period over the coming weeks and months.

So just talking about the efficiency of that financing that we've got in place. You can see there the average interest rates both for the group and for South West Water, pretty consistent period-on-period, a slight reduction at the Pennon level. And a chart that I've shown before, but as you can imagine, I do like showing that chart because it shows where we are in terms of our effective rates compared to our peers in the water sector. So the top line is the water sector and the other 2 lines are Pennon and South West Water, and you can see there that we are sector leading in terms of our financing and the efficient rates that we are securing.

Just a quick note on our hedging. We have a predominance of floating-rate debt and the regulation methodology has moved on for the next regulatory period. And in terms of our hedging, for embedded debt, we'll be following what we had done previously, which is hedging for the next regulatory delivery period. But for new debt, we'll be following more closely the new methodology while putting in rolling 10-year hedges for that K7 period.

And lastly, for me, those good financial results flow through into the dividend, which I said at the beginning, the interim is increasing by 7.3%, really reflective of our sector-leading policy of increasing the dividend at 4% above RPI. For those investors who would like to reinvest in shares, we are offering the dividend reinvestment plan and we know many of our shareholders like to do that.

So with that, I'm going to hand over to Chris.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [3]

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All right, Susan. Thank you. So as you can see, a strong half-year performance and a strong half-year results. So I would just, before we go to questions, just pick out a few more of the sort of operational highlights, develop 1 or 2 of the things that Susan and I have been mentioning.

So starting with South West Water. I mentioned the operational challenges we had in the last year or so. I mentioned the freeze-thaw event and it was the rapid thaw that actually was the most challenging part of it and it was particularly severe down in our part of the world. It was, as I say, a once-in-a-lifetime event, as assessed by the various meteorological offices, one in 60-year event. And we overcame that and kept our operations online commendably, and Ofwat were kind enough in terms of their independent assessment to say that in many cases, not everything, of course, in many cases, we were showing industry-best practice.

That was quickly followed by the hot, dry summer -- incredibly hot, dry summer. As you can see, it was in -- we had to deal with the hottest summer on record. And again, through good planning, good preparation and good management of the stress that was put on our networks, we managed to maintain our supplies uninterrupted and that has become our 22nd consecutive year without water restrictions. So we're very pleased about how we stood up to that operational challenge.

So turning to SIM, that's the incentive mechanism that Ofwat used to assess your customer performance in this 5-year period. As you might remember, at the beginning of the 5-year period, we were down here somewhere with the industry laggards and we were saying this was an area of focus for us. Well, you can see on the current assessment, we are ranked second in the industry at the moment in SIM. That's based on the first half of the year and we've just recently had the third quarterly assessment, and although it's not published yet, we're confident that momentum is carrying on through for the whole of the year. So that's a very good position for us and we're very pleased to report, which is what we forecast at the beginning of the 5-year period that we wouldn't see any SIM penalty for us in the -- over the 5-year period.

So just to pick out a few more details of RORE and our sector-leading RORE performances have been through, and I've mentioned it in passing. But continuing to deliver RORE, return on regulated equity, outperformance against the 6% sort of baseline, more or less double returns throughout the whole of the 5-year period is where we are. Cumulatively, 11.8%. And crucial is that we're outperforming in each of the component parts: so Totex, as Susan has mentioned; ODIs are in positive territory as well; and financing, our performance as is normal. So continuing to outperform on RORE compared to our peers, and as I say, easily the sector-leading.

So just thinking about the future and a few more words on South West Water's business plan. Obviously, the business plan is under assessment by Ofwat at the moment. We're very confident we've put in a good plan to Ofwat. We await their initial assessment of plans at the end of January, but we believe there are some elements of our business plan, which were groundbreaking and different to what we've done before and what our peers are doing, particularly in terms of understanding what's driving customer behavior and understanding what's the -- what they require from us so they're looking for more in terms of putting control into their hands, making sure that they're empowered to deliver -- they're empowered to hold us to account to make sure we're delivering what we've promised.

We're continuing with our sharing mechanisms that we've had. WaterShare has been very successful and will drive that forward and continue that going forward into the next 5 years. But through various parts and various elements, we'll put customers more in control, and I've given some examples there. So they'll directly hold us to account through I talked about the customer AGM. So that would happen every year. The customer challenge group would be voted on by real customers and they'll be able to hold the customer challenge group to account, they'll be able to hold the Board of Directors to account. We'd also have regular, probably quarterly, meetings where our customers would hold the executives and the directors of South West Water to account.

So a whole range of mechanism, some of which have put down there. But over and above that, and crucially, we wanted to align the interest of shareholders and customers. So we're proposing to do that by giving customers real shares in Pennon and we'll finance that -- prime that development from some of the outperformance that we're doing these 5 years, give some shares to our customers. As and when we outperform, hopefully, in the coming 5 years, there'll be opportunity for that shareholding to grow through time and they will be able to share in the benefits or otherwise of South West Water's performance. And I say we think that's got some innovative and sort groundbreaking developments, but we're very pleased with our plan and we'll wait to see what Ofwat's assessment is.

A final promise there is to eliminate water poverty in our part of the world by 2025. That's a big and bold pledge as well, which hasn't had too much pertinacity.

So we think we've got a good plan. We await the assessment. But what's really important is we need to get on with it. We need to have a fast start and the preparations for our fast start are well underway. You may or may not be aware that Ofwat will be doing more in-year assessment of the plans. So rather than 5-year assessments, in-year assessments, so year-by-year assessment, so you've got to have a good start to the plan. And we're really looking forward to working within a standard -- standardized ODI regime where the triggers for performance, outperformance or underperformance are standardized across the industries. We have a real benchmark or way of performance and we're really looking forward to working within that regime. And there are 14, I think, it is, standardized ODIs and we're already outperforming on 10 of those and obviously focused on the other 4 as well.

So I think we're well advanced, a whole range of things we're doing. The partnerships to deliver our capital program are already set and established. The contracts are already in place with appropriate incentive mechanisms. We're proposing 2 new water treatment plants in the Bournemouth era, building on our Mayflower technology in the Plymouth water treatment plant. The pilots of those have already been done. We've run our pilot plants on real waters to make sure we've got the process ready and ready to roll out straight away. So all prepared and ready for a fast start.

So moving on to Viridor, just picking out 1 or 2 highlights from the Viridor plan. And I think the basic point is we're very confident in the outlook for Viridor and for the waste sector generally. I mean, our focus, as I said in my opening remarks, our focus is on recycling and the residual waste, the waste that can't be recycled. We're focused, as you know, on asset facilities with long-term contracts. That's part of our strategy for quite a while now. So processing and transformation assets.

And we think there's quality of dynamics for both recycling and for residual waste. And taking recycling first, I mean, a lot of government action has been stimulated by public perception. The so-called Blue Planet effect, particularly in plastic, is encouraging governments in their Resources & Waste Management strategy, which is coming out in few weeks to stimulate further investment, to simulate further levels of recycling.

And some of the things we anticipate being in the government's Resources strategy is more standardized -- a move to more standardized household collection. So customers -- householders will be less confused about what to put in which bin. That will increase the waste quality, make it easier for us to recycle and separate out the good-quality recyclates that will be helpful for the whole industry. And various incentive mechanisms for the producers of packaging and the sort of handlers of packaging, various incentive mechanisms to encourage them to make products recyclate and also to transfer some of the costs to the processors, ourselves, to make sure we have good investment going forward. So that's a good, positive dynamic for recycling and we think we're well positioned particularly in polymers and high-quality papers, as I say.

Similar story in residual waste. I mean, we continue to forecast, and pretty much everybody does, a shortfall in capacity for residual waste going forward, so that's in ERFs and landfill. And we're currently handling about 1/5 or 20% of the combustible residual waste in the U.K. is going through our facilities. We're optimizing that portfolio, as you know, extending the capacity incrementally where we can in local facilities, Trident Park, Oxfordshire and so forth, and increased our shareholding in Runcorn I as I mentioned before.

So that's all a positive development. But whatever happens, there's going to be residual waste looking for homes and some of it is exported at the moment. And although I wouldn't like to predict to what is going to happen with Brexit, but if exports to the European continents become slower, more difficult or more expensive because of exchange rates, there will be an increasing demand for, in the short to medium term, for landfill, and as Susan says, we're seeing volumes and prices holding up very well in that regard. So we slightly repositioned our messaging on that because we thought that was fading away to virtually nothing in a year or two's time. We don't think that's the case now and I'll talk a little bit more about that in a moment.

Just on the bottom there is something else I wanted to emphasize is that we have landfill, we've got grid connections. As gas volumes decrease with time naturally, that means there'll be some spare grid capacity connections. So we look to use of those grid capacity connections with other generating assets. And also both with the ERF and landfill, if you can bring users of energy to those sites, you can do with a private wire connection generation and cut out the grid in a distribution costs and give whatever facilities come towards our operation sites a cost advantage. And we're calling that sort of energy parks or energy park developments. And we've doing quite a bit of that over the last few years, but we're going to focus a little bit more on that where it makes sense on a site-by-site basis.

So just talking about recycling. I think I've said most of the things on the recycling slide there. We're going to focus on investments where we have long-term contracts to support the investment. We'll focus on investment where we see value back with long-term contracts. We're focusing on higher-value recyclate, particularly polymers and particularly high-grade papers, as I say. The results did bounce back from the difficulties over the last half year and the second half of last year affected by global effects, as Susan was mentioning, and we're on track to deliver a full year expectations for the year.

Just a word on ERFs. As you know, we've been outperforming on ERFs. That yellow element is the outperformance against the base case that was put in the original investment case. We're continuing to do that. Increased availability, so avoiding unplanned or unscheduled downtimes. 90% -- greater than 90% availability is where we are at the moment. And as I say, there's further incremental value from extending capacity and also from energy park developments.

That's the current picture of the 3 plants, I hope you can see it. But Glasgow, Beddington, Dunbar are all operating. They're receiving wastes, they're burning waste and generating electricity. As you can see, they look like finished facilities. I must say, I did wonder whether the Dunbar plant was an artist impression at one stage because I've never seen it with a clear blue sky and a clear blue sea, but I guess it must happen sometime.

At Avonmouth there on the right-hand side on the bottom there, very well advanced. You can't see it very clearly, but the steel work is up and a lot of the process equipment is in place. So that's progressing well as well.

So just lastly on this section, some thoughts on landfill, as I say. We see some further prospects, so there are slight modifications in our plants and our strategy for landfill. We've got 10 operations at the moment. And those that are coming to the end of the lives, we're responsibly returning them to alternative uses and we've done three of those over the last few years.

Gas generation. So continuing to invest in engines to make sure we get the optimal amount of gas out of the facilities, and as I say, we will continue to look and explore for energy park opportunities both for landfill and ERFs.

So I think that's all we wanted to say, so we can move into question and answers. But good half year for us, good results, good operationally, good operational challenges resisted in terms of South West Water. We're delivering on our promises, we're delivering on our promises made to our customers and our community. Strong financial performance. Good outlook. We're confident in our business plan. We're cracking on with it. And we think the market dynamics for waste, generally, residual and recycling are strong.

So with that, I'll sit down and hand over for questions.

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Questions and Answers

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [1]

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I should say, yes, if you could just put your hand up and we'll get a microphone to you and if you could just say who you are. And if you could try and just 1 or 2 questions rather 3 or 4. And if you have 3 or 4, come back for a second try. So I think Jenny is out there.

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Jenny Ping, Citigroup Inc, Research Division - Director and Analyst [2]

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It's Jenny Ping from Citi. Two questions from me. Firstly, clearly, in the context of Brexit, the water company's been brought into the political frame about the lack of -- or the potential lack of chemicals on the back of a bad Brexit deal. What is your perspective on that and how you guys see in terms of the risk on the operational side? And then, secondly, just again, in the context of Corbyn risk and post-Brexit environment, what sort of conversations have you had at the board level about the levers you could pull to deal with any risks of nationalization? Have you talked about splitting the 2 businesses once again? Is that something on the agenda?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [3]

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Okay, Jenny. So shall I start with the chemicals and the Brexit discussions, as you say. This is like anything else and I mentioned here at great length about how we'd resisted our -- the operational challenges from cold weather and from hot weather over the last year. And we get forecasts of these things coming, so Stephen and team will prepare for that. They'll think about that and they'll mitigate the impacts of that. And that's exactly what we did for the cold weather and that's exactly what we did for the hot weather this summer. And we'll approach Brexit in the same way. Let's hope there's a smooth transition to Brexit. I don't want to get into political debate about that, else we'll be here all day. But in terms of chemicals, we naturally look forward to having the appropriate level of stock in place. We do that naturally. And if there's a heightened risk of some interruptions to supplies, for example, in bad weather, we'd make sure we have the appropriate stockpiles. But some of the media stories, which I haven't actually read too many myself, but I've heard, that it will run out of it in days is certainly not the perspective that we see. And as an industry, we're working together on collaborating as an industry to make sure we have access to the appropriate chemicals. And there's a local community working with Local Resilience Forums, that's what we do as well. So I think we're prepared for it and I wouldn't anticipate there being big difficulties for that. In terms of renationalization, that's a huge subject as well. So you started with 2 big subjects. Obviously, we want to focus on reality in South West Water and Pennon, particular because we could worry ourselves to death with things, which may or may not happen. And running a good water company, running a good business in the round is what we're focused on. Of course, we look at what we think might happen. In scenario planning, of course, we do that. And in terms of splitting the business, that's been a debate that's been there or thereabouts for a long, long time and my answer today is the same as it's always been: at least every year, we look at the feasibility or the wisdom of splitting the businesses and we're quite sanguine about it. If it's in the interest of shareholders, that's what we would do. But our current assessment is it isn't in the interest of shareholders and we continue to run the 2 businesses as one. Is there anything you want to add? Okay, Iain had a question over here.

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Iain Stewart Turner, Exane BNP Paribas, Research Division - Analyst of Utilities [4]

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Yes, Iain Turner from Exane. Can I just ask a couple of questions? Firstly, we're now on hiatus with the capacity market. Could you just go through the impact of that view for the second half and maybe for a whole year perhaps, who knows? And just on bathing waters. The sort of annual maps come out and there are 4 or 5 in your part of the world that don't yet meet standards. Could you just go through those? I think, from memory, those actually aren't anything to do with you, but if you could just confirm if there's anything that you do need to do on those.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [5]

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Yes, I will do that first. Bathing water's only 2, which haven't met the standards in our part of the world and neither are anything to do with us. So it's nothing to do with this agricultural runoff from other sources and so forth and that's accepted by all the regulators. So the bathing water standards are commendably high despite the fact that we've got even higher standards coming from Europe, which we've improved in the last couple of years. In terms of the capacity, can you do that?

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [6]

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Yes, I can do that, yes. So in terms of -- well, first thing to say is our kind of base case assumptions for ERFs didn't ever include anything like capacity market aspects. In terms of sites where we have capacity market contracts in place, we have 5 sites that have those. In terms of an impact, it's very low single-digit millions in terms of an impact.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [7]

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Good.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [8]

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Depending on what happens.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [9]

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So we'll hand over to -- you were first, I think.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [10]

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Chris?

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Christopher Robert Laybutt, JP Morgan Chase & Co, Research Division - Research Analyst [11]

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Chris Laybutt, JPMorgan. Two questions. Just on Runcorn, could you just give us a refresher on the price you paid, the book value and the rationale behind the transaction.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [12]

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So Runcorn I, yes?

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Christopher Robert Laybutt, JP Morgan Chase & Co, Research Division - Research Analyst [13]

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Runcorn I, sorry. Yes, everything I've got written down is Runcorn I. And just in terms of whether you had higher revenue coming through, could you give us an idea of what sort of assumptions we should be making for fiscal year '21?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [14]

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For Runcorn again?

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Christopher Robert Laybutt, JP Morgan Chase & Co, Research Division - Research Analyst [15]

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Yes -- no, that's for water.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [16]

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Oh, water. Sorry.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [17]

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For water, yes.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [18]

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Susan, can you do those?

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [19]

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Yes, I can do those. So in terms of Runcorn and the increased shareholding for the TPSCo JV for that, we've increased from 37.5 to 75 in terms of our holding. The price we'll be paying for that is some GBP 54.52 million. It's equity accounted, so what we're buying with that is the shareholder loans that were in place and the shareholding of that and that's some GBP 33 million. And as I said, it'll be equity accounted and will still be shown in the JV line going forward. And in terms of the revenue, yes, so in terms of the revenue impacts, so we have seen the increased amount of the hot summer. We have had -- you'll see in our bridge of revenues for South West Water where we do have increased demand, but it does back to customers with

(technical difficulty)

the 2.7%, that equates to about 6 million to 7 million, which will go back in 2 years' time.

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James Brand, Deutsche Bank AG, Research Division - Research Analyst [20]

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James Brand from Deutsche Bank. Two questions. The first is on WaterShare and I was wondering whether you could just give us -- just remind us really a bit more about what makes that GBP 100 million up? My impression is that the large majority or potentially all of it is sharing on outperformance on new debt issuance during the period and that gets reflected in adjustment to the RAB at the end of the period. If you could just remind us if that's correct or not? And then, secondly, your cash -- you talked a bit about corporation tax. Your cash tax rate, I believe was 9% in the first half. I was just wondering what your expectation was for the full year for cash tax rate.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [21]

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So okay if take those?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [22]

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Yes.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [23]

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So in terms of water, the GBP 100 million, so that's made up of 3 elements: there is the sharing of efficiency, so that's some GBP 71 million; there's the ODI piece, which is GBP 9 million; and then there's the cost of new debt piece, which is some GBP 16 million. So that's the makeup of that GBP 100 million WaterShare piece that goes back to customers and that's how we are with that to date in the regulatory period. And then in terms of the cash tax, yes, I think you saw on the corporation tax slide that we have some prior adjustments that come through that obviously kind of bring down the overall cash tax rate that we paid. But we see our range kind of 9% to -- between 9% and 11% in a kind of year that we are forecasting out.

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John Musk, RBC Capital Markets, LLC, Research Division - Analyst [24]

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It's John Musk from RBC. Two relatively small questions, I think, on Viridor. On the landfill gas side, the improvement in the rate of decline in the gas fields, how sustainable is that? So are you going to move away from the 5% to 9% longer term that you mentioned? And then, secondly, on the cost base, the overheads, how should we think about those going into the longer term now that you're broadly through the build-out phase? Should we start to see those come down?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [25]

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This is on Viridor?

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John Musk, RBC Capital Markets, LLC, Research Division - Analyst [26]

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On Viridor, sorry.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [27]

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Okay. The gas yields, obviously, we are investing to make sure we have sustainable gas yields going forward. The 5% to 9% is the guidance we've given in the past. I'm not sure we've modified that at the moment, have we?

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [28]

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No. It's just, certainly, the investment we've made, we have seen a betterment for this first half year. So that 4% that we talked about this first half year we're pleased with given the investment we've made. But we haven't modified our kind of a longer-term predictions just yet.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [29]

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And the cost base?

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [30]

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The cost base, we saw from the slide I presented, it's a real focus area for us across the group. Obviously, the more things we make, the better it is for investors and for customers in terms the overall charges both on water and waste. We have had that 17% real reduction in overhead since '15/'16. And Viridor scenario we continue to focus on, and certainly, we'd be putting more initiatives in place to continue that trajectory.

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Fraser Andrew McLaren, BofA Merrill Lynch, Research Division - Director [31]

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It's Fraser McLaren from Merrill. Two questions, please, both on Viridor. On the Glasgow remediation, can you speak a little bit about the likelihood of recovery given the ongoing issues with Interserve? And is the GBP 64 million balance net of the GBP 25 million that you booked in the first half? Also, you refer in the statement to other recoveries that are outside your control, what are these? How material might they be? And the second question is just on medium term growth in Viridor. Could you expand, please, on your remark about ERF expansion and energy parks in terms of scale and also the timing, please?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [32]

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Yes, so thank you, Fraser. So in terms of Glasgow first, Susan might give you the -- more detail on -- in a bit. I mean, clearly, we have terminated the contract -- the arrangements with our principal contractor a little while ago and used an alternative EPC contractor and then moved into final stage of commissioning. And the contractual discussions with Interserve is what I'm sure you're talking about ongoing and there are definitions within the contract with how we would recover the moneys that are due us from Interserve. The contractual arrangements would require you to finish -- complete build out so you quantify the totality of your losses as a consequence of Interserve's actions. But clearly, we might want to try and get into some more of a negotiated settlement with Interserve if that's what they would wish to do as well. So that's currently where we are. We watched with interest how they are performing in the market and noticed their share price on those public statements and I think fairly recently they gave quite a strong statement saying that they're confident and they want to trade through their current difficulties. So we take some comfort from that. So you want to go to the precise numbers?

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [33]

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Yes, well, just in terms of the receivable that we're showing against that. So we put away a gross achievable of around GBP 72 million and then we have provided around GBP 8 million against that. And the way we've done that, we've looked at it by looking at the kind of credit default risk and we've assessed that using the kind of 1-year credit default rates that we can see publicly and we've made an assessment on the basis of that and that's how we provided. So obviously, we are watching the announcements from Interserve, but that's how we've taken that to that point, and obviously, the charge to that will go through as it has done, the ERF EBITDA line.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [34]

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So in terms of the second question, Fraser, about the prospects for further investment in ERFs, I think we've had a very strong and ambitious program to build out a fleet of -- large fleets of ERFs now and I know 1 or 2 people in this room were cautious about the deliverability of that program. So we thought we'd try and move forward and bring those facilities online and we are getting very much through that sort of execution risk now, there's only Avonmouth to bring into operation now and that's going well. And I will say, the prompt in your question, we still feel confident about the market dynamics in the residual waste market and we do feel there may be some possibilities going forward. But the way we would look at the possibilities going forward is to try and be consistent with our strategy, which is to focus on infrastructure, which are backed with long-term contracts. So once we got through this execution risk of ERFs with where we are the moment, we might take stock again and see if there's any other capacity possibilities, but it will be very localized, if you will. And indeed, that would apply to recycling as well. If we were thinking of investment in polymers, for example, which is, obviously, a positive market dynamic in terms of the direction of travel there, we would try to be looking at putting in the same investment proposition, which is to do with we've got long-term contracts to underpin that investment and that's how we would look at all of those things. I hope that answers the question. So I think Richard behind you, I think.

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Richard Alderman, [35]

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Richard Alderman, Macquarie. Can you just talk a little about gate fees. In the statements, you talked positively about landfill gate fees. Could you just quantify where you see those going? And specifically also, gate fees at ERFs for commercial waste arriving going forward. Some of your competitors have been quite specific about putting up prices in Q4 and did want to talk about putting up prices in Q4 and then repeating it in 2019.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [36]

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In ERFs?

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Richard Alderman, [37]

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In ERFs, yes. If you got any comments around that, any thoughts?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [38]

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On gate fees, I mean, we can add on more details to this and we could talk about this again all day. But as I said, landfill, as you mentioned first, as I said and Susan said as well, we're seeing, if anything, prices holding up quite well, and in the short term, we see demand for landfill being quite strong. But it is varying by geography. So it isn't a uniform picture across the country and you do need to look at this on a sort of more geographical basis whether it's a shortfall capacity. And we see that trend carrying on. And as I think I said in my remarks, that if there were a more awkward Brexit, you can well see that there'll be further residual waste looking for home in the shorter or medium term and that would obviously have an impact on volumes and prices going forward. But I think we've previously said we'd have a dynamic strategy for landfill and I guess that's basically saying we're going to just keep alive -- to be alive to this -- the sort of market dynamics side-by-side and geography-by-geography on landfill. In terms of ERFs, I think you are quite right, which is the medium term is very strong. We've tried to have a contract-backed investment. So largely, and I think we used the figure of 80% of our inputs to the ERFs are backed by contracts and that's been a deliberate policy for us. So our exposure to merchants -- so-called merchant pricing is quite low, and indeed, it's, even then, it's not as though somebody turns up with a truckload of waste on a day. These are typically 2-, 3-, 4-, 5-, 10-year contracts even then. Yes, there is a possibility that we could -- and those are longer-term, short-term contracts, and indeed, the contracts we're signing with local authorities are seeing an upward pressure rather than a downward pressure on prices. So we think that's the trend that's going to continue. Susan, you want to add to that?

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [39]

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No, it's fine, yes, yes.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [40]

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And we feel very confident about that. But it's a bit balanced between our investment proposition of having long-term contracts and capitalizing in short-term ups and downs. And some of our competitors might have a slightly different strategy to us, which is being less focused on long-term asset-backed infrastructure and contract-backed infrastructure than we do, but that's our strategy. I hope that answered the question, Richard. There's some other -- Verity right behind you. But no microphone. You can shout.

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Verity Mitchell, HSBC, Research Division - Analyst [41]

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Verity Mitchell, HSBC. Can I just take you back to your financial resources because you say you have GBP 750 million. So that's quite a lot that you could possibly spend on things. Do you think the waste strategy is going to deliver the clarity you need to think about your investment going forward? And then I've just got a second, sort of slightly related question 2. Landfill looks positive. Where are we on site closure or opening or new sales? I mean, is that -- are you really looking at that given it's looking positive?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [42]

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Yes. I mean, the financial resources, and to some extent, how we might use that or where we might use that and will we get clarity ourselves with the waste -- the Resources & Waste strategy going forward? I was just debating that with Richard, really, that it depends upon -- if we believe there's an investment proposition, polymers might be an example or further ERFs might well be an example, if we believe we can put forward a business case, which is underpinned by long-term contracts, that's something we'd be interested in doing. The TPSCo investment is the extension of our involvement in Runcorn I, was exactly that. It's fully contracted. So the risks of -- contractual risks are there, really. So it would be interesting investing in those things. But it'd be on a case-by-case basis and if we can fit this into our strategy of backing it up with long-term contracts, then we can do other things. So that was the last probably. And then the second question, I've written down landfill, but I forget what it was.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [43]

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Yes, yes -- no, no. So investing in new sites. So we invested in 4 new cells last financial year. And I think on the slides, we said we've got the ability to have at least 5 sites opened pass 2030. So we'd be looking at the conventional opportunities for those.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [44]

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Any more questions. No? Good. Well, thank you very much for joining us. As I said at the beginning, thank you for giving your time to be with us. I know there's many other things you could do with your time today, but we're very grateful for you to come to us. And as you can see, we think we've got a good half-year results -- set of results and a good strong performance and good prospects going forward.

So thanks very much, and safe journey to wherever it is you're going to next. Great. Thank you.