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Edited Transcript of PNN.L earnings conference call or presentation 30-May-19 8:00am GMT

Full Year 2019 Pennon Group PLC Earnings Presentation

London May 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Pennon Group PLC earnings conference call or presentation Thursday, May 30, 2019 at 8:00:00am 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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* 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

* Mark Freshney

Crédit Suisse AG, Research Division - Research 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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All right. Good morning, everybody. We were wondering how long the video would last. I hope you had a chance to look at it. It's a very nice video about plastics and plastics recycling. So welcome, everybody and welcome to the presentation of Pennon's full year results for 2018/'19. And thank you very much, everybody, for joining. I know you've got plenty of things to do with your time, so thanks very much for giving your time. We're very, very grateful.

So we'll follow the usual format. This presentation will be shared between Susan and myself, and then we'll hand over to questions from yourselves. I'm sure there'll be many, many questions. And then I'll -- and that -- follow the questions and answers.

So I'll start with an overview of the high-level messages and some of the key things in the results; hand over to Susan, who will go through the financial results and, of course, some key metrics in more detail. Then I'll come back and talk about some more operational and some highlights of what has been a very good and very strong year for both South West Water and Viridor, but I'll particularly focus on the next stage of Viridor's development. And what I'm feeling quite excited about is a new investment in a plastics recycling facility at Avonmouth, but more of that later.

So without further ado, we'll go straight into the disclaimer. And I'll trust you all read that at your leisure and ask questions in the Q&A at the end. So I'll start with, as I say, the overview.

So I think you can see, and those of you who've seen the results so far, that these are a strong set of results, a very strong set of results right across the board, but I've said many, many times that for a company like Pennon and just to repeat, for a company like Pennon which is delivering these essential services to the local communities that we support, water and waste management services, it's not good enough just to deliver good or strong results. They have to be delivered in the appropriate way, in the right way. And I'm very pleased to say -- and I'll give some examples in a moment about how we've delivered the strong results in a responsible and sustainable way and continuing to understand their obligations to the communities that we serve.

So we've got very positive momentum in the results. You've seen year-on-year growth there. And albeit there's many positive developments right across the board, but the strong momentum in the results is really particularly driven by a strong performance from Viridor and in particular the ERF portfolio coming online during the year. And as you know, 3 plants came online during the year. So that's really driving that underlying strong momentum and strong growth in Pennon's results.

So just picking up some highlights from both parts of the business.

Viridor first. We're continuing to focus on a derisked infrastructure model that we call it. So assets backed by long-term index-linked contracts, so an investment thesis not a million miles away from the water franchise as well. We've seen in the course of this year that, the ERF portfolio, we've gone through a successful, very largely finished and successful buildout phase. And now, as I say, we're into an operational phase. I'm very pleased to see that we're getting good operational availabilities from our ERF portfolio in excess of 90% availability again in this year.

As we said at the Capital Markets Day, which was in January, which many of you may have attended, that we've got long-term confidence in the long-term market outlook for Viridor. And we think they -- that there are a number of growth opportunities, developmental opportunities in the waste management space here in the U.K., and Viridor is well placed to capitalize on those. And as I say, we're announcing today a brand-new facility, a plastics recycling facility which will be very large, probably the largest multi-stream recycling facility in the U.K. And we're announcing that investment today, and I'll go through that in a bit more detail.

South West Water has also been strong. It's been a good, strong year, probably an outstanding year in many ways because we've been fast tracked by the industry regulator Ofwat again for a successive price review. So that's 2 price reviews in a row, the only company to achieve that. And we're continuing our sector leadership in the water business; many, many measures for that but most particularly, in terms of outperformance, the return on regulated equities, a measure how well or how otherwise you're delivering against your regulatory settlement. Strong continuing momentum there through our return on regulated equities at 11.8% cumulatively, 11.6% in the year, easily standout compared to the rest of the sector.

As you know, we've been tested by extreme weather events. So the hottest, driest summer on record in our part of the world; and also the Beast from the East freeze/thaw events and very pleased to say that our operations held up in a very resilient way. And I'll talk about that in a little bit more detail as well, but tested to the extreme but we've resisted that. But if there's one message I wanted to leave you with in terms of South West Water really as an overview is we're performing very, very well in this 5-year period, but we're very confident about maintaining that performance into the next 5-year period as well. And we're confident that we'll be able to deliver it in all 3 areas, so financing, totex and ODIs. So I'll talk about that in more detail, but that's a takeaway message now that we've got the draft determination.

So really just to conclude with overview, high-level messages. That growth driven particularly by ERF rather than the water business but ERF and Viridor is meaning that we've got a sustainable, attractive dividend into the future. And we're very confident about that as well.

So that's some big, high-level messages. Just to give you a little bit more flavor and color on how we're delivering the results and the way we're delivering results, but what I'll say, it's not just about delivering those strong results. We live to the values that we've espoused for ourselves to be trusted, collaborative, progressive and responsible. And we believe we are operating that way, and we believe that those core values are embedded throughout the organization and completely integral into the whole of our operations. And you can't just take our word from that but there's a whole range of independent accreditations that will certify to that. And we put a few of the logos up there but most notably the Fair Tax Mark. So we've been assessed. And I think we -- well, we are the first in the sector to achieve the fair tax accreditation, to say that we're paying our taxes in a responsible way. And we're first in the sector to do that, as I say. And a whole range of other ones there as well.

So I think it's fair to say and we feel very strongly that we are a leading, responsible and sustainable U.K. water and waste operator. And as I say, we've got good results and a good platform for future development.

So with those overview messages, I'll hand over to Susan. I will not switch off the machine for you.

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

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Thank you. Okay, good morning, everybody.

So a strong set of results for Pennon for 2018/'19, key indicators of performance all increasing year-on-year. So underlying EBITDA up 7.2%, earnings per share on an underlying basis and statutory basis up 13.6% and 6.5%. And as Chris said, that's really reflecting the buildout and growth coming through from Viridor and also the sustained good performance from South West Water as it is delivering year-on-year. So real focus on effective operations and cost control as well as efficient financing. In terms of the balance sheet, good, robust cash inflows; strong liquidity which we've put in place, certainly, as was, ahead of Brexit. And we've got a sound balance sheet and, you can see there, with an effective interest rate of 3.6% which is slightly lower than it was last year.

So all those financial metrics really go to underpin our sector-leading dividend policy of growing the dividend by 4% above RPI, March RPI it is. And the dividend per share for 2018/'19 is up some 6.4%.

So looking at the Pennon financial performance in some more detail, the underlying results.

As I said, in terms of the growth momentum, you can see that coming through in the EBITDA. So really strong performance across the group with that EBITDA going up by the 7.2%. Obviously, we're a growing business, so as you might imagine, given the investments that we're making, depreciation and amortization in absolute terms is increasing, reflecting that growing asset base and how that's been depreciated through the revenue statement. And the interest cost in absolute terms is again increasing, again reflecting the investments that we're making, but as I said, the effective interest rate is efficient and slightly lower than it was last year.

Our share of JV profit after tax, good performance reflecting the ERFs that we have in joint venture with Runcorn I and with Lakeside, again a good performance year-on-year; and reflecting, in December '18, the fact that we increased our holding in Runcorn I as well.

So overall, on an underlying basis, PBT is up some 8.3%.

So moving to statutory results. As is usual, we've excluded a small number of items to give a better representative view of our underlying performance. There are 3 of those for this year, which I'll cover off in some more detail in a moment, but the sizable one is the Interserve provision that we've increased during the year. And we now are holding a provision reflecting their credit quality. We're now holding that provision against the GBP 72 million that's due to us.

So in terms of our statutory results, based on a before-tax and after-tax basis, fairly consistent year-on-year and earnings per share increasing both on an underlying and statutory basis, again reflecting our efficient financing. We moved our hybrid, our GBP 300 million hybrid, from a 6.75% to a 2.875% rate; and the benefits of that obviously coming through in the EPS line.

So moving on to take a closer look at the subsidiaries and looking at their performance in a little bit more detail and starting first with Viridor.

As Chris said, a really strong set of results for Viridor for 2018/'19. And that benefit of the buildout of the ERF portfolio; and the 3 ERFs that have come onstream, we've got Beddington, Dunbar and Glasgow, those 3 new ERFs, contributing to the profitability for this period. In addition to that, it's worth noting that, for those ERFs that have been operational for some time, there's a good, strong performance from those year-on-year as well. And on a like-for-like basis, the contribution from those has increased in addition. So looking at the ERFs, you can see there we've got a 25.1% increase year-on-year.

So in terms of residual waste, moving from ERFs to landfill. We've said for some time that there was undercapacity in the U.K. for dealing with residual waste. And on the landfill side we have said, certainly our Capital Markets Day earlier this year, that we anticipate, forecasting 6 sites remaining open to waste arisings given the demand that we have and the volumes that we still see coming through. So volumes year-on-year are pretty much stable in terms of the profitability, just a slight change there just reflecting some of the mix of the volumes that we're getting into the landfill sites, but volumes are holding up. And whilst we've closed 2 landfill sites in the year, we had invested in new cells on our open landfill sites. That's how we can manage those volumes that are still coming through.

Now for the landfill gas, it's all about the efficiency of those assets that we have; and the ability to make sure, whilst naturally yields decline year-on-year, that we're managing that yield decline. And in fact, on the landfill gas side, the yields that we've had, there's around about 4%, 5% reduction this year. It's one of the lowest yield reductions we've had for some time, and that really reflects the investment that we've been making.

On the recycling side, very much delivering what we said we were going to do. We guided to EBITDA this year being very similar to last year, and it is despite the fact we've had lower volumes in terms of recyclate sales because our focus is on ensuring we've got high-quality product and, when we've got high-quality product, getting the higher price. And our margin has actually improved slightly this year. So despite the volumes being lower in terms of our recyclate sales, the profitability is very much the same.

Now for the group we focus on costs, and for Viridor we are focusing on the cost base. And our indirect costs in absolute terms have decreased year-on-year, really reflecting some of the efficiencies and the initiatives that we've been delivering. And actually, from 2015/'16, we've had 17% reduction in real costs, for those indirect costs for Viridor. So overall a very strong performance for Viridor financially. In terms of the capital expenditure, I will touch on a little bit more detail in a moment but that capital expenditure really reflecting the buildout of the ERF program.

So I'm turning to South West Water and the results for South West Water for 2018/'19. This is the '18/'19 is the penultimate year of this regulatory delivery period out to 2020; and a good, strong set of results for South West Water really delivering against the business plan and outperforming the business plan period-on-period. In terms of revenues, they're slightly up, really reflecting not just the tariff increase that we've had but also the fact that we had a summer where we had significant demand and volumes are up compared to the prior year.

Moving on to the cost base. Now in terms of our bills, whilst we can see a slight increase in demand and a slight increase in tariffs, as Chris said at the beginning, our bills are lower than they were 10 years ago. And the reason we can keep our bills low is because we're really focusing on the cost base and outperforming the cost base allowances that come through into the determination. And again focusing on that efficiency despite the fact we've had GBP 5 million of costs reflecting the operational costs that we've had to fulfill supply/demand in the summer and replenishing those water resources, our overall costs have risen, but they are below the average inflation rates. So that really is a reflection of the efficiencies that we are delivering.

And one of the areas that we've been focusing on for this regulatory period out to 2020 has been our cost to serve in terms of our customers and making sure that our bad debt costs are as low as they can be. And you can see there, as a proportion of revenue, they're 0.4% of revenue. And that's actually fallen from where we ended the last regulatory period in '14/'15 at 1.7% of revenues. You can see there's been a real focus there from the teams and that cost base has come down. So overall a good set of results for South West Water, the expenditure really just following the regulatory outputs that we said we were going to deliver.

And the return on regulated equity, as Chris said at the beginning, a good set of results, cumulatively 11.8% year-on-year performing. And there are 2 measures there. And I know I've said before we calculated it slightly differently ahead of Ofwat determining their methodology, but on either measure you can see that we are sector leading at -- for the water sector.

So as I said, really important to make sure we're focusing on the cost base and efficiencies. And this slide

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about GBP 27 million that we thought we would benefit from in terms of having that merger. And I'm pleased to report today that we have secured those efficiencies that we thought we would do.

And in terms of our group position, we also had an initiative where we are looking at costs across the group, both at Viridor and South West Water. And we identified around GBP 17 million that we said we would deliver, and again I'm pleased to report today that we have delivered those and are on track with our efficiency program.

So just going back to looking at the underlying results. And I said there were 3 items on the non-underlying chart that I would take you through. On our profit before tax, the charge of GBP 19.9 million for this year, the 3 items: the first one is something that we've pulled out for a number of periods now. So as you know, for Pennon we have a predominance of floating-rate debt in place. And we use derivatives to commercially hedge that interest rate volatility, short-term derivatives which are hedge accounted for. There is, however, one instrument, a 2040 bond in South West Water; and there is a small number of long-dated derivatives that sit over that bond. And the fluctuation for those, we take through into non-underlying items, and for this year, there was a credit of GBP 5.8 million.

The second item is guaranteed minimum pension equalization. So as a U.K. company that's affected by the court ruling for Lloyds, those companies that are affected, obviously we've had to review the costs for us. And it's a past service cost of around about GBP 3 million. So again, we've pulled that out into non-underlying. And lastly, in terms of the Interserve position. So as you know, we provided last year-end around about GBP 6 million, noting that Interserve was obviously going through some credit issues. And we were watching from a market perspective to see what that looked like to allow us to consider whether we needed to provide against the debt that's due to us GBP 72 million. We've been watching that for the last 12 months. We know obviously Interserve Plc went into a pre-pack administration. And reflecting those credit issues, we have looked at available market information and further increased our provision, just reflecting that credit risk. And if it's worth saying, though, that obviously in terms of what we are pursuing is what's due to us, which is the GBP 72 million gross.

So just moving on to corporation tax. And Chris mentioned at the beginning the fact that we've been accredited with a Fair Tax Mark. I think, first, in terms of our position on tax, you can see there on the right-hand side of the slide -- I'll talk about corporation tax in a minute, but in terms of our total tax contribution, this is on GBP 281 million. So this is about how we responsibly look after the taxes that we bear and collect for HMRC. And we went through the accreditation. We did a lot of work on our tax strategy, and we issued that and refreshed it again this year. And in doing that, we consult with our customers to get their views on what they think a responsible business should be doing in this area and reflect those in our tax strategy. So that's one of the reasons why we got the Fair Tax Mark accreditation is our transparency in this area and the fact that we are reflecting our customer views.

So moving from the overall taxes that we paid to those affect the results in terms of the corporation tax. You can see from the box on the right-hand side, in terms of our current year tax, our effective rate is very similar to last year and is lower than the U.K. headline rate of 19%. That just really reflects the fact that we are investing significantly across the group. And it's the way the tax system incentivizes businesses to invest.

So talking about that investment. The chart on the left-hand side just shows you the profile of investment for both Viridor and South West Water that we've had since '15/'16. And '19/'20 is straighted out because that is a view on where we are focused for that year, obviously not delivered yet. And overall, the CapEx is slightly lower than last year but still significantly investing in the asset base both for Viridor and for South West Water; and on the water side, very much focused on the new innovative technology with the Mayflower water treatment works that's in commissioning and the network resilience improvements again to improve our performance, certainly around pollution incidents. And on the Viridor side it's all about our ERF program and the delivery of the three that came onstream for '18/'19 and construction of Avonmouth.

So looking at Viridor and that growth CapEx in a little bit more detail. So whilst that's the overall CapEx on the last slide, this slide really just picks out the growth CapEx and reflects the investment that we've been making in Viridor over the recent years. And it also reflects the committed growth projects that the Board has signed off that we're delivering on for Viridor.

So 2 things to say. First is, in terms of the growth CapEx profile, you can see there obviously significant investments in the ERF portfolio. There's still some more with Avonmouth; and then with the announcement that Chris talked about today, the new plastics recycling facility in Avonmouth as well, which is due to come onstream. And on the right-hand side, I'm just showing there the charts of PBT, EBITDA and adjusted EBITDA over the same periods. And you can see there that the profitability has more than doubled in the period '14/'15 to '18/'19. I'm not making a forecast for where that's going to go, but you can see there we've got the committed investment. And you would anticipate that, that investment is obviously going to again grow the earnings going forwards.

On the South West Water side, given we've had our draft determination, I thought it's worthwhile putting up the chart around RCV. So that covers the period both for the regulatory period we're in now to 2020 but also the next one to 2025, and you can see there the nominal growth in K7 is 10% and about 28% over the 10 years. Now the interesting thing to note there, whilst you can see some RCV growth, is obviously the methodology changed in K6. And this is the same for K7, where it's not just about how you're investing in your base but also how efficiently you're doing that. And the methodology obviously seeks to incentivize companies to outperform their totex allowance, i.e., spend less than the allowance. And that is obviously returns to investors in the RORE numbers that Chris and I spoke about earlier.

So we've talked about the profitably, we've talked about the investment. And what does the cash flows and balance sheet look like?

In terms of our cash flows, obviously you can see the robust cash inflows from operations on the left; and then a significant investment that I've just been talking about on the right both for the capital expenditure, but also there's a GBP 54.8 million in there for the extra holding in Runcorn I that we completed in December '18. And then you've got cash flows reflecting contributions to the pension scheme; as well as taxes and payments to providers of finance, be it interests and/or dividends.

And that balance sheet, just a couple of things to say on there. The financing approach, diversified funding mix. And that is our strategy. That's something that we continue with. We're aiming for longer maturity perhaps compared to some of our peers, just really for us reflecting what we think the asset base is doing there. And on the South West Water side, our index linking is around about 25%, broadly similar to Ofwat's notional position. It is RPI linked. We are looking at the RPI-to-CPIH transition but noting that there is no question mark as to how those indices will converge, obviously monitoring that. And when we feel the need -- we've got headroom at the moment. When we feel the need to do that, then obviously, yes, we will look at perhaps issuing CPIH.

In terms of the gearing, pretty stable year-on-year. And the key thing, given our investment that we've been making, our headroom for investment is some -- at GBP 725 million and so when we're talking about these growth projects and obviously we've got headroom to invest in those projects. And once again, I know many of you in the room help us with our financing, and thank you for your continued support.

In terms of the financing we've been actively undertaking this year. Chris touched on this sustainable financing framework that we've got in place, and that is going very well for us. We have secured GBP 830 million during 2018/'19. As I said, given where Brexit was going, we want to make sure we have liquidity given the investments that we're making. And the sustainably -- sustainability-linked financing has gone very well for us with just over GBP 600 million that we have raised through that framework. And what that does, given the nature of the business that we are, is really link effectively what we pay on those -- what we pay on that debt with our performance on the environmental side, linking either to our ESG performance or our sustainability KPIs for South West Water.

Now in terms of South West Water, we do have predominance of floating-rate debt and that we fix going into a regulatory period. At the top of this chart, you can see the finance costs for '18/'19 and the interest rates for '18/'19 both at a group and a South West Water level. One of the things we have been doing is looking at our hedging for the next regulatory period that starts in 2020, and we have hedged over 50% of the South West Water floating-rate net debt for that period. Now the chart on the right-hand side shows you there are some red rings around the chart. It shows you when we have been hedging, so that just gives you an indication of the rates at the point of which we were doing that hedging in the market.

So finally and given our robust results and strong results that we've had and obviously in terms of our dividend policy, we are announcing that we are increasing our dividend for '18/'19 by 6.4%, reflecting that policy of 4% above the March RPI, very much supported by good, strong performance in South West Water but actually the kind of growth kicker that we're getting coming through from Viridor. And for those investors we know like the dividend reinvestment plan, that will be available again this year.

And with that, I'll hand back over to Chris.

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

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Yes. Thank you. Excellent.

So as I said, I'll go through the operational results Viridor and South West Water in a little bit more detail, put a little bit more color onto it but particularly focus this time on Viridor and the next stage of -- phase of Viridor's development and the plastics recycling investment.

So just to recap. I mean strong results. We've said that several times, but this gives us a platform for future development and future growth. And just to recap and just to highlight that over the years I think it's fair to say that Viridor has emerged -- evolved and modified its operations in accordance with shifts in the market trends but also shifts in government policy. I think we've been very successful in doing that. We've had early-mover advantages in many fields, but obviously we moved into recycling. We moved into Energy from Waste and executed those programs very well. And we do see a confidence in the market outlook. And we do see opportunities opening up and another shift in the shape of the industry going forward. And I'll say it's driven by the government's resources and waste management strategy, which obviously we work very hard with to try and influence and anticipate what it was going to say. And our strategy is completely and absolutely aligned to that strategy.

The Blue Planet effect is probably giving plastics and plastics recycling a bit of a boost. And we use the word "fast track" there, so fast-track investment in that. And of course, that stimulated the government strategy as well, but we continue to see the fundamentals for residual waste, ERF and residual waste management strong. And as Susan has already mentioned and I'll say a few more words on, landfill continues to be a feature in the U.K. waste management scene. But whatever we say about the growth prospects, whatever -- however we focus, we will continue to focus on that derisked infrastructure model. So assets backed by and investments backed by long-term index-linked contracts to give certainty to our revenues and certainty to our sort of returns going forward.

So just to focus on the existing portfolio, first, before I go back to the growth opportunities. So often asked how's our investment in ERFs comparing to our base returns and our base assumption when we committed to building these facilities. The chart on the right gives you the 2 bar charts built up by plant. So the individual colors are the individual plants last year and then going on to the current or the year just gone by. And as you can see, across the whole portfolio, the yellow at the top is the outperformance on the whole portfolio against the original investment portfolio that we made at the time of committing.

As you can see, the margins, EBITDA margins, are very attractive. And we've got a high availability, I mentioned before, across the whole fleet now because, as we move into operations, one of the key determinants for us is how well and how available these plants are running, how available and how well they're running. And we got for the third consecutive year in excess of 90% plant availability, which is very good. And we have been able to benchmark against the industry, I think. I definitely look at analysis of this sort of thing, but top-quartile availability in the industry. So the existing portfolio is performing well against the original investment decisions.

This is just a reprise of the chart we've shown many, many times. So this is looking at the supply/demand for residual waste. So the -- obviously the blue blocks are the capacity from people other than ourselves which is anticipated and forecast. The gray in the middle is our facilities coming onstream, and the green is the gap where there's a shortfall in capacity of handling the residual waste. Now we've updated this chart and it's consistently what's in the government strategy. And the 2 dotted lines there: the top dotted line, the solid dotted line, if you will, is from the government's assessment of if nothing happens, so if there's no change of policy. Then the smaller dotted lines going downwards is if the government strategy and moving waste into more recycling is successful, but what you can see is there is still a shortfall. And the government's assessment and our assessment is there's a capacity gap going forward right through until 2035 of 7 million tonnes, I think it is.

So you've shown -- seen a chart like this several times before. So what is the growth from business as usual? This isn't the longer-term growth and new investments. So you've seen a chart like this before; and on the left-hand side, the EBITDA contribution of very nearly GBP 200 million, GBP 198.9 million, built up over the share of the joint ventures and the interest receivable. This is a slide -- I recall we used to show a chart like this with a GBP 100 million target. And I think it's fair to say -- but nobody in this room, I'm sure, is somewhat skeptical about whether we'd get to the GBP 100 million target successfully. Well, that seems like a long time ago now because we're now looking at GBP 200 million EBITDA from the portfolio and opportunities to have incremental business-as-usual growth.

So Glasgow is the first block, which we'll build this up to 2020/'21 to a higher EBITDA for the whole portfolio. We've invested in upgrading the facilities. As we were finishing commissioning, we upgraded facilities and, I think, increasing capacity by 50,000 tonnes there on that plant. Susan has already mentioned the investment that we made in getting a larger share of the Runcorn I investment and the acquisition that we've talked about. And of course, the 3 facilities, Avonmouth -- not including Avonmouth -- Beddington, Dunbar and Glasgow, they are still ramping up into full production, so as we go through to the coming years, they will make a greater contribution. And Avonmouth is progressing well and that will add to the overall business-as-usual growth, if you will.

Just a word on Avonmouth while I'm there is that we've now secured a new contract. I think this is the first time we've talked about it, a new contract for Avonmouth, 120,000 tonnes per annum from the West of England Partnership. So we're now 85% contracted for Avonmouth before we go into operation, probably more actually but long-term commitment of 85%. And these incremental growths, we're targeting about 3% to 5% improvement across the whole portfolio from things like planning extensions and engineering modifications, which I've just been talking about. So that's the business-as-usual growth.

Just a word on landfill. And I think Susan has covered most of these points really, but we're still about optimizing value from landfill. We're still seeing a market demand for landfill. We have sold -- or agreed to sell another one of the closed sites to a third party who will use it for alternative means. And that will mitigate that long-term sort of liability that obviously have aftercare provisioning and so forth. So that's something new as well. Demand continues to be strong, as we say, so we will be opening new cells, as Susan mentioned, when they're commercially viable. 2 further plant closures and 1 reopening actually in '19/'20 down in the South West. So we will be looking at opportunities. And it's continuing to have a place in waste management, albeit declining.

So moving on to further development. So that was business-as-usual things. Moving on to further growth opportunities, and this is really a reprise of the Capital Markets Day for those of you who were there. So breaking it down to 3 sections. We said we were developing opportunities and options for new -- 3 new ERFs. So nowhere near the commitment stage yet. We will be focusing on our infrastructure model, so looking for anchor contracts and looking for geographical areas which are more attractive. And as you can see, population growth and waste demand is increasing in the South and East, which is not a surprise to anyone. So that will be the areas that we're refocusing on most particularly. So that's work in progress, but as I said, if we do progress any, it will be against our infrastructure model.

I've talked about developing the energy parks, and I'll talk about that in a moment. I think it's on the next slide or the next one, I can't remember. Next slide, energy parks. And there are a lot of opportunity, a dedicated team of people looking at and capitalizing those opportunities as well. And plastics, announcing a new plastics facility, plastics recycling facility, today. The policy and the forecast do support more opportunities, and we are actively investigating and developing options for possibly another 2 of those as well. And as I say, if we can develop those and locate those with our Energy from Waste plants or ERF facilities, it gives you a decided cost advantage because you cut out the grid costs and so forth.

So energy parks was the next slide. So looking at energy parks and how we're developing those. And I'll say, if you can see on the chart, it's not that clear too, but the orange dots and the blue dots are where we've got either energy park potential -- energy park developments actually happening or we've got very close near potential. And the green ones, where there's potential but on a little bit further timescale away. So we've given you some examples, not all of the examples there. So Dunbar, for example, there's a landfill there at the moment. We've had a private wire connection to the Tarmac cement works nearby for some years. As the ERF comes online, we'll look at strengthening and seeking further commercial opportunities. Runcorn was always dealt with heat and power to Inovyn in the adjacent chemical works, as you know. Beddington is very interesting. Beddington, we've signed a district heating system for the Sutton local community there. So that's piping heat into local housing development nearby. And we're also quite excited that we're developing an opportunity with a data center. And it's actually a large, very large, data center to co-locate with, which as you know are very heavy users of energy, so that will be a great opportunity for us as well.

So -- and Peterborough and Exeter is interesting because there's a private wire to connect the ERF to our sewage works, so South West Water sewage work. So again giving a cost advantage to both parts of the business. So that's our largest sewage works -- sewage treatment works in Peterborough and Exeter. Obviously, Avonmouth, we're going to talk about, and so forth, but I think the thing about this is there's lots of opportunities. And as I say, we've got a dedicated team now focusing on these but with a really modest capital involvement. We can increase profitability site by site by something like 5% or 10% for really modest capital requirements and sometimes no capital requirement. So for example, the data center may well be no capital requirements from us.

So moving on to recycling and moving on to the area I've been teasing with all the way through. So here is some of the sort of market dynamics. Obviously, I've talked about the government strategy underpinning that. I won't reprise all of the things that are in the government strategy to stimulate and encourage more recycling, recycling of plastics in particular, but responsibility is putting -- put onto the packaging manufacturers to make sure that they can -- the products they're using can be recycled. And there'll be a tax if they don't have it done properly and so and so forth. And what we've seen is that, ahead of that legislation and sometimes proposed legislation, ahead of that, the big brand leaders, the Unilevers of this world for example, are moving early for various reasons and they made public declarations. And you can see the business driver for them. So they're moving very, very early.

So on the right-hand side you see about 46% of plastics packaging is currently recycled in this country, but the strategy requires that to go up to 75%. I don't know. Well, that is a 60% growth or something like that. We currently have -- about 1 million tonnes of plastic is collected in the U.K., but 2/3 of it goes overseas. And you've seen more and more pressure about markets overseas finding it difficult to receive or actually indeed banning it. So you can see there's a clear market dynamic driven by government strategy, driven by the Blue Planet effect, driven by the tightening of export markets. There's a clear market opportunity here.

So this is what we're proposing. And we're building an 80,000-tonne plant, which represents about 80% -- 8% of the current market requirements. And as I say, that's due to be about 60% or so, but this is a very large facility. Here's an artist impression at the bottom. I don't know if you can see it, but at the back is the ERF in Avonmouth and at the front is the plastics recycling facility and the (inaudible) to the left-hand side there.

So what typically happens is, as you probably know, waste is collected for recycling. It might be mixed paper, plastic and glass and so forth; typically goes to a materials recycling facility, a primary MRF as we might call it, Crayford being an excellent example. You've seen bundles of waste, pails of wastes, plastic waste, which may well good off to export, well, they'll come to this facility now, and we'll segregate it out into 3 multi-streams, HDPE, polypropylene and PET. And we'll be able to handle it. And this will take the process a little bit further than the facilities we currently have. So you've seen the flakes of plastic. This will take -- this will process further. So we've got little beads, which is that picture at the top there, so that it can go straight into direct manufacturing.

And so just to give you a sense of scale. I think it's the largest multi-stream plastics recycling facility, or it will be in the U.K. It's about 4 times the size of our Skelmersdale plant, for example. So it will be co-located at Avonmouth, as I said. That picture shows it. And it will give you -- the energy park concept will give you the significant cost advantage. So GBP 65 million investment. And we've deliberately tried to change the model for recycling so it does fit our derisked infrastructure model, so it will be backed by long-term contracts. You can see that we've set ourselves a business case of 7 years, which is quite short as you can imagine, but we think the plant will last a lot longer than that. We'll be signing up contracts against that 7-year business case model. Already -- before we've even formally announced, before we've even sort of started to dig any holes in the ground almost, we've already secured 3/4 of the inputs, at least 3/4 of the inputs; and half of the plastic offtake, so the selling of the beads onwards. And IRR, very attractive IRR hurdle rate is 15% to achieving, and a payback of 4 years.

So let's say that's a significant development and it's changing the model. And it does fit the infrastructure model very, very well. And that's what we're very pleased and excited to be announcing today.

So that was the Viridor story. So good, strong results; ERFs performing well; good growth prospects; and announcing the plastics recycling facility today at Avonmouth.

So moving on to South West Water.

I mentioned that it was a tough operational year for us; resilience to weather extremes and so we got the hottest, driest on record in the summer; the Beast from the East, the significant, fast and rapid freeze/thaw, which tested us to our limits, but very pleased to say that we came through all of that. This has been our 22nd consecutive year without any water restrictions, met our leakage targets. Always there's a challenging dry -- hot, dry summers and freeze/thaw conditions. We met our leakage targets again this year, so that's every single year since leakage targets have been met. And supply interruptions, also a challenge during extreme weather events, our lowest-ever level.

So I just wanted to say a word about customer service because I know I've talked to you in the past that our SIM or service incentive mechanism hasn't always been our strongest suit. And if you look at the chart at the bottom, you can see the gray bars there, the industry average. Bournemouth was always sort of top of the pile but South West Water wasn't, but we've now, with a lot of hard work, got ourselves to be top or ranked second in the industry for quality of service. And both companies now are achieving a SIM score of 88 -- but we can't read on that -- 88.

So great achievement and a great focus and a great effort by everybody hand-in-hand with that recovery that Susan was talking about. So customer service is going very, very well in South West Water.

I won't dwell on this too much, just to say we continue to be the sector-leading company. Susan and I have talked about the cumulative 11.8%. You can see it's 11.6%. The bar chart gives you the mix and where it's coming from: totex, ODIs and the financing outperformance -- outperforming in each of the area. Gives us a very strong foundation for the next -- in the coming 5 years. The chart on the bottom there is about our debt levels or average interest rate, in the dark blue, level down on the bottom there, compared to the industry average. And consistently below industry average, as you probably know very well.

So looking into the next period. As I said in the opening remarks, the only thing I wanted to give you with is a sense of confidence that we know where we are and we're confident of being able to continue that outperformance into the coming 5-year period. It's a bit vague. But the top chart on the left-hand side there shows the RORE of leading companies. So more companies to the left there which are performing much more weakly than that, but as you can see, we're standout in terms of our RORE performance compared to our peers. And on the right-hand side is Ofwat's assessment of the potential for outperformance from the fast-track companies, the ones that got the draft determinations. And you can see our potential for outperformance is the biggest of the 3 that got their resettlements so far.

So we're confident about continuing to outperform against the 3 elements. So totex, it's interesting to observe, and that's what the bottom chart is talking about. We're all having to close the gap in terms of our totex allowance to get into the next price review. We've got an efficiency challenge to get there. We've actually been given more in terms of in like-for-like than we were in the current run rate. So we were already achieving what we need to achieve for the current business plan, so therefore we're confident about continuing outperformance into the next 5-year period. We've talked about financing and we've got to secure a base in place; and that, that should continue going forward. And ODIs, ODIs have changed a little bit in the coming 5 years. So there's a mixture of what's called common performance standards. So these are ones that are set by Ofwat and mandated for the whole industry. And then there's a mixture of those and also ones that are bespoke to the company. And those are designed and sort of set by the companies themselves and, to meet the customer prejudices and preferences in their area.

So in terms of the common ones, the point I wanted to leave you with is already we're rather upper quartile, above average on 2/3 of the common ones already before we even start the 5-year period. So we think we have a good platform for that.

This is just an assessment of where the target areas are for reward and indeed potentially some penalties. So the bespoke ones or company specific, bathing waters for example. So GBP 68 million potential reward. The common ones, GBP 74 million potential reward and those are the areas where we are currently outperforming, as I say. And the area of focus, like we did last time. We had SIM down there last time, for example, and that moved up to neutral and positive places where we are now. So those just give you a shape of this.

I won't spend too much time on this, just that the business plan was approved. As I say, setting the standards -- standard for the industry to meet. That's quite a quote, as I say. That's quite a quote from the regulator. Our bills are lower, will be lower in 2025 in cash terms than they were in 2010. That's quite a thing as well. So lower in cash terms. Obviously, our pledge to eliminate water poverty by 2025 is quite a pledge as well.

Upstream thinking project. So this is our catchment management schemes, so that comes way beyond pilot schemes now. That is 80% of our catchments will be affected by these catchment management schemes. And as I say, we won't talk about it again today, but our unique WaterShare mechanism, making sure that we share the benefits between our shareholders and our customers in a fair way if there is any outperformance and aligning their interests between shareholders and customers by giving customers the opportunity to have a share and a say -- a stake and a say in our business.

So one thing I just wanted to leave you with on this slide is that we're ready for the fast start. We're going to make a fast start. So all the -- for the next period. So all the key partnerships are already in place and have been in for a while actually. So it's not just capital delivery projects. It's the operational partners, indeed The Wildlife Trusts and so forth. So they're already in place and ready to go.

So a good position; a good, solid performance. We're pleased with the fast track status. And South West Water is in good shape for the next review.

So just to conclude and before I hand over to questions. We're delivering strong results, delivering in the right way growth. And the growth from Viridor is driving a sustainable and attractive dividend going forward into the future.

So now over to you for questions. Thank you very much. And if you do have questions, if we could ask you to just restrict yourself to a couple and come back later if you've got any more so that everyone has a chance.

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Questions and Answers

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

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So Mark, please? Yes.

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Mark Freshney, Crédit Suisse AG, Research Division - Research Analyst [2]

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Mark Freshney from Crédit Suisse. I have 2 questions. Firstly, on the opposition party's strategy of nationalization. Clearly, that must be at the top of your risk registers when you have your Board meetings right now. What measures are you considering taking to protect value in the event that policies followed through? I think it's fair to say the industry is looking at things like splitting businesses. Or for example, would you look at IPO-ing Viridor separately to protect value and using overseas holding companies? So can you go through some of the measures you may take? And secondly, there's been a little bit of negative press on dumping overseas following China stopping its imports of waste. Untreated waste has gone to other areas. So can you talk about the controls you have in place to check -- to ensure that your agents aren't taking those measures?

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

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Sure. Thanks very much, Mark. So nationalization. As you say, we're fully aware of the political debate. And I don't think you can predict the political situation any better than I can really. I don't think any of us really know, but we're very aware of them, very mindful of that. But I think what the thing I would say and I think I do say internally within the company, we can spend a lot of time, a lot of energy, a lot of our effort and devote ourself worrying about things which may or may not happen, scenarios that may or may not happen, but the thing we should need to focus on very clearly is what's -- delivering good service and good outcomes for our customers and the communities we serve. And that's absolutely what we should focus on. You talk about the potential for splitting the organization, Viridor and South West Water. Well, our answer to that is what it always is. We review that regularly, but of course we -- at least once a year, formulate and see whether it's in the long-term interest of our shareholders, to create value by doing that. And that assessment continues to be alive and we will continue to look at that going forward. So I think we just need to focus on delivering good results for our customers and our -- the communities we serve, and that's what we focus on.

So in terms of waste dumping. Yes, there has been a bit of publicity about that. And I think we, like everybody else, have been following that quite carefully. We have -- obviously, I think, the whole industry has been talking about waste crime and making representations to the government and making sure that the waste strategy -- the resources and waste strategies that came out seriously and effectively address that. And it seems clear from -- and the environment agency has a regulatory role, I believe, in this regard. It seems very clear to me that there are some sensible material -- responsible operators desperately trying to avoid waste crime or inappropriate transfer of waste out of the country which is not being recycled which should be. And then there are some people on the margins who don't operate in the same responsible way. And I think the responsible part of the sector is absolutely focused on trying to eliminate this, has very effective control mechanisms in place and take a very dim view. And frankly, that's why we're investing in a polymers -- our plastics recycling facility. Because as I say, it's become tighter, become more sensitive for some of the overseas countries to receive waste, so -- or recycled waste. So the government policy is definitely to have more of this processed here in the U.K., and that's what our investment is all about. Yes, please go ahead, Iain, yes.

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

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Iain Turner from Exane. Let's ask a couple of timetabling questions. Just how you see the Interserve case going and the timetable for that? And then the new ERFs, when do you think that might -- you might have an announcement or more details on that, please?

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

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Do you take first one?

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

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Yes. So in terms of the Interserve position, obviously, let's focus on the fact that we've got the Glasgow asset up operating well and performing as it is. Obviously, in terms of that legal case and how we're going to progress that, obviously we've been in dialogue with Interserve. And we are now -- we've got a completion account and we are in progress with that process, but that will take some time inevitably.

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

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ERFs. Well, as you can imagine, the planning and the approvals process and (inaudible) process is quite significant. And I think you've known that we're developing that portfolio. We heard, at the moment, the sort of from start to finish has been quite a long process. And I think -- even in the case of Avonmouth, I think we've got approvals quite a long time ago. And I think we waited 4 or 5 years before we had the anchor contract in place. So I think we'll address them as the market develops and as we can get approvals for them, but it is a longer-term timescale than something like the plastic plant, for example. James?

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James Brand, Deutsche Bank AG, Research Division - Research Analyst [8]

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James Brand from Deutsche Bank. I'm sure this is -- there you go. It's a bit better. 2 questions, please. The first, I was on a plastics recycling plant. And I was quite intrigued that you're just guiding for a 15% IRR on that project but you're describing it as a hurdle rate. And I was just wondering why you're looking for such a high -- I don't know whether that's levered or unlevered. I -- the impression is unlevered, but it's obviously a very high rate of return. And why you were looking for such a high rate of return on that project and also whether that would also be the kind of hurdle rate that you will be looking for some of the incremental investments that you're planning around business parks and uplifts to profitability for the existing ERFs and landfill. And then the second question is on Slide 36, where you showed, as you said, the potential outperformance available according to Ofwat for the next regulatory period for water. And I was -- just wanted to clarify exactly what you're showing there, whether you're taking the kind of Ofwat flow diagrams that show potential ranges for RORE and you're just taking the potential totex and ODI upsides there and that's what you're showing; or whether that also includes financing outperformance which you're showing on the comparison for the period that we're in at the moment. And also whether we should draw, probably not, but whether we should draw anything from the fact that you're showing those upside estimates next to your existing performance, whether you're maybe pointing to that as achievable for the next regulatory period. I'm sure, not, but...

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [9]

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Okay. I'll do the last one first, I think. So just in terms of that slide and what it's depicting. So on the left-hand side of the chart it's really just showing the outperformance and which companies have outperformed in this regulatory period. On the right-hand side -- and showing on the left-hand side we obviously are outperforming the most. And then on the right-hand side what we're trying to show there is that again we have the opportunity to outperform the most. And what that represents is the upside in the RORE. So first, it went up to about 8.6%, I think, in terms of the DD. So that's what it's showing relative to the same values for the other fast-track companies UU and Severn Trent. Now in terms of the financing outperformance, actually when Ofwat do the RORE for the business plan, that is assuming an outperformance for a notional company on a notional gearing, so it's not a position for the actual company. It's just a notional aspect. So it's Ofwat's RORE and the potential for outperformance for those 3 fast-track companies' upside. So that was that question. And then the first one, around the hurdle rates and the rate of return. So obviously we look at the hurdle rates across the group and think about what those should be given the relative nature of investments; the risks that are included in those, whether it be construction risk and delivery risk; and also the markets that they're operating in. And that's how we just internally come up with those, so that's what that represents. So compared to hurdle rates that we've had for ERFs, for example, then obviously it's a higher hurdle rate given the nature of the investment, the nature of that market. And that's what that's reflecting, and it is on a levered basis in terms of that return.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [10]

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Okay. Any more questions? Yes, Fraser, Fraser up there. Nobody is going to give you a microphone for...

Oh, I'm sorry. I beg your pardon. Excuse me...

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Unidentified Analyst, [11]

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Just a quick question on the GMP equalization. Are we expecting any further payments to the pension plan? And have you had any -- I just wanted to understand the status of the pension plan. And has there been any conversations with the trustee? And then second question was are you looking for a hedging strategy for the 2040 bond as well.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [12]

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Okay, yes. So in terms of the GMP equalizations, that was a kind of a U.K. ruling that affects companies who have those past service costs to consider. So that's where that GBP 3 million come -- came from. In terms of our broader pension position and liability, so our net deficit rose by circa GBP 10 million compared to last year. So we're around GBP 60 million pretax basis from that liability in that pension scheme. We will be going through a valuation with the trustees, 2019 valuation which we will -- we have just embarked on. And it will then obviously conclude in 2020. So far, in terms of our profile for contributions into that scheme, very much on track with the schedule that we agreed with the trustees, and nothing that has come out of any review we've done so far that would suggest that would change. And then in terms of the hedging, you asked a question around the 2040 bond. I think we've got our derivatives in place and we've got our strategy in place for managing that one.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [13]

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Okay. So Fraser? (inaudible)

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Fraser Andrew McLaren, BofA Merrill Lynch, Research Division - Director [14]

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It's Fraser McLaren from Bank of America Merrill Lynch. Aside from returns, could you speak about what in your view are the largest items in the regulatory review that still need to be nailed down in the July update, please?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [15]

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[Do you take that off?]

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [16]

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Okay. So obviously we -- alongside the other 2 companies, we were fast tracked, which given us a head start on our plan in terms of the cost base. Then obviously we went through a review as part of our IAP and part of the draft determination. We do know that, depending on where the rest of the sector lands and how Ofwat redo those models, then that may change. So we know that there is a potential for that to change. In terms of our ODIs, again, we've been through a process with Ofwat to confirm our own bespoke commitments and confirm the ODI design for those at common performance commitments, but again depending on the absolute outcome of those, it depends on where -- for the common ones, it depends on where the other companies land with their DD. So there are a few moving parts, but I will say around the edges obviously the largest, significant item that we won't know until we get to the final determination is what the cost capital is going to be. I'd say that, that point, the Ofwat obviously will determine that. We obviously understand there will be an update in July, but actually it's not until you get to December that, that's concluded.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [17]

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And Verity has a question as well, might be 2. I don't know.

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Verity Mitchell, HSBC, Research Division - Analyst [18]

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Verity Mitchell, HSBC. It's following on from Iain's question actually just about the timing of the construction of this new facility. How long is it going to take to build? And when is it operational? Just so that we can look at it. And just a second question also, about your net debt. As the group net debt's gone up again and you've mentioned your headroom again, can you just talk us through how you get to your headroom for investment of GBP 725 million, I guess?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [19]

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Okay. So the timing on the new facility. I think they're in one of the slides somewhere. I went through it, and Susan has. That starts to come online in 2021, but the full contribution is for the later year or the year after that. But we'll be expecting to start construction very soon, I think. And probably within a few months, I think, is probably where we are. It's worth pointing out that the shed the facility goes in is already being constructed as part of the ERF portfolio. So it isn't completely starting from a complete greenfield cycle. It's adjacent to the ERF. That answers the question [certainly] and the net debt...

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [20]

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Yes. And then on the debt side, obviously in terms of our CapEx expenditure that we've had in '18/'19 and the acquisition of the extra holding with Runcorn I, that kind of take this to just short of 450 million. So the net debt has increased really reflecting that significant CapEx buildout that we've had. In terms of our headroom for investment, where that comes from, it's quite simply a function of what our kind of covenant is -- headroom calculation is compared to where we are. That's what gives us that differential.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [21]

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Thank you. Any more? Yes. Mark again.

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Mark Freshney, Crédit Suisse AG, Research Division - Research Analyst [22]

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Mark Freshney from Crédit Suisse. You were fast tracked in the last price review. And that gave you a lot of time to do things such as buy another water company, get a lead run into your CapEx plan. If I look now, you've got 3 listed fast-track companies. One of them is already signing, fixing down some of the costs, and is using a paneling and sub-paneling strategy. Another one is just going back and reoptimizing all of their CapEx. What are you doing? Because clearly you're in that period now where it will determine what totex efficiencies and even ODIs can be for the next 5 years. So what are you actually doing to capture those?

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [23]

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Yes, it's a good question, Mark. And I should have probably spent a little more time in the presentation on it, but I think I tried to give the sense, it was on one -- that slide on the fast track there, that we've been doing that for ages. So in terms of the working with the partners on a capital program, this isn't just a capital program. It's the operational program and delivering to other third parties as well. Those arrangements have been in place. The capital partners helped us develop the plan, in the first place, so it isn't a question of giving them the plans that we hadn't -- had received or have got endorsed by Ofwat and seeing how we get on. They helped us develop the plan. They helped us sort of make sure we have the billability. They understood the targets and the efficiencies that we were putting. And indeed I think it's today, isn't it? Today is the kickoff program formally for all of the partners to engage in taking the programs forward and delivering in terms of the capital plans and also the ODIs. And that's been there for a long time. So I didn't need to announce anything new because that's probably been there for a couple of years. And I think I've said on the last price review, but the one before actually, I think, if you start to approach it, "Well we've just got a fast track approval now. We need to develop our plans of how to deliver it," you've missed the boat, frankly. You've got to do it a lot, lot, lot earlier than that. And that's what we did. And that's how we got to the really fast start and the good outperformance that we got in the current 5-year period. And we obviously have understood how we did well in that and moving on from that this time frame. So if I didn't give you a sense that we are on with it, I'm sorry. I didn't. I should have done.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [24]

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And I think the other thing just to, I suppose, amplify what Chris has said in his presentation. But in terms of a run rate where we are with totex and how we're performing, we are spending less than we were allowed in the business plan. We are in real terms outperforming, so we're in a very good place compared to the allowance that we're getting next time if there is a differential there already. So our momentum is good. We're delivering year-on-year. And as Chris said, we've had that in place for some time. And you can see from our results we haven't front-end loaded what we're doing for efficiencies. We're doing it every year and we're performing very well. We can see a good run rate continuing for that.

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

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Please?

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Richard Alderman, [26]

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Richard Alderman, Macquarie. Can I just go back to the very first question from Mark just to clarify the point about the Viridor spinout answer? Because just perhaps unfairly you put -- your answer didn't quite match the answers that you've previously given us in the past in the sense that you've argued sensibly that Viridor has a much lower cost of capital inside the group. And you put a slide up that suggested the group cost of capital is 3.6 and the water cost of capital is 3.5. So clearly you're still benefiting from that. Can you just clarify, when you said that it's -- remains a continuous live debate and continuously reviewed going forward, that you are not realistically looking at spinning out Viridor? Because despite the fact there appears to be more bankers in the room than sell-side analysts, I can't see the benefit of you doing that in the worst case scenario of nationalization. You're an attractive waste business with an existing listing which might then have a very large pot of cash to do something with rather than spinning cap...

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

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So yes. So Richard, I wasn't trying to give you a different answer. And I think I'm just trying to give the sense that it's always a live debate and we always keep it continually under consideration. And there's nothing new to say really. So I wasn't trying to give a different answer. It was just perhaps the way I said it was slightly different. I don't know -- unless you want to look up.

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

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No. I mean, as Chris said, it's just, as you might imagine, a live debate in the Board room. It's bound to be given the attention around the nationalization point.

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

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James again.

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James Brand, Deutsche Bank AG, Research Division - Research Analyst [30]

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I just want to ask one more just on the Interserve receivables. As I understand it, every half, you go through a process of looking at where the Interserve debt was trading. And that would be the benchmark for how you calculate your provisioning, but obviously then subsequent to year-end, we had the whole shenanigans and then restructuring of Interserve and, I think, ring-fencing of the entity that you would be owed the receivables from, where that entity now as -- I'm no expert on Interserve, but being in a much better financial position than Interserve group was in before. So the question, I guess, is have things improved in that respect subsequent to year-end, when you calculated the provisioning around those receivables.

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [31]

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No, it's really a good question. So as you imagine, obviously we look at that on an ongoing basis. And I think you're quite right in the sense, having gone through that pre-pack administration, it is almost harder for us to look at some kind of very distinct market indicator to talk about the kind of credit risk. So what we've had to do at the year-end is look at various fact patterns and data points that we can see. So there were some reports that were done around about the pre-pack, and there are some accounts that have gone online around Interserve. So we've had to basically triangulate the information that we have available to come up with what we think is a sensible provision given the credit situation that they went through. And now obviously we're going to be monitoring what's happening now, but that's the only information that we now have available given that they've gone from a listing position to where they are now. So I think it's just a sensible approach, that as directors we've taken that assessment and put that provision in, but it doesn't take away from the fact that obviously we will be pursuing the claim for what we believe is due.

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

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Okay, thanks, Susan. Probably one last question...

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Richard Alderman, [33]

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Just 1 follow-up question. In the statement you mentioned that the ERF portfolio is earning a return above the base case of 8% IRR. Can you give us some indication of where that is?

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Susan Jane Davy, Pennon Group Plc - CFO & Executive Director [34]

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Well, I think, Richard, on the -- there's a diagram that's in there that Chris talked to that shows the kind of buildup of the returns. And then there's a bit of a slice that looks at the outperformance chunk. So we don't give a number per se, but we've given indication of what that's looking like.

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Christopher Loughlin, Pennon Group Plc - CEO & Executive Director [35]

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Okay, thanks very much. I mean there is one last question. We'll take it, but I think probably we need to be getting adjourned, might as well close, so can I just say thank you all for attending. Thanks for all your interest and your questions.

And as I said, I think there's a good, strong set of results there. And we're very pleased that the Viridor story is continuously evolved and developed. And we have plenty of opportunities, not least of which is our exciting plastics reprocessing facility.

So thanks very much for attending, and thanks for your time. Bye-bye.