It’s a snowy day in London at the end of November. Richard Flint, the chief executive of Yorkshire Water, has brought the Northern weather with him. On a rare meeting with the press, Flint settles down in the bustling lounge of the Conrad St James hotel to explain why Yorkshire, normally one of the most reticent water companies, has gone public with an ambitious plan to become a top quartile performer in the next two years.
Flint has held the reins at Yorkshire Water since 2010, having risen up through the ranks since joining as a graduate trainee more than 20 years ago. In his seven years in the top job, he has seen steady performance, with the 2016/17 annual results showing an operating profit of £285.8 million, up from £275.2 million the previous year.
Through this time, Yorkshire has kept a low profile – like Flint himself, shying away from unnecessary publicity. But with the renationalisation of the water sector firmly on the public agenda, there can be no hiding from the spotlight for any of the companies. Hence Flint’s decision to sit down today with Utility Week and explain the company’s strategy, its recent decision to close its controversial Cayman Island offshore arrangement, and the very public nature of its performance commitments.
There’s no escaping the context. Pressure has been mounting on the water sector ever since nationalisation was added into the Labour party’s 2017 election manifesto at the eleventh hour. It may have been an unplanned move, but it was not an unpopular one, with one opinion poll suggesting that 83 per cent of the public back renationalisation. This startling turn of political events has caused water regulator Ofwat to up the ante on key messages it has been putting out for years – banging the drum so hard on financial structures, transparency and governance that companies have been left in little doubt the regulator means business. The response has been a flurry of announcements in recent weeks from water companies, Yorkshire among them.
First up, though, is Ofwat’s latest company monitoring framework (CMF) results, published on the morning of the interview. The CMF assess how well companies have explained and assured their information. Yorkshire was promoted to the “targeted” class of companies, from “prescribed” – a move which Flint says “fits the broader improvement narrative we’re working to in the business”.
There is a value I think in saying let’s be public about this and put a time span against it and therefore drive our own performance
And so on to the performance commitments, which make impressive reading. Yorkshire’s board, under new chairman Anthony Rabin since September 2016, has been doing some soul searching, or, as Flint says: “Speaking to lots of customers, in a structured way.” This has triggered what Flint describes as a “reset”. He says: “There’s a real desire to move forward on the back of what customers are saying and not wait for PR19. We’ve taken some open decisions in order to drive performance into the top right hand box [upper quartile].”
The company has pledged “dramatic reductions” in leakage – with actual figures to be confirmed shortly – as well as a 40 per cent drop in sewage escapes causing pollution; a 70 per cent drop in incidents resulting in internal sewer flooding; and a massive two-thirds reduction in the average interruption to water supply, all before the start of the next AMP (asset management plan) period in 2020.
To achieve these goals, Yorkshire has hired 300 new staff, ranging from traditional engineers to more cutting-edge data scientists, accompanying enhanced investment in technological solutions. So how much will all this cost, and who is going to pay for it? Flint won’t be drawn on a number – “it’s commercially sensitive information” – but confirms that it involves “significant and material expenditure”. The cost will be met within the current price framework, and Flint insists it will be achieved via efficiency. Pressed with the question, will investors take lower returns, he responds again: “Efficiency is what allows us to drive this.”
Going public with such a plan is a bold step, particularly in the water sector, which has regulatory targets enough to deal with. Flint acknowledges: “We could have said, let’s make a set of goals and pursue them privately, but there is a value I think in saying let’s be public about this and put a time span against it and therefore drive our own performance.”
The plan represents a narrowing and deepening of the company’s focus. Flint reiterates the company’s commitment to wholesale water operations, mentions a number of disposals parent company Kelda Group has already made of non-core operations, and hints at a number still to come. Of the business retail market, where Yorkshire has been rumoured to have been touting its business Three Sixty for sale, he says: “I’ve made it quite clear this is not a market we want to be in. I think you need big players in that market operating at scale and bringing expertise proven elsewhere to be able to make that market work.” He adds that while Yorkshire is still currently in the market, it has “an eye open to opportunity”.
Our offshore companies in the Cayman Islands have nothing to do with tax
The performance plan is the second major statement to come out of Yorkshire Water in a matter of weeks – the first being made by group director of finance and regulation Liz Barber at a recent Moody’s conference for investors in the sector, held in London in October. Barber announced that the company would be closing its Cayman Island operations, later explaining to Utility Week: “Our offshore companies in the Cayman Islands have nothing to do with tax and no matter how we try to explain, people just don’t understand them. Because it affects our reputation and legitimacy we have taken the decision to get rid of them. It may take time but that’s what we have decided to do.”
Yorkshire uses the companies to manage high levels of borrowing – another controversial issue for the sector, and again, one where the company has pledged to take action, outlining plans to reduce its gearing from 76 per cent to 70 by 2020. This move will no doubt please Ofwat chairman Jonson Cox, himself a former chief executive of Yorkshire Water, who has publicly questioned the suitability of complex, highly-leveraged financial structures for water companies.
Reflecting on the move, Flint emphasises the importance of perception: “That’s one of the things it’s important for leaders of organisation to grasp: the concern out there among customers, among the man and woman in the street. You could look at [the Cayman Island companies] and say, they’re not doing any harm so why should we work on that? There’s a lot of other things to do in a busy environment. But it’s what they look like that concerns people.”
It’s a sign of changing times. Yorkshire reviewed its offshore arrangements a few years ago and decided at that time it would be too costly and complex to remove them. Today, with the Labour party committed to that manifesto pledge to renationalise water companies, the world looks very different. Flint acknowledges that the prospect of renationalisation “really throws down the gauntlet” to companies to “demonstrate the value we bring and can continue to bring for customers”. He muses: “A challenge is a good thing. That’s not to say it makes life easy, but challenge tends to be good.”
Without being too glib about it, the nature of investment [in the sector] has always been evolving
Flint must be looking forward, then, to PR19, the next regulatory review, which is itself set to be very challenging for companies. Ofwat has made little secret of its intention to set the investor returns – the weighted average cost of capital (Wacc) – at historically low levels to reflect the macro-economic environment. Some companies have publicly protested at the regulator’s decision to take less account of historical financial trends than is usual in such calculations, with Northumbrian, Anglian and Affinity Water commissioning a report from consultant KPMG to challenge the model. Yorkshire has not been among the protestors, though Flint admits the company will be “keeping a very close eye” on the Wacc, the provisional level of which was set to be announced alongside the methodology for the price review on 13 December, after Utility Week goes to press.
One of the major talking points in the PR19 methodology is the increase in financial rewards and penalties for performance on key metrics – outcome delivery incentives (ODIs). ODIs have worked well for companies in the current regulatory cycle, and Flint welcomes the increased emphasis on them, commenting: “Companies respond really well to incentivisation.”
He is also positive about direct procurement, the new model requiring companies to competitively tender the financing, building and potentially operation of capital projects costing more than £100 million. He suggests that Yorkshire will bring forward a project under direct procurement in the next price cycle and also hints that the company, as part of the wider Kelda Group, is well positioned to tender for other companies’ projects.
The financial questions surrounding the upcoming price review are of particular interest to Yorkshire at the moment given the change in its investor profile. Two of the companies’ owners, Deutsche Bank and Corsair Capital, are looking to sell their stakes, which together represent 55 per cent of the company, ahead of the review, for up to a reported £4 billion. Infracapital was reported to have sold its 10 per cent stake earlier this year.
Speaking about the investment profile of the sector in general, Flint insists: “Without being too glib about it, the nature of investment [in the sector] has always been evolving.” He enumerates the different financial models the sector comprises, from not-for-profit to listed to privately held, and adds: “As investors get to understand the market, which they have done over time, I think it creates more scope for direct investment rather than through infrastructure funds, and I think that’s really quite a statement of confidence in the sector.”
Whoever buys into Yorkshire, they will be buying into the company’s publicly-stated performance commitments as well. They are bold, ambitious and, according to Flint, non-negotiable. With just two years until the start of the next AMP cycle, there’s a busy time ahead.