Nigel Hawkins, investment analyst specialising in the utilities sector Non-domestic water retail, Regulation, Sewerage networks, Strategy & management, Wastewater treatment, Water, Water networks, Water treatment, Analysis

The business plans are in and Ofwat must now rate 17 water firms on how they intend to spend their income in 2020-25 to meet the needs of customers and the environment.

With a thump on its doormat or via a bulging inbox, Ofwat has taken delivery of 17 water company business plans. They are chunky documents; medium-sized Anglian’s is almost 300 pages.

As part of the regulator’s 2019 price review, PR19, all water firms must set out how they will meet the needs of their customers from 2020 to 2025 and beyond. Inevitably, there are many differences and varying priorities, but some key themes apply across the sector.

Not surprisingly, some very hefty investment is proposed, although there is a distinct regional element to the expenditure profiles.

In Thames’s case, its business plan reveals a profound change of policy marshalled by new chairman Ian Marchant, whose utility expertise dates right back to the 1980s.

Thames has been savagely criticised for its excessive dividends, its soaring net debt, its minimal corporation tax payments and its woeful record on leakage reduction.

For the 2020-25 period, Thames’s planned total expenditure (totex) is circa £11.7 billion; capital enhancement represents £3.3 billion – more than a quarter of this figure. Importantly, Thames is seeking to resurrect the Abingdon reservoir project, a controversial scheme that has been debated for decades.

Given the high level of house-building locally, both Anglian and Wessex are planning a circa 30 per cent uplift in investment.

Similar criteria apply to Southern, where a 25 per cent uplift in investment is planned – from £3.2 billion to £4 billion over the five-year period. Impressively, Southern’s long-standing metering programme is now bearing fruit – 87 per cent of customers are now metered, with a claimed 16 per cent cut in consumption being achieved.

Severn Trent, too, operates in a region where new-build levels are high. Of its ­forecast £6.6 billion of totex, £1.7 billion is earmarked for enhancement expenditure.

Cutting bills

By contrast, United Utilities is projecting a £1 billion-plus cut in expenditure, when compared with 2010-15, as it focuses on ­cutting average bills.

It envisages price cuts of more than 10 per cent in real terms between 2020 and 2025; only Northumbrian, with its front-loaded cut proposals, plans to exceed this figure.

Other companies are less aggressive in reducing customer bills, with most working on single-digit cuts over the five years: ­Severn Trent, for example, is focusing on a 5 per cent cut in real terms.

In Thames’s case, it expects its average bills to be flat – in real terms – throughout the 2020-25 regulatory period.

Dividend policy

For investors, future dividend policy is key. While Thames is unquoted, its new policy limits dividend payments to about £20 million per year.

Under Thames’s old regime, annual ­dividends regularly cost more than £100 million per year – and, in 2009/10, topped £300 million.

Quoted water companies will seek to avoid a dividend cut. Until the final determinations are announced in December 2019, the quoted trio – Severn Trent, United Utilities and ­Pennon – are unlikely to be over-specific on their future dividend-paying intentions.

However, Pennon has confirmed its plans for approximately £20 million of accrued benefits to be passed on to customers via a share option – an arrangement Pennon describes as unique. A harbinger for UK ­utilities in the future?

Reducing leakage

For politicians, leakage levels are a key parameter. Since privatisation in 1989, it has to be said that – £150 billion of industry expenditure later – the sector record on reducing leakage, with a few exceptions, remains dire.

Thames admits that “currently, 25 per cent of all the water that it treats and puts into the system is lost…”.

Water companies are now according a far higher priority to reducing leakage ­levels. Yorkshire is particularly aggressive in ­stating: “Our leakage will reduce by 40 per cent between 2018 and 2025.”

Investment focus

Ofwat will not lack reading material.

John Russell, director for strategy and planning, stated: “From now until January 2019, we’ll pore over each business plan and we’ll be looking for evidence that they are robust, ambitious and, crucially, that they have been shaped by customers.”

While Ofwat will no doubt trawl for its favoured buzzword – innovation – which appears in virtually every business plan, it will focus on the investment programmes and whether there is any evidence that ­“lilies have been gilded”.

After all, under the water regulatory regime, higher investment means higher earnings – much welcomed by investors. And Ofwat will have noted United Utilities’ comparatively conservative expenditure proposals.

Ofwat may even disqualify some schemes from being eligible for a regulated return. Bristol’s experience in the last periodic review over the Cheddar Reservoir/Seabank Power scheme is a salutary lesson.

Wacc acceptance

Ofwat itself will be pleased that some water companies, such as United Utilities, seem implicitly to have accepted its aggressive 2.4 per cent weighted average cost of capital (Wacc).

Indeed, United Utilities has adopted “an RPI-stripped appointed cost of capital of 2.4 per cent consistent with Ofwat’s early view”. Of course, the pivotal Wacc figure may be adjusted before December 2019.

Publication of the business plans saw shares in the three quoted water firms edge down. But for Ofwat, a massive reading and financial modelling exercise has begun.

And, early next year, there will be the eagerly awaited – and price-sensitive – announcement of the “exceptional” and “fast trackers” among the 17 water companies.

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