Higher revenues driven by customer demand and cost savings at South West Water have contributed to an 18.3% increase in underlying Profit Before Tax, according to the annual results for owners Pennon Group for 2016-17 published this morning.

Pennon said the merged water company of South West Water and Bournemouth Water is outperforming the regulatory contract with sector-leading Return On Retained Earnings (RORE)- a measure which shows how well the profits of the previous year were reinvested. The water business  is expected to remain sector-leading through to 2020.

South West Water was awarded enhanced status for its 2015-2020 Business Plan and has the highest potential returns in the water sector.

Water business’ profits up  4.9% to £173.9m

Incremental growth in the water business is being achieved through the successful merger of Bournemouth Water with combined licences and operations and a new retail venture for business customers with South Staffs/Cambridge Water which was launched on 1 April 2017.

Revenue from the water business was up by 2.6% to £561.0 million as a result of 2.5% higher demand on metered volumes, tariff increases of 1.4% (with RPI of 1.1%) 9,050 new connections offset by 9,800 customers switching to a measured supply and benefitting from lower bills.

The water business’ profit before tax increased by 4.9% to £173.9 million (2015/16 £165.7 million) reflecting tariff increases, increased demand from the drier weather and stable operating costs of £211.9 million (2015/16 £211.8 million).

South West Water’s capital expenditure was £190.9 million compared to £134.1 million in 2015/16.  Pennon said this reflects the change in the nature and extent of capital activity with an increase in activity in year 2 of the AMP6 programme.

Total operating costs in 2016/17 were comparable to last year, with savings arising from operational maintenance synergies from the company mergers as well as targeted efficiencies contributing to cost performance. Operating costs also include a fine for £1.8 million issued in April 2017 relating to a HSE prosecution following the death of an employee at a wastewater treatment works in December 2013.

Totex outperformance leads to savings of £129m in first 2 years of AMP6

Totex outperformance at South West Water has resulted in cumulative savings of £129 million and financing outperformance of £67 million in the first two years of K6 (2015-2020) compared to the Final Determination allowances. Pennon said South West Water is confident in its ability to remain at the frontier of cost efficiency for the water sector.

The Group said the cumulative Totex savings to 2016/17 (£73m delivered in the year) are being driven by:

• continuing advantages from strategic alliances including a new water distribution framework and the H5O capital alliance in place since 2010, now delivering efficient schemes within the Bournemouth region
• ensuring efficient capital investment through the use of data analytics optimising the capital and operating solution and promoting efficient off-site build techniques
• changing ways of working through the iOps programme including utilising new technology and equipment to increase the resources needed to deliver wastewater improvement, realtime pressure management targeting efficient interventions

South West Water leakage has reduced to 82 megalitres per day resulting in an ODI reward. Pennon said that investment in real-time pressure management and additional network monitoring has again ensured South West Water has met or exceeded its leakage target every year since inception.

Despite the significant increase in customer demand, water resources in the South West region remained unrestricted for a twentieth consecutive year and the Bournemouth water region maintained its position of having no water restrictions since privatisation.

New non-household retail venture with South Staffs continues to grow

In the non-household retail market, the Group said Pennon Water Services is operating successfully and is one of only three incumbent companies growing, with net customer growth since market opening.

Pennon Water Services, the separate legal entity operated from Bournemouth providing retail services for existing non-household retail brands, along with South West Water’s wholesale operations, successfully entered the retail market on 1 April 2017.

On the same day a new retail non-household venture arrangement with South Staffordshire Plc (incorporating South Staffs and Cambridge Water) began with Pennon retaining an 80% share.

The business has a common customer billing platform which will continue to be supported by the South Staffordshire Group.

The combined business is growing with over 1,500 net customers secured since market opening. In addition a programme targeting existing water-only customers with a dual water and wastewater service has been successful.

Lower base returns expected  in 2019 Price Review

On the upcoming PR19 price review, Pennon said that whilst lower base returns are expected it expects these to be balanced with greater incentives for outperformance for top performing companies.

South West Water will be publishing its 25 year strategic plan later this year which will focus on customer priorities through extensive customer engagement, its strong operational performance and longer term plans for resilience, reliability and responsiveness.

Negotiations continue with EIB to secure additional funding for South West Water

During the year the Group drew down the South West Water European Investment Bank funding of £130 million signed in 2015/16.

The Group has also agreed a further £110 million of funding from the EIB into Pennon Group plc, in relation to the capital investment in Cardiff’s Trident Park Energy Recovery Facility.

The funding is anticipated to be signed later in 2017 when the EIB expects to have clarity over the implications of Article 50 being triggered. Negotiations are also continuing with the EIB to secure additional funding for South West Water, so this can be delivered in a timely manner following the Article 50 clarity.

£60m Mayflower WTW is largest single AMP6 scheme

As anticipated the largest single project for South West Water’s spending is the development of the innovative Mayflower Water Treatment Works at North Plymouth. Construction works are well advanced and the formation of the process elements is underway with over 5km water pipeline and effluent pipes already installed.

In addition investment has been targeted to improve wastewater compliance with process upgrades and improvements at 6 sites.

Pennon  said it is focused on driving greater synergies and savings across the Group, successfully completing the Shared Services Review.  This has resulted in the centralisation of a number of corporate functions including corporate affairs and communications, human resources, finance and information services, as well as operational functions including procurement, logistics and facilities.

Pennon is also targeting further savings through a groupwide procurement approach.

Key areas of water investment and activity during 2016/17 included:

• ongoing expenditure for a new £60 million state-of-the-art North Plymouth water treatment works
• improved water treatment processes with investment in Granular Activated Carbon (GAC) filters being installed at three water treatment works across the region
• real-time pressure management and network modelling technology targeting interventions efficiently
• continued investment in the ‘Upstream Thinking’ programme of catchment management working in partnership with a range of stakeholder groups including wildlife trusts and river authorities. 

Key areas of wastewater investment and activity during 2016/17 included:

• process improvements and upgrades at four key sites including increasing filters and additional treatments
• investing in supply demand schemes increasing capacity at wastewater treatment works, specifically at Fluxton in Devon and Hayle in Cornwall
• improvements in the sewerage network reducing the impact of saline infiltration

Commenting on the results, Chris Loughlin, Pennon Group Chief Executive said:

“Pennon has delivered a strong performance in 2016/17 across its water and waste businesses. South West Water’s Return on Regulated Equity continues to lead the sector while Viridor is growing through its Energy Recovery Facility portfolio, delivering EBITDA(1) of £107 million, ahead of our c.£100 million target.”

“Across the Group we are investing for growth while driving efficiency to keep costs low for the benefit of our customers. We have delivered savings of £129 million in total expenditure at South West Water since the beginning of the current regulatory period, cementing our commitment to reduce the real cost of water bills to 2020.”

“We believe Pennon is well positioned now and for the future and our performance underpins our long established sector-leading 10 year dividend policy of 4% growth per annum above RPI inflation out to 2020.”

One of the largest environmental infrastructure groups in the UK, Pennon is at the top end of the FTSE 250. The Group has assets of around £5.9 billion and a workforce of around 5,000 people