Pennon Group Plc (OTCPK:PEGRF) Q2 2023 Results Conference Call November 30, 2022 3:30 AM ET
Company Participants
Susan Davy – Chief Executive
Paul Boote – CFO
David Harris – Drought and Resilience Director
Conference Call Participants
Bartlomiej Kubicki – Societe Generale
Dominic Nash – Barclays
Martin Young – Investec
Sarah Mitchell – HSBC
James Brand – Deutsche Bank
Mark Freshney – Credit Suisse
Sarah Lester – Morgan Stanley
Susan Davy
Good morning. I’m Susan Davy, Chief Executive of Pennon, and welcome to our half year results presentation for 2022/’23. Over the past 6 months, turbulent political and macroeconomics escalating costs [indiscernible] pressures and the continued war in Ukraine have weighed heavy on the U.K. and globally, creates an extraordinary degree of uncertainty and volatility. Closer to home and in our region, climate change has driven the hottest, driest year in the Southwest since records began. Against this backdrop, Pennon’s results for the half year 2022/’23 demonstrates we are continuing to deliver fundamental services as we execute our strategy and drive sustainable long-term growth.
Our business model ensures we have the headroom and capacity to be fleet of foot to respond with agility when it matters most, where they’re facing a challenge or an opportunity. What gives us that headroom is threefold: driving efficiency and performance, delivering on our plans and having a strong, robust balance sheet. We also couldn’t do this without the pioneering spirit of our 3,000 employees who see opportunities when they see obstacles, and show extraordinary care for customers, communities and each other.
Turning to the highlights for the half year 2022/’23 and starting first with the environment and the outcomes from our largest environmental program in 15 years. This has been a half year in which we have been particularly focused in our catchments, delivering tangible benefits on a community-by-community approach. Stretching from Bristol to Bournemouth, Devon and Cornwall, including the outer city, we operate across a unique topography surrounded by water and with 860 miles of coastline. Our network stretches over 22,000 kilometers, and is Britain’s most treasured tourist region. Our infrastructure regularly flexes to accommodate a population that swells from 3.5 million to over 10 million visitors in the summer months.
Nine bathing water investments have been accelerated to support water quality improvements so far in K7 with 1 in the half year ’22/’23. And I’m pleased to say we have achieved 100% bathing water quality standard for the second consecutive year running with 99% achieving good and excellent status.
We announced our WaterFit plans earlier this year. We are underway with investing GBP 45 million over the next 2 years, targeting a reduction in the use of storm overflows with a 50% reduction through the 2022 bathing season. With the climate crisis, it is important we remain focused on delivering our Net Zero objectives, and our plans across the 3 pillars have made progress this year, investing in an electric fleet, capturing carbon through our restoration of 2,800 hectares of peatland during K7 with 1,000 hectares delivered so far cumulatively. And developing our renewables capacity to support 50% of self-generation ahead of the 2030 target.
We are continuing to invest across our asset base to support service outcomes, delivering a record amount of expenditure with a 30% increase this half year, representing GBP 143 million of investment.
Alongside our innovative operational ways of working, we continue to deliver against our business plan ODI commitments. And despite targets ratcheting, we are continuing to deliver 80% ahead on track for South West Water and 75% ahead on track for Bristol Water.
At Pennon, we believe every customer should benefit from what we do. Our investments aren’t just in places and infrastructure. With rising food and power prices, we are focused on keeping customer bills as low as we can.
Average bills for South West Water customers are low in ’22 than they were 10 years ago with our recently launched second watershed plus issuance, customers of South West Water and Bristol Water will be able to reduce their bills further this year at time when it counts. We are also helping over 100,000 customers with specific affordability pinch points, and we are seeking to double those assisted by 2025.
We are delivering over GBP 78 million of benefits to customers at a time when they need it most, including our commitment to share the benefits of financial outperformance with customers through our second issuance of our unique WaterShare+ scheme with GBP 40 million funded so far in K7 to give customers the option of a stake in the business and a say in the water company, all money off their bill, and this is unique to our business.
Robust financial and operational outcomes underpin the return on regulated equity, which the South West Water continues to double base returns for ’22/’23. And for the half year, we are delivering double-digit return on regulated equity across the group. Driving outperformance of plans across the group gives us options to go further faster within a regulatory delivery period, whether that’s through reinvestment over a time we’re sharing of those benefits with customers, lowering their bills.
The outperformance delivered to date in K7 is GBP 225 million, and that’s supporting reinvestment this period through Green Recovery, WaterFit and additional water resources investments, as well as funding the WaterShare+ scheme. Underpinning the business is a robust balance sheet delivered through long-term financial discipline. This half year, we have absorbed the impact of elevated inflation on power and interest costs, delivered significant operating efficiency alongside record investment and ensuring the pension scheme continues to be in surplus.
The water business has degeared to 58%, and there is hedging capacity for growth across the group of GBP 500 million. Through our disciplined capital allocation, we have a sector leading position on growth, both organically and through acquisition. The water business RCV is set to grow by 50% over K7 with our 2 business-to-business retailers profitably growing in a competitive market and GBP 160 million earmarked for value-enhancing renewables investment across the U.K. In summary, we’re delivering fundamental service, executing our strategy and delivering long-term sustainable growth.
Before we look at the financial results, recently, I went to visit one of our new water resources, Hawkstor, which you can see just off the A30 in Cornwall.
I couldn’t talk about the half year results without acknowledging the impact of climate change that we witnessed firsthand in the Southwest this year. And to bring that to life for you, I’m filming this today from Hawkstor on the Western side of Bodmin Moor in Cornwall, joined by our new Drought and Resilience Director, David Harris.
The Southwest is particularly vulnerable to climate change, given its 860 miles of coastline, and adjacency to the western approaches of the Atlantic Ocean. The drought of 2022 for the Southwest is set to be the worst since records began, over 130 years ago with the hottest driest summer leaving river flows, groundwater levels and reservoir stocks depleted. Despite this, for the majority of our regions, services remained unaffected across the group, continuing to supply Bristol, Bournemouth, [indiscernible] City and the vast majority of Devon, without restriction, thanks to the efforts, hard work and resilience of our teams using our quality-first approach, prioritizing the delivery of clean, safe drinking water services to homes and businesses across the great Southwest.
We have, however, needed to work innovatively and at pace in challenging circumstances to preserve supplies to Cornwall and a small part of North Devon with communities coming together to avoid using hosepipes. Just over 6 months ago, Hawkstor was a redundant China clay pit, a brownfield site and a lasting remnant of the Cornwall Heartlands, where mining and manufacturing are forgotten symbols of once prosperous past. Fast-forward to today, and in just a matter of days’ time, Hawkstor will become an important part of Cornwall’s future, securing vital water supplies for our customers.
Along with upgrading Stannon Lake and Port Reservoir, these additional resources will provide up to 30% of Cornwall’s water supply for the future. It’s a great example of where Pennon’s pioneering spirit, agility and innovative thinking have delivered real benefits to customers and communities in real time. That pioneering spirit has also been evident in the way we have responded to the challenges, not just for Cornwall but for the wider region in the sector and in the way we are approaching longer-term resilience.
I’ll hand you over to David Harris, who will explain more. David joined the group recently with his previous experience of leading Water New South Wales through the worst drought in Australia’s history. And it’s great for the region and the sector to benefit from his experience. Welcome, David.
David Harris
Thanks very much, Susan. Over 90% of our current supply comes from South West Water, rivers and reservoirs. Hawkstor is just one of a number of engineering projects we’re progressing in tandem as part of a GBP 75 million investment in securing supply, introducing further new water resources and with a focus on repurposing ex-quarries, dewatering mines, and for the first time, desalination. We’ve also delivered a number of firsts for the sector, working in collaboration with local government, regulators and communities. For example, in a first of its kind, our Stop the Drop campaign launched this month is already bringing together the collective might of the people of Cornwall, incentivizing customers and businesses to work together to restore reservoir levels and save money. This is on top of the work we’ve been doing to support water efficiency with teams of people outdoor knocking. So far, we’ve issued over 75,000 water-saving devices from water butts to water-saving shower heads. Together, with our ongoing communication campaign, we estimate to have the potential to save more than 500 megaliters over a year.
We continue to work around the clock using the latest artificial intelligence, drone and satellite technology to find and fix up to 2,500 leaks a month and to have also introduced free found and fixed services for customer-side leaks, 30% of all leakage.
Secondly, using our expertise from the Isles of Scilly, we’re currently accelerating plans to introduce desalination units at a number of sites across Cornwall to treat seawater and produce either raw or potable water supplies and to ensure our resilience to 2050 is in place now.
Thirdly, and looking to the future and across the wider Southwest, we’re also progressing our plans for a new reservoir in Bristol that will allow water to flow into the Southwest when it is needed most.
Susan Davy
I hope you agree that this is a great example of where Pennon’s pioneering spirit, agility and innovative thinking have delivered real benefits for customers and communities in real time.
I will now hand over to Paul to take you the financials for the half year 2022/’23.
Paul Boote
Thank you, Susan, and good morning, everyone. As we’ve previously flagged, the current high inflationary environment does change the profile of the group’s earnings, transferring it from the near-term into future years. This change in profile does not impact the regulatory financial performance of our water businesses, which continues to be strong and sector-leading. The change in profile of earnings reflects the more immediate impact of higher power and financing costs, which are more than compensated for through higher inflation-linked revenues and RCV growth in future years.
These power financing costs are the 2 significant factors that result in underlying profit before tax of GBP 22.5 million compared to GBP 90 million in the previous year.
On a statutory basis, the group’s profit after tax of GBP 18.5 million compared to a loss of GBP 22 million in the prior year, which included a significant one-off deferred tax charge related to the increase in corporation tax rates.
The group’s adjusted earnings per share have reduced in line with profits to 7.9p. The group’s return on regulated equity increased in the period to 13.4%, driven by strong financing outperformance and underpins our interim dividend of 12.96p, which increased in line with our stated sector-leading dividend policy.
Looking at underlying profit before tax in more detail, there are a number of moving parts to highlight. Firstly, there is the full year effect of the Bristol Water acquisition, which in last year’s numbers reflected 4 months of Bristol Water’s contribution. The full 6 months effect this year adds GBP 14.5 million of EBITDA before power costs.
In terms of revenue, over the past few years, we’ve talked about COVID and the impact it’s had. It’s pleasing to see non-household demand has returned to pre-COVID levels, and it’s also notable that overall demand has increased further from the already elevated levels that we’ve experienced through COVID.
South West Water’s revenues were GBP 16.8 million lower period-on-period, due to regulatory revenue passback mechanisms. This contributed to South West Water’s average bill for 2022/’23, reducing year-on-year.
As expected, our power costs have increased by GBP 24 million, reflecting both higher non-commodity usage charges and higher wholesale market charges. This position is over 95% hedged for this financial year, with the remaining sensitivity due to winter pumping requirements.
Whilst there have been other inflationary cost pressures, including chemicals and consumables, our ongoing efficiencies have largely mitigated the impact. Pleasingly, Pennon Water Services performance is continuing its positive momentum, fueled by contract wins and the recovery from the COVID pandemic. EBITDA was GBP 2.3 million, up 44% period-on-period. Around 30% of debt was index-linked through the half year, positioning us well in comparison to the sector and demonstrated by our sector-leading effective interest rate of 5.8%. This current high inflationary environment has driven a GBP 38 million increase in the group’s interest charge, which has increased to GBP 75 million.
Whilst this is a significant impact on the P&L charge, it should be noted that the majority of the inflation element of the charge is noncash. The cash interest cost remains in line with last year, having adjusted for the full 6-month effect of Bristol. The water business’s cash cost of interest remains low at 2.9%.
We anticipate capital expenditure and delivery to be higher year-on-year and at the half year investment is 30% higher. This increase reflects investments in water quality and resources, including commencement of works at our new Alderney Water Treatment Works that uses the same state-of-the-art technology first deployed at our Mayflower works in Plymouth. On wastewater, spend includes targeted investment to reduce pollution incidents and deliver on our WaterFit commitments launched earlier in the year.
The group’s net debt position remains sustainable with cash inflows from operations remaining strong and benefiting from the additional 2 months of Bristol Water contribution.
A key focus in delivering this performance is our approach to cash collections. We are very aware that the cost of living crisis driven mainly by energy bills will mean that some customers may be struggling financially. We believe that nobody should worry about their water bill, and we have a variety of initiatives to both identify and support customers in financial difficulty.
In K7 to date, this approach has benefited over 100,000 customers, many of whom benefit from our social tariffs. This also helps to maintain our sector-leading bad debt charge of 1.1% of revenue.
Our corporation tax paid is lower this year at GBP 3 million, reflecting both the lower profit level and super deduction capital allowances on higher spend levels. I have touched on interest in CapEx already, both of which are higher period-on-period with the full year impact of Bristol contributing to this.
Equity flows related to the final buyback tranche and our 2021/’22 dividend resulted in an overall group net debt of GBP 2.9 billion or GBP 2.7 billion when acquisition-related noncash fair value adjustments were excluded.
The group has a strong balance sheet position with a relatively low gearing level, pension schemes and surplus and sector-leading effective interest rate on our debt. At a water business level, Net debt was GBP 2.7 billion at the end of September, with a GBP 400 million increase in RCV to GBP 4.6 billion expected by March 2023, in large part driven by inflation. Our regulatory gearing has reduced to 58.4% below Ofwat’s notional level of 60%.
We now anticipate that RCV will grow by around 50% over K7, up from 40% when we last reported. 20% of the increase relates to organic growth with 30% driven by inflation. This higher level of RCV will drive higher annual revenues in future regulatory periods starting in 2026.
Our agile and efficient financing strategy has positioned us well in the current macroeconomic environment. Our relatively low level of index-linked debt reduces the impact of inflation compared to industry peers, and together with our approach to hedging, results in a sector-leading effective interest rate of 5.8%. This sustainable position reflects our debt portfolio mix, which has an average maturity of 15 years and includes a substantial proportion of floating rate debt, which we hedged in line with the regulatory methodology to lock in outperformance.
Following the acquisition of Bristol Water, our level of index-linked debt increased to around 30% where previously our financing strategy positioned index-linked debt is around 20% to 25%.
In the last month, in line with this strategy, we’ve reduced the amount of index-linked debt in line with our historic levels. We’ve achieved this through repaying Bristol Water’s index-linked bond at a level that will generate a GBP 20 million non-underlying gain in the second half of the year. In addition, we have swapped GBP 300 million of RPI debt to fixed through to 2025.
Our future funding requirements continue to be steady at around GBP 200 million per annum. This level covers both existing debt refinancing and capital investments. This run rate is in line with Ofwat’s notional assumptions and ensures we are protected from the rising interest rate environment on new debt through the true-up mechanism.
To support the achievement of our Net Zero 2030 commitment to mitigate the current high forward market energy costs, we are looking to make significant investments in renewable energy projects. As previously reported, we plan to deploy GBP 160 million of capital into such projects, and we are currently in active discussions with a number of counterparties regarding the ownership and operation of renewable energy sites that range in generation capacity from 20 to 50 megawatts. These projects will be able to supply our water businesses with energy through power purchasing agreements, providing price certainty and derisking our exposure to wholesale markets.
Our Net Zero 2030 plan targets generating half of the 400,000 gigawatt hours of energy we currently use. Whilst we are continuing with the rollout of solar PV at a number of our operational sites, we believe our plans will enable us to meet our targets ahead of schedule and potentially go much further in terms of generation. In addition to reduce our exposure to volatility and wholesale power, we maintain a dynamic hedging strategy and forward by our energy requirements. These purchases are made in small tranches over time to spread the risk of market movements. Forward power prices have been particularly elevated since Russia’s invasion of Ukraine and have further peaked post June.
The group has over 95% of energy needs hedged for 2022/’23. Our derisked positions for ’23/’24 and ’24/’25 are 60% and 30%, respectively. These hedges have locked in prices around 30% below current market forward prices for these years, but are still elevated by historical standards.
It is worth noting that the regulatory true-up mechanisms at the end of this period will partially mitigate the impact of these higher power costs. In line with recent announcements, we expect our full year results to be H1 weighted. Focusing on our expectations for the second half of this year, this now reflects a lower revenue expectation as we work with our customers and incentivize them to reduce usage in Cornwall. We are closely monitoring demand over the period of the incentivization to the end of December, and are also anticipating a sustained reduction for behavioral change.
Whilst lower demand will reduce revenue in the year, any revenue shortfalls to the final determination will be recovered in future years. In line with the usual seasonal usage, we expect our power usage and therefore costs to increase in the second half of the year. Full year power costs are expected to be GBP 50 million higher than last year. Whilst we are delivering efficiencies and other costs, inflation is increasing and is likely to add further cost pressures into H2.
Interest costs are expected to be lower in H2, out turning for the full year in the region of GBP 130 million to GBP 140 million. This reflects the active management of our index-linked debt portfolio that I’ve described earlier.
There are also some specific significant one-off items expected in H2, including our second GBP 20 million WaterShare+ issuance reducing revenue, Bristol Water integration costs of around GBP 5 million, the Cornwall resilience schemes, including the customer incentivization payment, and finally, the GBP 20 million gain on the termination of the Bristol Water index-linked bond that I mentioned earlier.
Turning to the balance sheet, we expect the pace of investment to continue with the full year amount likely to be in excess of GBP 300 million which will include spend on water resource resilience in the Cornwall region. And as I have mentioned, we expect RCV to increase by around GBP 400 million to March 2023, contributing to an anticipated RCV of GBP 4.6 billion of the full year.
And with that, I’ll hand back to Susan.
Susan Davy
Thank you, Paul. Whether it’s been COVID, conflict or climate change, all have shown us how important it is that we value and protect our green and blue spaces, our environment and our natural resources. We’ve all become universally intolerant of our Victorian sewage system, once revered worldwide for innovation with [indiscernible] flows now seen as the acceptable symbol of failing water quality in the U.K. In response, we are already transforming the way we work ahead of any government-mandated changes, accelerating, working across catchments locally as well as regionally through partnerships and collaboration with customers, communities, businesses, local government, NGOs, landowners and the people who love our region and who live in our region coming together to start changing what we all do today.
Supported by our GBP 45 million investment in WaterFit, our plan for healthy season rivers, we already are starting to see results. This will be the second year of maintaining 100% bathing water quality for our region. Releases from storm overflows are currently 30% lower than in the previous year and 50% lower over the bathing season for 2022.
We are on track to reduce releases from storm overflows to an average of 20 per overflow per year by 2025, using our SpillSure data, enabling 24/7 triaging of events and we’re investing GBP 20 million in additional storm storage at 58 sites.
WaterFit will also see us reducing our impact to reverse by 1/3 by 2025, with further plans to achieve 0 impact on rivers by 2030. Using our pioneering catchment management approach, we have now restored around 100,000 hectares, enhancing biodiversity through tree planting and investments in 6 of our wastewater treatment works this period will reduce phosphorus and ammonia.
We are progressing our first-ever bathing water pilots for the Dart and Tavy, and we’re engaging communities in our plans. And in another example of our pioneering spirit, we are also ensuring data on water quality is more accessible, whether that’s ensuring all our overflows are 100% monitoring by the end of this year, again, ahead of target. And we will be launching WaterFit Live in early 2023, covering 1/3 of the nation’s bathing beaches with real-time data accessible to customers and communities.
A key focus area for K7 is ensuring we are delivering a sustainable step change in reducing the number of pollutions. The deployment of our pollution incident reduction plan is delivering the maximum environmental benefit. In 2021, we had our best performance in 10 years, and in 2022, we’re on track for a continued sustained reduction. Compared to other regions across the country, our networks and assets have the closest proximity to water courses. To mitigate risks, we’re using predictive modeling using asset and weather data, we’re adding to our data points by rolling out 9,000 sewer depth monitors in the network. We are using our joint venture with the University of Exeter, the Center for Resilience, Environment, Water and Waste analyze root cause issues. The outcome of that modeling is driving our catchment focus plans.
We’ve also increased our resource in our supply chain by 25% to deliver and intervene in over 260 hotspots since 2021. And we know that over 70% of issues on our network are caused by wet wipes, [indiscernible] and greases, and we are running activity programs to influence customer behavior as well as comping down on illegal connections to our network.
We know we have more to do, and we are moving in the right direction. With ratcheting targets, we do not anticipate a change in the EPA rating for 2022, but we are following a trajectory to achieve 4-star status for 2024. This regulatory period will see us investing over GBP 1.4 billion across the group and across the asset base. With 95% of our capital program under framework contracts, we are investing across water and waste assets, and these investments alongside our innovative operational ways of working means we continue to deliver against our business partner agile commitments, delivering for customers and communities.
On the water side of the business, across the group, we have been focusing on water quality, investing in granular-activated carbon technology to further improve the taste and appearance of water supply, coupled with a step change in our service reservoir maintenance, all critical for ensuring top quality drinking water for our customers.
At a time when resource levels are under pressure, delivering on leakage reduction plans is ever more important. We’ve been using satellite technology, investing in acoustic loggers and fixing more leaks than ever before with leakage plan yielding sustainable results.
On the wastewater side of the business, we’re investing in storage schemes through our WaterFit investment to hold back flows and reduce the use of storm overflow releases. We’re investing in 58 storm storage schemes, increasing headroom and capacity at treatment sites and mitigating risk with an accelerated main replacement program and delivering 9 bathing water schemes with 1 this half year.
This is underpinning our pollutions reduction program supporting our bathing water outcomes and ensuring we remain sector-leading in reducing internal sewer flooding instance. Even though ODI targets are ratcheting, we are continuing to deliver 80% ahead on track for South West Water and 75% ahead on track for Bristol Water. As we share best practices across both businesses, there are opportunities to achieve more.
At Pennon, we believe every customer should benefit from what we do, with customers receiving GBP 78 million of benefits so far in K7 and our unique WaterShare+ scheme with our second issuance currently underway, includes Bristol Water customers for the first time and allows all customers to save money or take shares in the business.
We continue to work hard to keep customer bills as low as we can. Average bill for South West Water customers are lower in 2022 than 10 years ago and GBP 10 lower than the previous year. Our affordability toolkit has unlocked GBP 28 million of support for customers across our region with over 100,000 customers accessing one or more of our schemes, and plans to double the number of customers benefiting from social tariffs to 2025. Ultimately, the more we can do to help customers save water, they will save money.
From our innovative Stop the Drop incentive to water efficiency advice, we have plans to roll out 70,000 smart meters by 2025, as well as extending our free customer leak repair program. We’ve issued 72,000 free water efficiency devices in 2022, including the new free water butt initiative, saving water and saving runoff.
The Southwest is a region, given its dependency on agriculture and tourism, that experiences large socioeconomic challenges with low productivity, low pay and pockets of deprivation, particularly in urban and coastal areas, resulting in low economic growth. At the same time, the Southwest population is getting older, with those aged between 17 and 24 believing they need to leave the region to get on. All this places an even greater responsibility on Pennon as the largest employer in the region. And as a living wage employer, ensuring employees earn a fair wage for a good day’s work. Given this, we’re announcing plans to double our pension and graduate schemes to 1,000 by 2030, and we’ll offer 5,000 work placements to schoolchildren. Over the same period, we will continue to support local charities and good causes providing GBP 1 million of support to those communities.
Our business model of driving outperformance across the group gives us options to go further faster within a regulatory delivery period and be agile to respond to whatever the circumstances. The group cumulative outperformance delivered to date across the group of 9.5% in K7 equates to GBP 225 million which is supporting reinvestment in the period, underpinning Green Recovery, WaterFit, water resources investment and our acceleration of returns to customers.
For the half year, we’ve delivered double-digit outperformance of 13.4% outperforming in the current macroeconomic environment with our set leading financing outperformance outweighing the Totex contribution. We are forecasting a positive contribution from ODIs in ’22/’23.
Post our acquisition of Bristol Water, we are on track to integrate the business, bringing together the best of the best to improve services for customers across the group and deliver synergy savings, deploying our proven integration blueprint which is focused on creating common systems and processes and driving supply chain efficiencies. The license change and strategic transfer is anticipated in early 2023. We are deploying our proven integration blueprint ahead of that date, creating common systems and processes and unlocking economies of scale. Funding changes have already been taking place with a free to fleet response given the macroeconomics with a 2040 bond of GBP 40 million repaid given rise to a GBP 20 million benefit. We are on track to deliver GBP 20 million per annum of synergies by 2025 across the group from the merger.
Turning to our business-to-business retailers, Pennon Water Services and water to business, we continue to see strong financial performance building on the base in ’21/’22. With a continued focus on the customer experience, the 2 businesses have the lowest customer attrition in the market and are winning new contracts in H1 ’22/’23, in summary, profitably growing in a competitive market.
As we look forward to PR24, whilst there are barriers to overcome with new legislative requirements and an ever-increasing need for resilience, driving significant investment, we are well placed to respond. There will be significant environmental investments driven by the new legislative requirements, responding to the government’s new Environment Act, alongside ensuring we continue with investments to secure ongoing drinking water quality given our quality-first priorities.
In summary, our half year has shown resilient performance for Pennon with robust fundamentals, ensuring we are well placed. We continue to execute our strategy and drive long-term sustainable growth for the benefit of all, outperforming our financial targets affords us the agility to reinvest and be fleet afoot, underpinned by a healthy balance sheet. At the same time, we are doing more for customers and communities than ever before. Our bills are lower than they were 10 years ago. We are helping our customers by accelerating our WaterShare+ plus second issuance, while supporting 100,000 of those customers most in need. And we’re delivering the step change we all want for our rivers and seas for the great Southwest and for generations to come.
We’re driving a record 30% increase in investment. We’re delivering GBP 225 million of outperformance, allowing us to reinvest in environmental schemes, all delivered with tons of people doing great things for customers and each other delivered in the right way. Thank you.
Operator
This concludes the presentation. We will now move to the Q&A with Susan Davy and Paul Boote will be happy to take your questions. I will now hand the floor to Susan Davy.
Susan Davy
Okay. Good morning, everybody. Thanks for joining us today at Pennon half year results 2022-23. Just to add quick summary from me. Obviously, we’ve reported another set of resilient financial and operational results on our long-term fundamentals as a group remain robust. We’ve driven a record amount of investment, 143 million in this half year, 30% higher than half year last year. I will continue to focus on our environmental performance since of the second year running. We have achieved a 100% bathing water quality, and our water fit program that we launched earlier this year. Healthy River and Seas has delivered now 50% reduction in storm overflow releases in the bathing season. And we’re on track this calendar year for a 30% reduction overall.
We’re out forming our regulation financial target by 225 million, allowing us to reinvest in environmental schemes, and for customers in this regulatory at delivery period. And cumulatively so far in K7, we’ve delivered over 78 million of benefits to customers at a time when customers need it. Underpin what we do is a robust balance sheet and we have sector leading efficient financing in place that’s driving regulatory outperformance. And all of that performance is underpinning our growth and our growth dividend. And we are announcing our insurance dividends say of 12.96 pence with a dividend yield of 3.8%. And with that, I’m going to open questions.
Question-and-Answer Session
Operator
[Operator Instructions] The first question comes from Sarah Lester at Morgan Stanley.
Sarah Lester
Hi, thanks so much for taking my question. And sorry, I am going to jump straight into the environmental aspect. Could you please just walk us through the steps needed to get from the current one star to the four stars by 2024? It’s obviously quite a steep trajectory, so any color would be great on how and why you’re confident that that’s achievable. Thank you.
Susan Davy
Yes. Good morning, Sarah, and thank you for the question. So I said we’re obviously investing significantly, and we are investing for our environmental performance. Now, some of that investment I talked about almost no releases aren’t covered by things in the environmental performance assessment. But what is covered in the environmental performance assessment are pollution incidents. And for the last 10 years, we have been one straight two star company. And predominantly that’s been as a result of our pollution numbers being higher than on a normalized basis, we’re targeted to achieve. So we’ve been working at pace over the last two years to reduce the number of pollution incidents that we’ve been incurring, and those pollution incidents if we don’t achieve target then we obviously end up with a either one or two star rating as a result of that.
Now, if you look beneath the star rating headline, the actual numbers of pollution incidents have been reducing, and have been reducing in 2021 from 2020. And they’re due to reduce again in 2022. So we’re driving kind of a sustainable reduction in those numbers. Now, in terms of the trajectory to get us back to target and to Four Star Company, I said previously that we on a trajectory to get there for the 2024 year, and that’s what we’re aiming for. We probably won’t see a change in our star rating this year, obviously the pollution numbers are getting better, but they’re still not back to the original trajectory, but they are getting there. So our star rating for 2022, I would imagine would, would stay where it is. But we are very much, focused on getting back to that four star position where we need to get to for the 2024 year.
Operator
Our next question is from Dominic Nash at Barclays.
Dominic Nash
Yes. Good morning, everyone. Couple of questions from me too, if I may. Firstly on the revenue number reduction with lower consumption and sort of change in customer behavior, and also with your increased sort of costs, the 2 million – 25 million pounds of sort of total improvements, sort of like coming through or our forms coming through, can you just give us some color on what of that is recoverable? Like is the revenue reduction going to be recovered in future years? And how much of your extra spend on decal and all the rest of it will be recoverable, the top mechanisms?
And the second question is the very quick one is, I sort of figure this through other, what’s happened about the legal action. Have we got any color on that? And do you still have that on your books for how much cash you could still get in if that goes your way. Thank you.
Susan Davy
Yes, morning, Dom. Thanks for those two questions. So, I think, Paul you’re going to pick those up.
Paul Boote
So well, I’ll start with your last one first. That’s pretty straightforward. So the legacy point from period was all resolved, I’m sure, over a year ago now, and it resulted in the cash inflow of 9 million that we will have reported at the time. So there is no further amounts to come or be recognized in any way. Totally closed. And then in terms of your second, I’m sorry your first question. So the first point was around revenue. Now clearly we flagged, in our announcement earlier this month, as well as again in the announcement that we are incentivizing customers in cobalt for all the right reasons to very much use less water and safe water to boost water resilience in that region. And with that incentivization, we will keep them £20. If we can have a reservoir that’ll 30% in that region by the end of the year. That actually itself could cost up to £10 million. That would be the cost of the incentivization. But then in addition to that, if customers are using massive demand plus all as we are trying to get the — change and trying to get that demand down and we are going to see a lower underlying revenue coming through in the period that we are currently now, through November and through December. And then also, we are hoping if you like that some of that behavioral change can be sustained and that would lead to lower, the new event for January to March as well in those regions. So that could be in the range of £10 million to £20 million in terms of a lower revenue number. It really does depend on the actual individual take and we will be monitoring that very closely.
Now in terms of revenue, as you know, within the final determination, the revenue is a set amount. And under the notice on those amounts have passed on to future years and recovered, whether it’s under — in future years, very much that will be trued up later in the regulatory period. And then your second point in your first question was on CapEx recovery. So in terms of the reinvestments, we talked about in our presentation today, we talked about £225 million of outperformance. And what we are doing is we are reinvesting elements off that. Now two particular areas where we are reinvesting is the £45 million in water pits, and we announced that back in April. And then today, we have been talking about £75 million and that’s associated with strengthening of the water resilience position. particularly targeted at Cornwall. Now within that £75 million that’s a £10 million financial revenue incentive, as I’ve already mentioned. And that leaves £65 million has CapEx focus. Now together with the £45 million is the CapEx investments effectively from that £2 million to £5 million of that performance.
Worth noting that the majority of our reinvestments, really that’s a shared element especially broadly between customers and shareholder. So that’s really hard. That impact is what will come through.
Operator
Our next question is from Mark Freshney at Credit Suisse.
Mark Freshney
Hello. Thank you for taking my question. Paul, on the debt refinancing that you have done post period end, could you talk us through that in a bit more detail, and where I’m getting to, I mean, real rate, fixed rates are higher or have been higher. And inflation has also been higher. So presumably, it would be swapping index-linked debt into fixed would be expensive at current levels. So can you talk us through the rationale and how that generates value there? Thank you.
Paul Boote
Yes, of course. And really there is two aspects of what we have been doing in terms of debt. So one is the swaps that you have just talked about there now, as you’re sort of indicating and whenever you enter into a swap, it’s on market and therefore there’s no value at the point in time you enter it, because it is literally an non-market swap. So we will be taking whatever the fixed rate is relative to the inflation index that we’ve swapped out. So really it’s not about value per say, that’s about managing volatility. So that will smooth out volatility in the P&L in terms of this — period, we going to reduce our exposure to further increases in inflation from where we are now.
And it’s really about inflation expectations as opposed to inflation deliver, because those expectations are bake into the market price. So to your point, from a value perspective, it being a swap, there is no value per say from the transaction, but it does provide, a lower level of overall exposure to doing index same debt from this point. So that’s the first point to note. And then the second point is we have repay, a Bristol water bond that was index [£240] million Bristol water bonds. We were able to do that a time when rates and particularly bond deals were very elevated, which very much reduce the termination cost of that bond. And that’s led to a £20 million gain, which will be coming through in the second half of the year. So that one very much giving value from that position.
Operator
Our next question comes from Martin Young at Investec.
Martin Young
Maybe we could just spend a little more time on the guidance for the full year, particularly sort of the interaction of slide 14 with what you set out in the technical guidance. Obviously, you’ve talked quite extensively before about the power costs. You’ve now put a number on the net financial expense expectations for the full year. But there’s obviously been a significant change of direction on revenue as Dominic has already alluded to. So if we sort of run through those in my back, the envelope calculation suggest that in the second half of the year alone, you’d have to see a revenue drop of about 40 million claims to get the full year number below FY ‘22.
And is that something that is going to feed through in a negative way to where consensus expectations for operating profits currently set. And of those significant items that you mentioned on slide 14, are they all within your definition of underlying or are some of them excluded particularly with reference to the [Indiscernible] water bond 20 million. Is that in underlying or outside it?
Paul Boote
Okay, so thank you for the question, Martin. So just taking that last point first, so those significant items, obviously, we’ve worked through that process. There’s process to go through in terms of internal governance and of course with auditors, but clearly, they are in their nature of what off. And in the past, for example, water share, when we’ve had big financial terminations, they have been non underlying. So you can take from that what you will. There’s a process to go through before we establish finally where we are on that. In terms of the broader guidance, I think we have perhaps if I take financing, yes, we have given a more specific range, I think, clearly we feel able to do that. I think locking those derivatives in is an element of that because it reduces the volatility. As you’ll have seen all companies that have indexing exposure, have seen their interest charge move around quite a lot this year. So putting those swaps in place has reduced that volatility and therefore increased certainty. And that’s why we’ve put a figure around that number. And we’re expecting that H2 financing cost, to be under what a H1 was, H1 being 75 million and our full year guidance being 130 million to 140 million. So financing costs coming down in the second half of the year.
In terms of revenue, I mean, I think, probably was, repeat what I said to Dominic, really in terms of guidance, what we’re doing is taking for the revenue incentive mechanism that we announced in November. And that really is around encouraging people to use less water and that will in itself reduce revenue. And that could be between, as I said, 10 million and 20 million lower in terms of our revenue expectation.
Martin Young
And the 20, the 20 million financial income on the Bristol water bond termination is that going through your financial expense line or is that going to be popped out as something that’s a one off?
Paul Boote
Well, yes, when we’ve had those in the past, they would’ve been one off. So as I say, we haven’t finalized those points cause they are obviously subject to review and audit. But that be for the second half. That’s where we’ve had similar one-offs in the past. That’s been the case.
Operator
Our next question comes from James Brand at Deutsche Bank.
James Brand
Hi, good morning. Thanks for taking my questions. I hope you’re all well. Two questions from me. Firstly on the 75 million of additional investment that you were highlighting today, of which 45 was announced, you said 45 was announced today and 30 million had been announced earlier in the month. And I wasn’t a hundred percent sure what the 30 million that was announced earlier in the month were referred to, whether it was, obviously had the announcement out on filling the reservoir, maybe it relates to that, but I I didn’t kind of feel that that was 30 million of additional investments. So maybe you could just clarify what, what that 30 million that had already been announced refers to. And then secondly Paul in your comments in the recorded presentation, when talking about power costs, those are comments that true up mechanisms should partly mitigate the impact of higher power costs. And I also just was looking for clarification on that cause I didn’t realize there was a true up mechanism for power costs, but maybe you were referring to some something else. Thank you very much.
Paul Boote
Okay. Thanks for the questions, James. So in terms of the 75 million, as Paul mentioned earlier in that 75 million is 10 million, which is the revenue incentive scheme, which obviously we announced earlier this month. And obviously that will be credit that we are giving to customers bills. So that’s the £10 million representing that sort of job campaigns. That is £65 million of which, the vast majority of that is investments into the asset base. So that’s the China trade hit that we have invested in. The new themes that are giving us extra resources across the Cornwall region. And so, there are schemes that we are just completing indeed in the next few days, which are increasing the take from some of those kind of playbooks out of the new ones or existing ones and recommissioning achievement works as part of that as well. And then into next year, we are again investing into mines, at quarries, some small-scale desalination.
Again, we have got experiences that, we have had on the out of — So that’s what value investment represents. But as I said in terms of the funding of that, given this change in £25 million of outperformance, that we have delivered then obviously a proportion of that is going towards this reinvestment. I’ll hand to Paul for next question.
Paul Boote
Yes. It’s just a mechanism. So that was referring to the general topics through a not any specific mechanism, Chase.
James Brand
Right. Okay. Fair enough. Great. Thank you very much.
Operator
Our next question is from Sarah Mitchell at HSBC.
Sarah Mitchell
Good morning. I just got a couple of questions. One is the £20 million on storm overflow investment, was that in the SD and that’s not additional spend. Secondly, and well done on refinance seen during the volatility and the energy companies have actually successfully done that and that’s real shareholder value. So good to see that. And my question on the £75 million using diesel, isn’t that quite a carbon intensive technology to use for water resources? Those are my three. Thank you.
Susan Davy
Okay. That’s about thirty. And, yes. Just to start with the first one, in terms of the — investment and I think £20 million euros that we mentioned. That column is £45 million at WaterShare that we announced back in April. Again, that’s part of this reinvestment that are out for us. So that is new investment, so you add note one in the regulatory plan per day. That is the investment going in there. So just to make sure we can deliver on that. Second question?
Paul Boote
But I think you touched on this.
Sarah Mitchell
I would just congratulate you, yes.
Paul Boote
Thank you very much. And then I think your final one was around.
Susan Davy
So the fee dilution is very sweet. So I think one of the things going through this year, which has been a record year in terms of climate impact for us is that, we need to have a diversified mix of sources. So in our region, 90.5% of sources, rely on surface walls, so reservoir and in particular taped from the river. So our reservoir region is ready for Cornwall, our largest strategic reservoir are currently used to obviously compensate the rivers, where not in a good state for this year given the particular dry and hot weather that we’ve had over this entire year. So I think in terms of the learnings from that is we need to have a diversified source of resources. And for us given our proximity to the water courses in the beaches, then it is important given that experience from the arts city, that we learn from some of those aspects. And desalination in terms of the approach for that, and the way the technology has moved on there is we believe the requirements for us to have that as part of our diversified source is going forward. And it’ll be really useful for us when we have the impact of the weather that we’ve had this year, that we’ve got the ability to draw those sources as required. So we’re investing in the China [Indiscernible] we’re investing in the mining water that — we’ve got in our region and we will be putting in retail as well. And it will be for us, again, another pioneering first — we’ve got it on the city and we’ll be investing in it for on the — and that region as well.
Sarah Mitchell
So you using quite low power technology [Indiscernible] technology?
Susan Davy
Well, you’re not wrong in sense it is power hungry, but what we’re looking at is how the renewable aspects of that will work alongside. If you think about the scale of what we’re talking about, we we’re probably talking about single digits, — in terms of what these small kind of plug and play containerized revers or most these plants are going to give us, but they’re going to be useful for us in the regions that have pinch points. So one of the areas where we have in North Cornwell an impact customers this summer, whilst we were delivering all the water that they needed that we did obviously, have the situation where we called upon communities to stop using their hose pipes.
That community of 3,500 customers that are impacted. Having desalination plan a small scale to help through those pinch point periods will be useful. And we are looking at how renewable aspects of that will work for those modules that we’re putting in.
Operator
Our next question comes from Martin Young at the Investec.
Martin Young
Just a quick follow up question on the guys specifically your thoughts on where the consensus is at this particular moment in time for operating profit in FY ‘23. I believe it should be around about 178 million. Given everything that you said this morning, are you now suggesting that that number is perhaps somewhat too high?
Paul Boote
Yes. I mean, I think, obviously it’s been quite a year in terms of the many moving parts and it’s been quite dynamic and obviously we provided guidance at the full year. We provided items, again, a trading statement in September. We then obviously have issued the announcement the start of November, and I think really her consensus perhaps needs to catch up with that announcement at the start of November. And then yes, reflect those particularly that revenue point, I think, is the key thing to reflect that expectation that revenue will and should be lower, because we are asking people to use less water. And that probably hasn’t fed through to consensus yet. And obviously we’ll be picking that up kind of where we’re out social.
Operator
Our next question comes from Dominic Nash at Barclays.
Dominic Nash
Hi there. Yes, sorry. Couple questions. On Cornwell your reservoir levels are very low indeed at the moment. So the first question is, is are you worried at all that we might actually run out of water in Cornwall? And then the second sort of leading question here is that your business plans that you are going to be submitting next year, I’m sure you’re already sort of setting what may or may not be in them. How much extra investment do you think we are going to need for both water resilience? So link to that first point, but secondly, with all your CSO issues, do you think that you might be needing to put through into your CapEx going forward?
Susan Davy
So in terms of Cornwall, we obviously have been doing a great deal of work this summer given at the climate impact that we’ve seen for a region that’s dominated by surface water at reservoir and River Tape. So what we need to do is make sure we’ve got a diversified mix of sources that we’re able to draw on, hence the investment in further ex quarries. ex mines, and some the small-scale detail, which is what we will be on with. Now in terms of the work we’ve been doing running alongside that, we’ve been working at pace with the regulators with government to make sure, that we’re in a good place given the river tape that we rely on, that our abstractions and our permits and our licenses are in a good position for when those rivers are plentiful that we can take from those rivers to recharge the reservoirs and to take it through into next year.
And I have to say the regulations have been, and government have been incredibly supportive to work at pace to get those in a good position. So it’s the abstractions working at pace to make sure the reservoirs are getting recharged going into next year. We’ve got interventions, that have just come on stream now, two of them, one, we’ve increased the tape that we can get from one of our ex-China play pick Fallon. We’ve done the same half, which another China play pick. We’ve got full control which we obviously bought in March this year, which is giving us about 10% of the needs of Cornwall going forward. And that in days coming on stream. And then we’ve got Port Riyadh, which we’ve recommissioned and it’s going to be up and running before Christmas, which again gives us another 10 cents for kind of Cornwell needs.
So, that plus the Stop the Drop campaign, which again, is going well and we are seeing customers reducing their demand, which has been pleasing to see given the investment we’ve put into that scheme. But obviously helpful in terms of the reservoir levels. That plus these schemes will get us into a better place going into the beginning of New Year. And then the new schemes that we’re looking at with the mining water, the quarry pit and the small sales desal will come online, for next year’s summer period. So we are moving at pace. Given we’ve got HO Store in March and that’s up and running as of as of this week, then you can see how quickly that we can respond and work at pace to get these resources up and running. So our trajectory for reservoir recharging and the ability for these other, the schemes to support next year, we we’re confident that that will be seeing us through into the future.
Now we have got schemes that come on and that investment that we are going to make. So the £65 million which is identified less than the £10 million, we’ve got on a customer incentive scheme, that should give us about half again of Cornwall’s needs going into next summer. So that’s the resilience that we are building at pace for next year. So that probably answers the question twofold in the sense that, yes, we can be able to get to get that to where we need to get to, and not having to rely so much on the climate. And that will get us there. But also in terms of the resilience in the future, we are building that resilience into Cornwall now. So in terms of future schemes, there will be more investment, which I’ll answer in a moment for the wider region, but in terms of Cornwall getting ourselves into good place now. And that’s the benefit of outperforming, having that agility and being able to move people to invest where you need to invest quickly on schemes that were in the business plan. And that gives you the ability to do that. And I have to say that, government amortized to be incredibly supportive and have been working at pace to help us to do that.
Dominic Nash
Can I just follow-up with that? Sorry. As you have been explaining all of that, I’ve been getting this kind of horrible feeling that, what you are doing using your outperformance elsewhere really probably should have been in — business plans. And I know that all folks were focusing on bills rather than on investment in the current review. But I’m looking at kind of going, this should have been 100% recoverable by you not 50% recoverable. And I’m looking at the numbers that you are looking at. This is our bookable, isn’t it? Or am I missing? Could you not actually go back and say, guys, this should have been in and you didn’t and we would have been in the next ramp and we are just bringing it forward. So it gives us 100% recovery for it. And by the way, is over 10% of our revenue?
Susan Davy
So I think, Doug, what’s going on making sure we are delivering for all of that, all our stakeholders. We are delivering these double based returns. We said we were going to do that. We have our performance over and above that. And we are reinvesting it into the asset base to deliver. In terms of what we experienced, in this region this year, and if you look at earnings reports on it, this has been a record year in terms of climate impact. So because it has been foreseen, well it’s happened. So we need to invest. We have got the engines through it, so we are getting on with it. So I think that kind of deals with that aspect.
In terms of what comes next and future investment you might, there will be a requirement and having experienced this. And there will be a requirement for us to invest further. And I’ve spoken previously about our acquisition of Bristol Water and the ability to then think about the 22 reservoir up in Bristol. And that opens up opportunities for us to develop the resource there that helps West Water with its resource in requirements that then perhaps freed up after reservoir we share with unprovable that again allows reservoir volumes to be used at South and West as required. And there will be obviously costs for that going forward that will be part of the future plan. So I think, as a quite honest sum, we are in a good place. We are outperforming. We are investing shareholders again what we said it would get, doubling the base return. And we will obviously look to the new plan to sell the — going forward.
Operator
Our next question is from Bartlomiej Kubicki from Societe Generale.
Bartlomiej Kubicki
Just one question from my side. I just wonder what your intention to do with the inflationary increase in tariffs for next year, whatever you’re going to — whatever you’re going to undertake the full inflationary increase, which could be around 10% or whatever you’re planning to do some deferrals. And if so, how would it work? Thank you.
Paul Boote
So in terms of tariffs, obviously, we’re very much aware of the cost of living crisis and the impact that has on our customers, probably most notably from energy bills, not from water per say, but that said, obviously it’s a challenging time for everyone. So we’ve certainly when we prepared our — tariff, we’ve looked very hard at what levers we have and where we can try and mitigate some of that impact particularly in one period alone. So we have been speaking with the regulator in that regard and seeing what we can do for deferrals. What we’re proposing would effectively defer elements into the next regulator period on and NPB mutual basis. But we are certainly looking at what we can do, and we’re trying to reach an outcome which would mean both crystal water and Southeast Water average bills by certainly less than the headline rate of inflation. So yes, we are actively seeking to do that.
Bartlomiej Kubicki
Okay, thank you. And maybe if I may one more. Do you think in why speaking on the next regulatory period, the regulator will be again focus on affordability or this time the focus will maybe increase more towards higher investments, given whatever you are saying on water is Island and what has been sent on the CSOs issues?
Susan Davy
So good question. I mean, I think, we always have to be mindful of affordability. You’ve got to look at the cost of living crisis and the support that customers need is obviously quite acute through that. And that’s twofold really. One is making sure that we are able to target those customers who find themselves in difficult circumstances and make sure we’re giving them the support that they need, but also being efficient with what we deliver. Now that efficiency, helps in terms of mitigating bill increases, but you’re right, there is investment on the horizon given the government legislation in the area, certainly around the environmental aspects that we’ll need investment. So we will obviously be seeking to get the balance right for the next business plan. But yes, there will be more investment that we see on the horizon. So how efficient we are with that is going to be incredibly important, and how we protect those customers who find themselves in difficult circumstances is going to be part and parcel of that plan.
Operator
We have no further questions on the call at this time, so I will hand the floor back to Susan.
Susan Davy
Okay. Thank you very much. Well, thank you for joining us this morning, as you can keep my results. It was a set of resilient financial and operational results and our long-term fundamentals of the group remain robust. Thank you.
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