Chairman's statement released on Company's progress - 30/11/2016

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Sutton and East Surrey Water -

Interim results for the six months ended 30 September 2016

Chairman’s Statement

Summary

  • Good progress with latest capital investment programme
  • Excellent health and safety performance
  • Outperformance of Outcome Delivery Incentives for supply interruptions and bursts
  • Industry leading performance on service to developers
  • Environmental education programme ahead of target
  • Disappointing performance on Service Incentive Mechanism being addressed
  • Water resources and asset performance healthy 
  • Preparations for competitive market for business customers on track
  • Operating profit up £0.3m to £10.7m

 

Financial performance

Turnover rose 2.5% (£0.8m) to £32.4m (2015 - £31.6m). Water supply income increased by £0.2m (0.7%) to £29.7m, reflecting the 2.0% increase in Wholesale charges permitted under Ofwat’s Final Determination for the last Price Review (PR14), including the impact of allowed inflation (1.05%). Growth in demand from new properties has been offset by savings customers are able to make from choosing to have a meter and lower usage by metered customers over the summer period. Other income rose by £0.6m to £2.7m. Operating costs increased by £0.5m (2.4%) to £21.7m (2015 - £21.2m), largely due to higher manpower costs (reflecting the agreed pay award from 1 April 2016 and investment in resources for Retail services and preparations for the opening of a competitive market for business customers from April 2017). Operating profits increased by £0.3m to £10.7m.

 

Net interest costs for the half-year increased by £0.5m to £3.3m (2015 - £2.8m), largely due to the impact of a small increase in the rate of inflation on the charge for indexation of the Company’s £100m index linked bond. Other interest receivable, which includes income from our pension fund investments (offsetting a small part of the pension costs included within operating costs) was £0.5m (2015 – £0.4m). Profit before tax fell by £0.1m to £7.9m. The Government's enactment of a reduction in future corporation tax rates to 17% reduced the provisions the Company makes for tax payable in future years by £1.4m, resulting in a net tax credit for the six months of £0.6m (2015 - charge of £1.6m). Largely as a result of these tax changes, profit after tax increased by £2.1m to £8.5m.  A dividend of £1.8m was paid in the period (2015 - £1.8m).

 

Net cash from operating activities remained strong at £11.8m (2015 - £11.6m). The Company has continued to make good progress with the capital investment programme for the five year regulatory period, with £9.0m invested in the six months (2015 - £8.6m). Corporation tax paid in the six months was £2.0m (2015 – £1.7m). Cash and cash equivalents increased by £0.3m to £17.7m (2015 - £17.m).

 

Output Delivery Incentives

The Company has continued to focus intently on the commitments we made to our customers in our last Business Plan. The performance measures reflected in the Outcome Delivery Incentives (ODIs) included in Ofwat's Final Determination for the 2015-20 regulatory period have remained the central focus of the Company’s monthly performance reporting to the Board, and are prominent elements of the bonus schemes shared by all our employees. 

 

I am pleased to report that the Company continues to perform well against the ODIs for drinking water quality, supply interruptions and the number of burst mains.

 

In the nine months to the end of September, our compliance with the Drinking Water Inspectorate’s definitions for overall water quality stood at 99.98%, representing just two failures out of approximately 11,000 tests for the quality of drinking water measured at customers' taps. The two failures were for nickel and iron that for nickel being caused by the materials used in the customers’ own taps rather than the quality of the water supplied. Two failures in a single sample taken from a service reservoir arose due to surface water infiltration. The reservoir was removed from service temporarily whilst remedial works and cleaning were carried out.  All tests undertaken on samples taken from our treatment works and other supply points in our network met every prescribed standard. Whilst performance is better than both the level at which financial penalties might be incurred and our own (higher) internal targets, we maintain the highest level of vigilance throughout the business to ensure than we continue this excellent performance to the end of the year.

 

Supply interruptions to the end of September were on average just 1.6 minutes per property served, similar to the step-change in performance achieved last year, and less than 15% of the target for the full year (of less than 14 minutes per property). Ensuring that all supply interruptions affect the minimum number of properties for the shortest possible time remains at the heart of all network operations, whether for planned events (such as mains renewals or leak repairs) or reactive actions (such as repairing a burst main). Maintaining such high standards of performance through the winter months will be more challenging, but we are encouraged by our performance last winter and aim to achieve a financial reward under this incentive mechanism for the second consecutive year.

The number of bursts that have occurred in the first six months of the financial year remains low, at less than 30% of the number expected for the full year, and we remain resolute in seeking to minimise the number that do occur.  As with supply interruptions, the winter months typically prove much more challenging (especially if the weather is particularly cold), but our experience last winter (when we continued to have less bursts than our target) proved the value of many years of focused investment in renewing those parts of our network most susceptible to bursts. We consider than we are in a good position to meet the familiar challenge of winter weather.

We have one of the lowest leakage levels in the country due to our continuous focus on this area, which we know is important to our customers. In 2015/16 we kept leakage below our target for the fifth consecutive year and entered the new year determined to keep leakage below a new, tougher target for the current year. The unusually mild weather in September saw overall customer demand remain high and continued night use undermined our ability to measure actual leakage levels accurately. However, we estimated that average leakage for the six months to the end of September was 23.7 Ml/d, below our target for the full year of 24.3 Ml/d, but not as low as we would like as we enter the critical winter period – when any significant cold spell can trigger a substantial increase in bursts and leakage. Nevertheless, we remain of the opinion that our long track record of investment in mains renewal, pressure management, and effective leak detection and repair techniques will stand us in good stead for the challenges the winter weather can bring and have focused our efforts on rapid repair of leaks as they are identified in an effort to drive leakage down even further while the weather remains relatively benign.

 

The incentive target for customer contacts in relation to the taste, odour or discolouration of water continues to prove challenging. In the nine months to the end of September we had received 299 such contacts, a reduction of over 12% on the previous year, but still 85% of the 350 included in our Outcome Delivery Incentive for the full year. Ongoing analysis of the contacts received still does not identify any dominant overall cause of contacts, and actions continue across many activities to reduce the need for customers to contact us for this reason. Whilst the actions already undertaken have reduced the number of contacts received compared to last year, we continue to seek new and innovative solutions to enable essential network maintenance and upgrade work to continue whilst avoiding causes for customers having to contact us about the appearance of their water.

 

Customer Service

Meeting our targets for the level of service we provide when customers need to contact us for any reason remains our single biggest challenge. Whilst we have invested heavily in additional resources for our Contact Centre and have made significant use of a supplementary third party call handling facility, we are still not handling the volume of contacts we are receiving promptly enough.  Delays in our responses to customer contacts mean that we still have more complaints than we allowed for in our Outcome Delivery Incentive, although the level is down on last year and at 4.2 complaints per 1,000 customers is still well below the industry average. Nevertheless, these circumstances are likely to have contributed to a disappointing overall 17th ranking (out of 18) across the industry in the latest independent Service Incentive Mechanism survey undertaken for Ofwat. A concerted effort to improve turn-around times for customer enquiries and a programme of call-backs to keep customers updated on the progress of work will be key to short-term improvements, while a programme of process and performance improvements addresses the underlying issues.

Despite these recent challenges, the regular monthly survey of all our customers continues to show high overall levels of satisfaction, with 92% of customers surveyed satisfied with the level of service provided by the Company and only 9% of customers considering our charges do not represent value for money. We will continue to seek to demonstrate good value for money to all our customers.

Meanwhile, a number of other initiatives are helping to improve the service we provide. Our Water Support scheme continues to enable us to help customers who have genuine difficulty affording their water bills by offering a 50% reduction in charges. The 6,200 customers receiving help in this way in the last six months is 24% higher than the target we set ourselves in our Business Plan and is contributing to keeping the amount that ultimately proves uncollectable from customers at the very low levels we have historically achieved. For the six months to the end of September, bad debt costs were only 0.62% of turnover, well below our target of always being below 1% of turnover.  Our updated paperless electronic billing service, launched early in 2015, now has over 37,000 registered customers, enabling easier access to current and previous bills and helping us reduce our carbon footprint by issuing less paper.

Water resources and demand

So far this year, the weather has once again been relatively benign. We started the year with water levels in our groundwater sources above average and with our Bough Beech reservoir full. Heavy rain in May and particularly in June more than compensated for below average rainfall from July through to the end of September and aggregate rainfall in the summer period was 5.7% above the long-term average. We enter the autumn and winter period, critical for replenishing our groundwater sources and our river-filled storage reservoir, with water levels in our groundwater sources above long term average. Assuming average rainfall this autumn and winter, we do not anticipate any issues about the availability of water for next year.

 

Our customers’ demand for water in the six months to the end of September was 3.8% higher than that in the previous year. This was largely due to the three months from July to September having below average rainfall, rather than to short spells of high peak demand. The highest demand in any one day this summer was 200.3Ml, some 10.5% below the peak of 223.9Ml in 2015. Healthy resources, full treatment capacity and a well-maintained distribution network meant that we continued to be able to meet customer demand comfortably. We anticipate that average demand for the whole year will be 162 Ml/d, which is 3% above the long-term average.

 

Water efficiency, sustainability and corporate responsibility

The Company has committed to extending its long-standing and highly successful schools education programme into a broader environmental education Outcome Delivery Incentive, with a target of reaching at least 8,000 participants in the current year, rising to 10,000 participants by 2019/20. At the end of September, 7,799 individuals have participated in our environmental education activities, nearly 500 more than at the same time last year and well ahead of the programme for achieving our target of 8,500 this year. We are confident that we will exceed our target for environmental education for the second successive year.

The Company continues to promote water efficiency measures as an important part of its demand management strategy and in the six months to the end of September estimated savings of 0.12 Ml/d had been achieved, 45% of the target for the full year.

This year we launched a new water saving programme in household properties, in partnership with Save Water Save Money. We completed 395 Home Water Efficiency Checks (HWEC) in the Worcester Park area between January and March. The next phase of HWEC, which started in Morden in September, has the aim of completing 1,000 visits - our largest ever programme. We expect this to be complete by mid-December. We continue to work closely with six other water companies in the South East England Water Efficiency Partnership, now renamed Save Water South East, to achieve greater collective action across the region to complement individual programmes within each company. We have also continued to support the Water Resources in the South East partnership which aims to provide combined resilience in the event of a serious water supply incident

 

Health and safety

The health and safety of our employees, contractors and members of the public who have contact with our business remains a key area of focus for the Board.  Reports of potential hazards and accidents, and the remedial measures taken to avoid them turning into actual accidents, are reviewed at every Board meeting. On site risk assessments for all our operational teams and our continued investment in training courses and safety audits evidence our drive for continuous improvement in health and safety at work.

I am therefore pleased to be able to report that in the past six months we have had no accidents involving an absence from work of at least one day and no significant injuries under the Reporting of Injuries Disease and Dangerous Occurrences Regulation (RIDDOR).

Capital investment

In the last six months we have made further good progress on the capital programme for the current five year period. We have invested £9.0m (2015 - £8.6m) and have made good progress across our key investment plans. Our major project to enhance the capacity and resilience of our water treatment works at Woodmansterne is well into the construction phase, with the off-site lagoon now fully operational, excavations for the new filter house well advanced and foundations being laid. Under our ongoing age and condition based mains replacement and reinforcement programme, 3.2 km of main and 383 service transfers had been completed by the end of September.

A total of 2,588 meters had been installed in properties under our schemes for installing meters at a customer’s request or when there is a change in the occupier of a property. This is somewhat lower than we had planned for at this stage in the year, largely due to fewer customers coming forward to ask for a free meter to be installed at their home. We have, therefore, started targeted mail-shots and other promotional techniques to encourage further volunteers to take up what is, essentially, a risk free option (with a right to revert to unmetered charges after a year if their bill turns out to be higher with a meter). There is no doubt, however, that other options for achieving our five year target will need to be pursued in future years.

Market reform and other regulatory developments

Ensuring that the Company is ready for the opening of a competitive market for all business customers in April 2017 has been a major focus in the last six months. We have committed significant resource to the work necessary to ensure that the Wholesale part of our business will not only be able to meet the service standards demanded by Retailers operating in the competitive market, but will be able to do so consistently for all Retailers, ensuring the requirements of a "level playing field" are being met. Briefings on the requirements of the competitive market have been held for all employees and in depth training provided for teams that are fundamentally affected. Our "Wholesale Service Desk" was established to act as a primary point of contact for Retailers in time for the opening of "shadow" market operation on 3 October. Meanwhile the enhancement of customer and premises data, including assessment against eligibility criteria, has been undertaken sufficiently rigorously that I am pleased to note that we were the first major incumbent in the industry to complete the upload of our data into the central market system ready for the start of "shadow" market operation.

 

We have been clear from the outset that we regarded the opening of a competitive market for business customers as an opportunity rather than a threat and have pursued a strategy to enable us to compete successfully. We recognised at an early stage that this would require fundamentally different skills and culture from those that made for a successful Wholesale business, and that capability is being built in a separate associated unit with a distinctive identity of its own. SES Business Water now has a strong and core team of ten employees, drawn principally from outside the Company, with the skills and experience to thrive in a new competitive market. From September, SES Business Water has been providing retail services on our behalf to the business customers in our area. From 1 April 2017, SES Business Water will acquire the right to serve these customers in its own name, as the foundation of an offering made available across the competitive market in England and Scotland. We have therefore applied to Defra to "exit" the market on 1 April 2017, with the aim of transferring our existing customers to SES Business Water.

 

Meanwhile our associated company has successfully applied to Ofwat (and the Water Industry Commissioner in Scotland) for Licences to serve eligible customers throughout the competitive market and has been actively pursuing opportunities to acquire new customers in Scotland prior to the market opening in England. I am pleased to report that this programme is making good progress, with new customers worth over £1m pa already signed-up, including some well-known High Street names. We remain positive and enthusiastic about the prospects for this new business.

 

A competitive market already operates for services provided to house builders and other property developers, and we have always sought to be responsive and flexible in meeting the needs of these customers. We were, therefore, disappointed by the results of the first industry-wide survey of service levels in which we were able to participate. Our response was, however, immediate with a dramatic impact on the results of subsequent surveys. For four of the last five months we have achieved 100% compliance with the service levels we have promised and have consistently achieved industry leading rankings. We remain committed to maintaining this level of performance in future.

 

Our Customer Scrutiny Panel has continued to build on the invaluable form of customer engagement that our Customer Challenge Group was able to bring to our proposals throughout the PR14 Price Review process. Under the Chairmanship of Graham Hanson, a local resident and customer, the Panel has been scrutinising our performance against the commitments we have made to customers on a quarterly basis, acknowledging the areas in which we are performing well and challenging us on areas where we are not meeting our expectations. A summary of the proceedings of each meeting of the Panel is published on our website, together with the Panel's terms of reference and details of the members of the Panel, and can be found at http://www.waterplc.com/pages/about/customer-scrutiny-panel/

 

Apart from reviewing the Company’s performance in the last six months, our Customer Scrutiny Panel also contributed to the Company’s published approach to assurance of its performance reporting, including our review of the process in its new form in 2015/16. We await Ofwat's assessment of the strengths and weaknesses of company monitoring frameworks in the first year of the 2015-20 period, but remain committed to continuous open engagement with customers and other stakeholders. The pattern of stakeholder briefings and open days at our Bough Beech treatment works established last year has been continued in the last six months and we have been pleased with the level of community engagement and positive feedback we have received. As a local company, deeply embedded in the communities we serve, we feel we have an instinctive understanding of their varied needs and expectations, but direct engagement at all levels across the business enriches and updates our understanding in an important manner. Further briefings, site visits and other engagement mechanisms are already being planned.

 

We continue to seek to work constructively to progress other regulatory changes aimed at benefiting our customers. We have welcomed Ofwat’s collaborative approach to the changes to company licences needed to implement the policy decisions for the next Price Review (PR19) outlined in May, and are strong advocates of the collaborative approach to the early development of cost assessment models and sharing of financial modelling tools for PR19. Improvements in the dialogue over enabling mechanisms cannot, however, obscure some of the fundamental issues the industry will face for the next regulatory period and we remain to be convinced that increasing complexity of economic controls and reliance on market mechanisms can deliver the step change in efficiency across the industry that will enable enhanced  investment in resilience and maintain the attractiveness of the industry for investors at the same time as reducing bills for customers. We look forward to clarity on the way in which Ofwat's proposed approach to future funding allowances will accommodate the historic financing decisions taken by many of the smaller local water companies in the interests of their customers.

 

Governance and organisational changes

Last year we completed the process of refreshing the membership of the Board in a planned and orderly way, consistent with the compliance with Ofwat’s principles for Board Leadership, Transparency and Governance. The only subsequent change has been the resignation of Seiji Kitajima as one of our two shareholder-nominated Directors on 31 October. Although a member of the Board since only October 2015, Seiji has worked closely with the Company since the acquisition by Sumitomo Corporation in February 2013 and has made an invaluable contribution to ensuring a strong mutual understanding of the needs of the Company and its shareholders. We wish him every success in his new role in Japan.

 

Following completion of the new process Ofwat has introduced for all new non-executive appointments to company Boards, we are pleased to welcome Mr Yoichi Sakai to the Board from 1 November 2016.

 

Future challenges

The Outcome Delivery Incentives included within Ofwat’s PR14 Final Determination quite properly pose real challenges in all areas. We are pleased with the progress and outperformance in some areas that I have already described, but recognise the work still to be done to achieve our targets in others. Undoubtedly our biggest challenge at present is our performance against the Service Incentive Mechanism, which is clearly driving up standards across all companies. We are determined to restore our performance to above industry average and avoid any penalties for below average performance when it comes to the next Price Review.

 

We made a strong start to meeting our own efficiency targets by achieving savings to offset inflationary pressures and unavoidable cost increases, without jeopardising the quality or security of service to customers.  We have purchased all our electricity needs for the current five year period at a price below that allowed in current price limits and have reinvested the savings in ensuring that our efforts to improve service to customers who need to contact us for any reason - and our preparations for the future competitive market for business customers - are well-resourced and comprehensive. We have also eliminated the risk of future pay awards escalating by agreeing a framework for pay awards for employees for the whole of the current five year period based on the RPI used to fix our prices to our customers and introduced an employee bonus scheme linked to targets shared by all levels of the organisation. Nevertheless, costs over which we have little control continue to exert pressure, of which the publication of draft valuations for business rates effective from 1 April 2017 (with reduced transitional relief provisions) is a recent unwelcome example. Investment in new technology and processes - and the encouragement of innovations from all our employees - will continue as a means of offsetting such pressures.

 

We have always concentrated on ensuring that we obtain maximum long term benefit from the capital expenditure allowed within our price limits and continue to apply this approach to our new investment plans. The retendering and award of our infrastructure services contract, based on a partnership approach involving shared rewards and penalties for achievement or otherwise of our ODI targets and co-location of contractor and our own teams, is an important milestone in ensuring that we will be able to maintain our strong track record of bringing projects in on time and budget, and gives us confidence that this familiar challenge can once again be met.

 

I have already described how we regard the new competitive market for all business customers from April 2017 as an opportunity rather than a risk for our business.  We are under no illusions, however, that competitive pressures will bring real challenges for the Wholesale parts of our business as well as for the new Retail business, SES Business Water. We will continue to enhance our internal processes and look to the period of "shadow" market operation as an invaluable opportunity to establish effective procedures for our interactions with the central market operator as well as with existing and future Retailers.

 

Looking further ahead, a new Price Review always brings new challenges and uncertainties, as regulatory methodologies change and new rewards and incentives are introduced. We see PR19 as no different - and consider that we are making good progress with our preparations. We look forward to ensuring that our customers' interests remain at the heart of future plans.

 

Risks and uncertainties

The principal risks facing the Company in the next six months are those associated with the normal course of business and the work needed to ensure we are ready to participate in the competitive market for business customers after April 2017. The unpredictability of the weather is a regular uncertainty at this time of the year. Despite the healthy position of our water resources this autumn we still need winter rainfall for a full recharge, while severe frosts could crack many pipes, having a damaging effect on our network and requiring more resources to manage leakage. Affordability remains an issue for some customers, despite our Water Support tariff and flexible payment options. Continuing declines in real incomes at a time when inflation is expected to pick up will only exacerbate this, and may once again impact on the levels of debt and collection costs - factors which may ultimately result in increased levels of bad debt.

 

Whilst the Company is pleased with its preparations for the competitive market for business customers after April 2017, uncertainties still remain around the performance of central market systems and the response of business customers to the new opportunities open to them.

 

Nationally, the country remains in a period of some economic and financial uncertainty following the Referendum decision in favour of leaving the European Union. Whilst it is still too early to assess what the impact on the Company will be, we continue to expect to be well-placed to respond to such external challenges.

 

Finally, I should like once again to pay tribute to the continuing dedication and commitment of all our employees, upon whom the Company depends to deliver the high standards of customer service that we always aim to provide.

 

Jeremy Pelczer

30 November 2016

 

 

 

 

 

 

 

 

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