Chairman's statement released on Company's progress - 30/11/2017

Sutton and East Surrey Water -

Interim results for the six months ended 30 September 2017.

Chairman’s Statement

Summary

·         Good progress with capital investment programme

·         Strong health and safety performance

·         Excellent asset condition and performance

·         Outperformance of Outcome Delivery Incentives for supply interruptions and bursts

·         Environmental education programme again ahead of target

·         Programme in place to address disappointing performance on Service Incentive Mechanism

·         Water resources currently below long-term average levels

·         Service to competitive market for non-household customers maintained

·         Business Plan for next Price Review on track

·         Profit before tax down £0.4m to £7.4m

Outcome Delivery Incentives

The Company has retained its focus 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 one failure out of approximately 11,000 tests for the quality of drinking water measured at customers' taps. All tests undertaken on samples taken from our service reservoirs, 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 that we continue this excellent performance to the end of the year.

Supply interruptions to the end of September were on average just 21 seconds per property served, continuing the step-change in performance achieved in the last two years, and less than 3% of the allowed upper limit for the full year (of less than 12 minutes per property). Ensuring that 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 (including mains renewals and leak repairs) or reactive actions (such as repairing a burst main). Maintaining such high standards of performance through the winter months is always more challenging, but we are encouraged by our performance during the last two winters.

The number of bursts that have occurred in the first six months of the financial year remains relatively low, at just over 26% of the number expected for the full year, and we remain focused on minimising 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 over the last two winters (when we continued to have fewer bursts than our maximum allowed bursts under our regulatory limits) proved the long-term value of many years of focused investment in renewing those parts of our network most susceptible to bursts. We consider that 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 very important to our customers, as well as to us. In 2016/17 we maintained our record of staying at or below the maximum allowed level of leakage and entered the new year determined to keep leakage below a new, lower maximum allowed level for the current year. Average leakage for the six months to the end of September is estimated to be 23.7 megalitres a day (Ml/d), the same as for the equivalent period in 2016 and below our maximum allowed upper limit for the full year of 24.2 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 sustained 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 maximum allowed upper limit 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 314 such contacts, an increase of just 15 on the previous year, but still nearly 90% of the 350 included in our ODI for the full year. Ongoing analysis of the contacts received still does not identify any single major overall cause of contacts, with suspected or confirmed third party hydrant use, known network activity and customer side issues being the largest identified triggers for customer contacts. Notwithstanding the small increase in contacts since last year, the actions already undertaken have reduced the number of contacts received compared to historic levels, and we continue to seek ways to allow essential network maintenance and upgrade work to continue whilst avoiding causes for customers having to contact us about the quality of their water.

Customer Service

Meeting our targets for the level of service we provide when customers need to contact us for any reason continues to be our single biggest challenge. The investment we have made in additional resources and a new management team for our Contact Centre has had a welcome impact on our ability to respond promptly to customers’ calls, with 87% of calls now being answered within 30 seconds and less than 2% of calls being abandoned before we have been able to answer. Improved call handling performance has meant that unwanted contacts have remained below the maximum allowed upper limit and complaints have started to reduce back towards our traditionally low levels. However, they are still too high at 6.9 per 1,000 customers, being higher than last year’s 4.2 and higher than the 3.5 allowed for in our ODI. These circumstances have contributed to an extremely disappointing, and candidly unacceptable, overall 18th ranking across the industry in the latest independent Service Incentive Mechanism (SIM) survey undertaken for Ofwat. A wide-ranging programme of process and performance improvements is in train to address the underlying issues, based on a detailed analysis of the causes of customer dissatisfaction revealed through our own weekly surveys as well as the independent surveys conducted for Ofwat.

Despite these on-going challenges, the regular monthly survey of all our customers continues to show high overall levels of satisfaction, with 90% of customers surveyed satisfied with the level of service provided by the Company and only 5% 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, several 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 6,400 customers receiving help in this way in the last six months is 28% higher than the minimum 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 0.77% of turnover, comfortably below our maximum allowed of 1% of turnover. Our updated paperless electronic billing service, launched early in 2015, now has 42,000 registered customers, enabling easier access to current and previous bills and helping us reduce our carbon footprint by issuing less paper. We continue to encourage as many customers as possible to register.

Water resources and demand

The level of our water resources has been an ongoing concern this year. Although we started the year with our Bough Beech reservoir full, high demand in early summer meant that the levels have been below the long-term average since then. At the end of September, the reservoir level was 4% below the long-term average for the time of year. Meanwhile, our groundwater sources (which supply 85% of all the water we treat) have been below long-term average throughout the year. We therefore enter the autumn and winter period, critical for replenishing our groundwater sources and our river-filled storage reservoir, requiring regular rainfall throughout this critical recharge period to ensure that we have sufficient water to meet customer demand for next year. Whilst rainfall has been 115% of long term average for the period April-September 2017, we are not allowed to replenish our reservoir from the local river during this period.

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 short spells of high peak demand in June and July when demand reached a daily peak of 218 megalitres, some 8.8% higher than the peak in 2016. We anticipate that average demand for the whole year will be 164 Ml/d, which is 1% above the long-term average. We continue to encourage customers to move to meters and to provide guidance on water efficiency, as noted below, as a way of longer term water demand reduction.

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 ODI, with a target of reaching at least 9,000 participants in the current year, rising to 10,000 participants by 2019/20. At the end of September, 5,321 individuals had participated in our environmental education activities, comfortably ahead of the programme for achieving our target of 9,000 this 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 0.09 Ml/d had been achieved, 29% of the target for the full year.

This year we have taken a different approach to our Home Water Efficiency Check programme, carried out in partnership with Save Water Save Money. Our associated company, SES Home Services, is now carrying out the visits, which involve the installation of a range of devices, behavioural change advice and the repair of simple leaks. The programme started in September, with around 400 visits planned before the end of March 2018. Customers are referred for a visit following a high consumption query or a website enquiry. In the new year, we also plan to complete 300 visits in housing association properties in association with Cenergist. These visits, alongside savings gained from the education programme and our savings calculator, are aimed to achieve savings at least equivalent to the 0.3 Ml/d target by the end of the year.

We continue to work closely with other water companies in the region as part of Save Water South East, to achieve collective action to complement individual company programmes, including the ThinkWater campaign launched on social media in the spring and two workshops held for local authorities and housing associations.

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.

In the past six months we have had only one accident 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).

Financial performance

Turnover fell 1.9% (£0.6m) to £31.8m (2017 - £32.4m), principally due to lower income from developers (down £0.4m), reflecting variability in the timing of work on new developments.  Water supply income was unchanged at  £29.7m, as the increase in wholesale charges permitted under Ofwat’s Final Determination for the last Price Review (PR14) and 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. Operating costs increased by £0.7m (3.0%) to £22.3m (2016 - £21.7m), including an increase of £0.3m (5.8%) in manpower costs (reflecting the pay award from 1 April 2017 agreed as part of a long-term pay deal in 2015 and continued investment in resources for Retail Services). Underlying operating profits fell by £1.2m to £9.5m (2016 - £10.7m). The sale on 1 April 2017 of the non-household retail activity to an associated company - trading as SES Business Water - generated a one-off profit of £2.0m for the appointed business (SES Water).

Net interest costs for the half-year increased by £1.1m to £4.4m (2016 - £3.3m) due to the impact of an 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 £0.4m (2016 – £0.5m). Profit before tax fell by £0.4m to £7.4m. The taxation charge of £0.7m for the half year represented a return to a more normal effective tax rate compared to the tax credit of £0.6m in 2016 (when the Government's enactment of a reduction in future corporation tax rates to 17% reduced the provisions the Company made for tax payable in future years by £1.4m). Largely as a result of these tax changes, profit after tax reduced by £1.8m to £6.7m. 

An ordinary dividend of £1.8m was paid in the period (2016 - £1.8m). In addition, a one-off dividend of £2.0m was paid on 3 April 2017 from reserves built up over a number of years in non-appointed activities.

Net cash from operating activities of £17.7m was boosted by receipt of £2.0m from SES Business Water for the acquisition of the non-household retail activity, lower cash tax payments and higher accruals associated with the increase in capital investment (2016 - £11.8m). The Company has continued to make good progress with the capital investment programme for the five-year regulatory period, with £14.4m invested in the six months (2016 - £9.0m). Corporation tax paid in the six months was £0.5m (2016 – £2.0m). Cash and cash equivalents decreased by £3.9m to £14.1m (2016 - £18.0m) as surplus cash from the Company’s five-year term loan was deployed in the accelerating investment programme

Capital investment

In the last six months we have continued to make good progress on the capital programme for the current five year period. We have invested £14.4m (2016 - £9.0m) and progressed in all our key investment areas. Our major project to enhance the capacity and resilience of our water treatment works at Woodmansterne is proceeding rapidly, with the new filter house and the filters themselves constructed, new raw water pumps in place and associated replacement generators and other equipment being delivered to site on a regular basis. Our strategic investment in new mains to improve the resilience of our network has moved from planning into on-site delivery, with the first of the mains now substantially complete. Meanwhile our ongoing age and condition based mains replacement and reinforcement programme had completed 11.6 km of main and 570 service transfers in the six months to the end of September.

A total of 2,781 water 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 a further round of 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 unmeasured charges within two years if their bill turns out to be higher with a meter).

Market reform and other regulatory developments

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 have made for a successful appointed business, and built that capability in a separate unit with a distinct identity of its own. Therefore on 1 April 2017 the Company 'exited' the competitive market under arrangements established by Defra and supervised by Ofwat. SES Business Water purchased the right to serve eligible customers in our appointed area at a price reviewed and approved by the Company’s Independent Non-executive Directors using the best available market information and valuation techniques. The Company continues to supply wholesale services to SES Business Water (and other retailers now acquiring eligible customers in our supply area) under arms-length trading arrangements put in place prior to the market opening.

Ensuring that the Company was ready to supply wholesale services to a potential range of organisations in the competitive retail market was a major focus last year. The six months since market opening has proved the value of this investment, with our new Wholesale Service Desk achieving 86% compliance with published service levels for all retailers. Clearly there are further improvements that can be made to ensure full compliance with financially-incentivised service levels next year, but we are pleased that this most significant change in the last 30 years in the way in which water and wastewater services are provided to organisations has been achieved without material disruption or inconvenience to businesses, charities and the public sector in our supply area. 

A competitive market has operated for many years 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 have maintained a high level of service (including 100% compliance with service standards for some months) and achieved 98.9% compliance in September (compared to an industry average compliance level of 97.1%). We are making good progress with arrangements to comply with the introduction of new charging regimes for infrastructure provision to developers across the industry, and will be consulting with local representatives in a manner appropriate to our close relationship with those developers serving our supply area.

Our Customer Scrutiny Panel has continued to build on the invaluable 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 members, and can be found at: http://www.waterplc.com/pages/about/customer-scrutiny-panel/

Apart from reviewing the Company’s performance, the last six months has seen our Customer Scrutiny Panel turn its attention to the wider customer participation requirements of the next Price Review, PR19. Our bespoke customer research programme has been constructed in three phases, starting with an exploratory phase of qualitative research earlier in the summer under the banner of 'listen, learn and inform'. Apart from facilitated customer workshops (observed by panel members), the programme included innovative ways of capturing customer insights, including the use of mobile phone apps and video selfies exploring what failure in water service provision would feel like for customers in different circumstances. The views of hard to reach customers, including those in vulnerable circumstances, were captured by providing home visits to enable participation. These preliminary views have informed the Board of the emerging priorities as considered by our customers through their feedback and are being discussed with the Customer Scrutiny Panel. These emerging priorities are now being further tested through a more extensive programme of quantitative research and co-creative workshops for customers and future bill payers. An online community facility for continuing dialogue with customers and stakeholders – going beyond the Price Review process itself – is now live.

Achieving continuous open engagement with customers and other stakeholders has been a commitment the Company made many years ago, and we continue to explore new ways of achieving real engagement with the communities we serve. A Family Fun Day at our Bough Beech treatment works in August proved particularly successful and demonstrated once again the value of the investment we made many years ago in the schools educational support facility at Bough Beech. A second facility at another of our treatment works – to promote a wider series of environmental awareness messages - is being considered for our next Business Plan.

The water industry has always been a long-term business, investing in assets that will serve customers for generations to come. We have therefore welcomed the extension of the time horizon for companies' Water Resource Management Plans to sixty years, and have been working closely with other organisations with a common interest in this essential long-term view of how we will continue to ensure water is available for an ever-increasing population in our supply area. Our own updated draft plan is about to be issued for consultation prior to the compilation of our wider Business Plan for the forthcoming Price Review, and we look forward to feedback on our proposals.

We continue to seek to work constructively to progress other regulatory changes aimed at benefiting our customers. We have warmly welcomed the level of detail provided in Ofwat’s consultation on their draft methodology for PR19, recognising the advances made in providing clarity on many key issues compared to the same stage of preparations for the last Price Review, and have accepted the changes to company licences needed to implement the policy decisions already made. However, it is clear that PR19 will present some fundamental challenges for the industry and we still remain to be convinced that the increasing complexity of economic controls and reliance on market mechanisms can deliver the step change in efficiency and service levels 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. That said, we very much welcome the greater focus on innovation in all aspects of our business and we recognise the importance of driving innovation in everything we do.

We remain keen to persuade Ofwat to adopt an approach to future funding allowances that allows a fair reflection of the historic financing decisions taken by many water-only companies in the interests of their customers when long-term borrowing arrangements were made to avoid customers and shareholders being exposed to the uncertainty of interest rate movements. In our case, the Company entered into a £100m 30-year index-linked bond with a fixed coupon to remove volatility of future interest rates from customers’ bills. We accept that it is important to seek customer feedback on this issue as a vital element of any argument we promote, and plan to do that in the coming months.

Governance and organisational changes

The Board has remained unchanged in the last six months, providing an important level of continuity and accumulated expertise in regulatory affairs as the industry enters a critical period for the development of plans for the next five years. Our Independent Non-executive Directors remain the largest single grouping on the Board and provide targeted challenge and support to management in the areas of their particular personal expertise. Our shareholders remain closely engaged in the business and fulfil their fiduciary duties to the Company with diligence and focus upon the long-term interests of the Company, its customers, employees and the communities we serve.

Our Finance and Regulation Director, John Chadwick, has advised the Board of his intention to retire at the end of September 2018 and a search for a successor has already been initiated. John has given superb service to the Company over the last eight years and will be a hard act to follow.

At SES Water we believe in creating a diverse and gender balanced workforce that ensures equal opportunities for all employees and reflects the communities we serve. We recognise that, like other employers in the sector, we have more work to do to achieve this goal, but we are well placed to do so and welcome the gender pay reporting requirements that will be implemented in the coming year. We have made good progress in preparing to meet this new requirement and will publish reports early in the new year.

Future challenges

The ODIs 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 remains our performance against the Service Incentive Mechanism, which has succeeded in driving up standards across all companies. We remained determined to restore our performance to above industry average and serve our customers in the way that they deserve.

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 are well-resourced and comprehensive. We have agreed 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 valuation for business rates effective from 1 April 2017 (with reduced transitional relief provisions) is the most damaging example. We also anticipate cost pressures will arise from the next valuation of our residual defined benefit pension scheme, which now provides retirement benefits to less than 20% of our current employees (whilst the remaining 80% of our employees benefit from Company contributions to other forms of retirement benefits). 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 new partnership arrangements with our infrastructure services contracts, involving shared rewards and penalties for achievement or otherwise of our ODI targets and co-location of contractor and our own teams, have taken a major step forward with the refurbishment of part of our Redhill office to enable teams to co-locate on a permanent basis. We are already seeing early examples of the cross-learning and process improvements that co-location was expected to bring, giving us confidence that we will continue to be able to maintain our strong track record of bringing projects in on time and budget.

There is no doubt that the PR19 Price Review will challenge all companies given securing adequate returns will be dependent upon achieving significantly improved levels of efficiency and securing rewards under tougher new incentive mechanisms.  However, we appreciate that is the role of a regulator representing customer interests and we have anticipated these challenges, set out a programme to ensure our Business Plan is of the highest quality and demonstrates our continuing determination to ensure that our customers’ interests and priorities remain at the heart of our business. We consider that we have made good progress in the last six months and remain confident that we will deliver a well-evidenced, innovative and stretching five-year plan (covering 2020-2025) on time in September 2018.

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 prepare our PR19 Business Plan. The unpredictability of the weather is a regular uncertainty at this time of the year. As previously noted, our water resources are below long-term average levels this autumn and we need consistent winter rainfall to achieve a full recharge of resources for next summer. Severe frosts can always crack many pipes and have a damaging effect on our network, requiring more resources to manage leakage. Affordability certainly remains an issue for some customers, despite our Water Support tariff and flexible payment options. At a time when inflation has been rising persistently for a number of months and incomes have failed to keep pace for many households, affordability of normal household bills (including water bills) is likely to become a growing issue 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 we are pleased with the preparations we have already made for the PR19 Price Review, the level of customer participation, the complexity of the proposed new form of controls and the level of evidence needed to support justifiable expenditure allowances all create additional cost pressures at a time of rising inflation. Tight expenditure controls remain a prerequisite in this environment.

Nationally, the country remains in a period of substantial economic and financial uncertainty as the Government seeks to negotiate arrangements for 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.

The Board also acknowledges there have been recent questions on the legitimacy of the water industry in England. This is less about the value for money or reliability and quality of service and more about transparency of ownership and governance structures. We will continue to engage in dialogue on such important matters and will further review how we can improve our own reporting in this area in our next annual report and on our website.

Finally, I should like once again to pay tribute to the continuing dedication and commitment of all our employees, who do so much to make us proud of our place in the communities we serve.

Jeremy Pelczer
30 November 2017

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