Earnings Transcript for UU.L - Q2 Fiscal Year 2016

Executives: Darren Jameson - IR Steven Mogford - CEO Russ Houlden - CFO

Analysts: Guy MacKenzie - Credit Suisse James Brand - Deutsche Bank Lakis Athanasiou - Agency Partners Ashley Thomas - SocGen Dominic Nash - Macquarie Iain Turner - Exane Verity Mitchell - HSBC

Darren Jameson: Good morning, everybody and welcome to United Utilities' half-year results presentation. I just need to run through a few housekeeping duties, if I may please, first of all, before handing over to our Chief Exec. And, as always, today's presentation should be considered in the context of the cautionary statement, at the back of your presentation packs. So without further ado, over to our Chief Executive.

Steven Mogford: Thanks very much, Darren. Good morning, ladies and gentlemen; and welcome to our 2016-2017 half-year results presentation. We aim to be the best water and wastewater Company in the UK, delivering a great service to our customers. And, as you'll hear, we have taken further steps towards this goal, over the last six months. In particular, we're seeing the benefit of a refreshed approach to customer satisfaction. And our program of accelerated investment is yielding improvements in operational performance, to the benefit of customer service and our Outcome Delivery Incentives or ODIs. In addition, we're making excellent progress in embracing innovation and new technology right across the business, in our drive for more efficient and effective ways of working. Today's highlights are as follows. We've achieved our best AMP6 score under Ofwat's qualitative customer service incentive mechanism. Our strategy for accelerated investment in the early part of this regulatory period has seen us invest capital of 383 million in the first six months of this year; and we expect to invest around 800 million by year end, similar to last year. That accelerated investment is contributing to another year-on-year improvement in operational performance in our water and wastewater businesses. And as a result, we're on track to meet our TotEx and ODI targets for this regulatory period. Operating profit is slightly ahead of last year and gearing remains within our target range at 62%. And our hedging policies are delivering strong financing outperformance and protecting our balance sheet from the pension headwinds hurting much of the FTSE. As you can see on the next slide, we're delivering sustainable dividend growth. Our aim for investors remains consistent

Russ Houlden: Well, thank you, Steve. And good morning, everybody. Moving on to our financial performance, the Group has delivered a good set of financial results for the six months ended September 30, 2016. In light of the ESMA guidelines, which have recently come into force, a wider range of communications, including investor presentations, must now show adjusted performance measures, with no greater prominence than IFRS measures. I'm, therefore, starting today with our reported numbers, mainly reflecting a deferred tax credit relating to the government's future planned tax changes. And reported EPS was up 18%, for the same reason that moved profit after tax. So now, looking at the underlying income statement, which we believe gives a more representative view of business performance, underlying operating profit, at GBP313 million, was GBP4 million higher than last year. This reflects the allowed regulatory price changes and slightly lower total costs, which I'll discuss in more detail on the next slide, partly offset by the accounting treatment of Water Plus. Underlying profit before tax was GBP189 million, GBP16 million lower than the first half of last year, as the GBP4 million increase in underlying operating profit was more than offset by a GBP19 million increase in underlying net finance expense as a result of higher RPI inflation, which principally impacted the portion of the Group's index-linked debt with a three-month lag. Underlying profit after tax of GBP152 million was GBP11 million lower than last year, reflecting the GBP16 million decrease in underlying profit before tax, partly offset by lower underlying tax on lower profits. Underlying EPS was down by 1.7p, or 7%, for the same reasons that moved profit after tax. The detailed adjusting items are shown in the profit after-tax reconciliation slide in the appendix to the presentation. Now, on to our cost base. We've continued to maintain tight cost control, although, as is often the case, there were some special factors affecting the comparison of underlying expenses between the two periods. The main decreases were depreciation, GBP7 million, as we recognized some accelerations in depreciation in the first half of last year, and other costs, GBP5 million, mainly because of legal and other provisions last year. The main increase was regulatory fees, GBP8 million, as we received a rebate in the first half of last year. Overall, our total underlying operating expenses were down GBP8 million. So now looking at bad debt in a bit more detail, deprivation remains the principal driver of our higher than average bad debt with the North West having the highest proportion of deprived customers in the country. Following the formation of Water Plus, we believe it's now more appropriate to look at household bad debt to provide a view of our performance. This is a new breakdown, and shows that we have managed to improve our performance and reduce household bad debt to 2.8% of regulated revenue, from 3.0% in the first half of last year. This is slightly better than our expectations. We have maintained our strong focus on improving our bad debt and cash collection performance, including working with Equifax to ensure that we share customers' credit data to encourage those who can pay to do so. We also have a wide range of schemes to help those who are genuinely struggling to pay. So we've made a good start to the year, but bad debts will remain challenging, given that we are a high deprivation region. Turning now to the statement of financial position, property, plant and equipment was up GBP165 million in the half year to GBP10.2 billion, reflecting expenditure on our large capital program. We again have an IAS 19 retirement benefit surplus, which I'll talk about on the next slide. Cash and short-term deposits were up GBP24 million compared with March. Derivative assets increased by GBP172 million to GBP938 million, reflecting both a weakening of sterling and a decrease in market interest rates during the period. Derivative liabilities were up GBP73 million at GBP335 million, reflecting the decrease in market interest rates. Gross borrowings increased by GBP339 million to GBP7.3 billion, due to debt raised exceeding maturities, the inflation uplift on index-linked debt, and a weakening of sterling, and a fall in market interest rates. Retained earnings have reduced slightly £39 million to £1.84 billion, impacted by re-measurement losses on our DB pension schemes. Net debt was £216 million higher than the position at March 2016, mainly reflecting accelerated expenditure on our substantial capital investment program, and, to a lesser extent, our loans to Water Plus. So, looking at our pensions' position in a bit more detail, our hedging policy for our pension schemes is to adopt an asset/liability matching approach to avoid unnecessary volatility in the funding and accounting surplus or deficit. This policy is working well, as you can see from the accounting surpluses in our last few sets of results. We've seen a decrease in surplus of £60 million compared with March 2016. And this movement mainly reflects a decrease in credit spreads, which has increased the pension schemes' liabilities, partially offset by a better return than assumed on the pension schemes' assets. Nonetheless, our pensions' position remains strong with a £215 million surplus at September 30, 2016. And we are in a much better place relative to many other FTSE companies. This chart shows our RCV and gearing level. The blue bars show the growth in our RCV. We have adjusted our RCV for this regulatory period to reflect our accelerated levels of investment, as suggested by a number of analysts. The green line shows the movement in RCV gearing over the last few years. Across the periods to March 2015, our gearing has remained relatively stable at around 60%, with the growth in net debt largely offset by the growth in the RCV. In the early part of this regulatory period, as expected, gearing has nudged up slightly, reflecting the acceleration of our investment program; our £46 million loan to Water Plus; and lower inflationary growth in the RCV. The acceleration of our investment has had a short-term impact on gearing, but this should reverse out in later years of this AMP. As at September 30, 2016, RCV gearing was 62%. This remains comfortably within our target gearing range of 55% to 65%, and supports our solid A3 credit rating. Moving on to cash flow, net cash generated from operating activities, at £420 million, was £50 million higher than the first half of last year, mainly as a result of lower profit last year, principally reflecting the impact of the additional costs associated with the operational incidents in that period. Cash used in investing activities was up £63 million to £376 million, mainly reflecting higher capital investment and lending to our Water Plus JV. Net cash used in financing activities was £14 million, compared with cash generated of £50 million in the first half of last year, as we received lower net proceeds from borrowings in the first half of this year. So now, onto financing. Over the 2015 to 2020 regulatory period, we have financing requirements totaling around £2.5 billion. This is to meet a combination of refinancing and our incremental debt to help fund the investment program. We've continued our good start and have now raised over £1.5 billion, which means that we have raised over half of our requirements for the five-year period. Since our full-year results in May, we've raised £53 million of private placements, in index-linked form, via our EMTN program. This fund raising was split into two tranches; one with a 12-year maturity, and the other with a 20-year maturity, and at our best-ever real interest rates. We have also raised a further £76 million in nominal form, via private placements, again, off our EMTN program, and these have 15-year maturities. This supplements the £250 million EIB loan that UUW signed in April 2016. As I have previously highlighted, Brexit will have no impact on the terms of our existing EIB debt portfolio, and for the time being, the EIB remains committed to signing new loans. However, further borrowings from the EIB are unlikely after the completion of Brexit negotiations. There is a chart in the appendix which demonstrates that our existing EIB funding has a medium- to long-term maturity profile. There will be very little impact in the short to medium term. Furthermore, since March 2016 we have agreed 200 million of committed bank facilities and the total under our bilateral revolving credit facilities program is now 700 million. As a result, we now have headroom to cover our projected financing needs into 2019. And finally an update on our approach to hedging, our hedging policy for business exposures is to leave the equity portion of the RCV exposed to RPI inflation by hedging the debt portion of the RCV for inflation through index-linked debt and the effect of our pension liabilities. The average cost of our 3.4 billion long term index-linked debt portfolio has now reduced to 1.4% real reflecting the more recent index linked debt which we have raised, which is at much more attractive rates. In respect of our nominal debt, this is virtually all fixed for the 2015 to 2020 period at an average interest rate of around 3.6%. The low cost of debt we have locked in, places us in a strong position to deliver financing outperformance up to 2020. Whilst we recognize that Ofwat wishes to transition from RPI to CPI or CPIH inflation, we will need to know the final form of that transition before we can judge the appropriate hedging response. In summary, we have delivered a good set of half-year results, and have robust financials. We've continued to maintain tight cost control. We have seen higher RPI inflation deliver further growth in our RCV, although this has also increased our index-linked finance change this half year. Our pensions' hedging strategy is working effectively, and this places us in a strong position. We continue to maintain a strong balance sheet and solid credit ratings. We've already raised well over half of our 2.5 billion financing requirements for the five year regulatory period. We've locked in a low cost of debt for 2015 to '20 with an appropriate mix of index-linked and nominal debt, and this is delivering financing outperformance. And our hedging policy means that we are well placed to manage future financing costs. Now back to Steve.

Steven Mogford: Thanks, Russ. Before Russ and I take questions, I'd like to summarize the key points from our presentation this morning. We are continuing to make good progress in delivering our plans. We are seeing the benefits of a refreshed approach to customer service, delivering our best ever satisfaction scores. We are on track with our program of accelerated investment and expect to invest around 800 million this year to deliver early customer and operational benefit. And we are embracing innovation to optimize ODIs, TotEx and through-life costs. We're continuing with our strategy of delivering enhanced operational capability, using our Systems Thinking model. And we have attained industry-leading environmental performance and are seeing improved water quality performance year on year. And we've gained external recognition for our strong corporate responsibility credentials. Our hedging policies are delivering strong financing and pension performance, and we have a robust capital structure with gearing within our target range. And all of this supports dividend growth of 1.1%; in line with our policy of an annual growth target of at least RPI inflation up to 2020. So, that concludes our presentation, very much appreciate your listening, and we'd now like to take questions.

Q - Guy MacKenzie: Guy MacKenzie, Credit Suisse. A few questions from me. Firstly, on TotEx, you reiterated your guidance of delivering in line with Ofwat's allowance over the regulatory period. I'm just wondering about these new initiatives that you discussed, DfMA, for example. Was this always a part of the plan? Or is this expected to deliver incremental efficiencies and potentially make outperformance a little bit more probable? Secondly, just on your JV performance, JV profits were down year on year, and that's despite having Water Plus in place, I guess, since June. Russ, you might have mentioned it, but I'm just wondering if you could clarify what's driving that. And then, finally, just on potential for household retail competition, just wondering what your thoughts were on that; how realistic the proposed government timetable is in terms of by the end of this parliamentary session, I guess, and this decade [ph]. And would Water Plus potentially be a vehicle for you guys to potentially compete in that market as well?

Steven Mogford: Okay, shall I pick up TotEx and household retail, and you pick up the figures around the JV? I think on TotEx, clearly, we set out with a tough target. If you looked at our original business plan, where we got with the final termination, we had about 400 million gap to find. And, as we said at the full results, we were confident that we could find a way of closing that gap. I think the issue for us is that as we're seeing performance in the first half of this year that's just simply reinforced that confidence. I think what we're going to do as we go through, and things like DfMA were in that plan to contribute and achieve efficiencies on our capital program. But I think what we'll be doing is we go through our business planning in the first quarter of this year, we'll be looking at where we are on overall TotEx and taking a view of our overall performance. I think by the time we get to the full year results we'll have a view of whether we're able to find any more in the things that we're doing. But at the moment, I think we'd say we're still on target to close the gap, that 400 million gap. On house hold retail, you'll have seen the submission that Ofwat put forward, which looks at the potential savings associated. And there are a range of scenarios, from the very optimistic through to a more pessimistic view of what retail competition would do. The government has got that. We know that they're thinking it through. I think the issues are that it's quite a complicated picture in terms of being able to bring a household retail through. Because you're dealing with what do you do with the more difficult end of the community in terms of those that are in financial difficulties, how do you deal with that? How do you deal with a lot of the cross-subsidies that exist? So I think government's working through that. Personally, the industry is entirely focused on getting business retail up and running. And I think we need to see that working effectively, see how we get a response. But there's no doubt that customers would prefer choice. And so, I think the government is yet to take a decision, we'll see where they are on it. But there's a lot, it's very complex in terms of what you'd need to do to make it work. So I think from a timing perspective, if we saw legislation we might see legislation dealing with that in this five-year period.

Russ Houlden: On the point about the JV income, one thing to understand about how IFRS works is that although it's shown as pre-tax what you actually see there is post-tax income from joint ventures. As you know, historically, the main one in there has been Tallinn. This time, we've got the months since June 1, to include Water Plus. Water Plus, for that period from June 1, to September 30, is in a small loss position. That's not an underlying profit issue, it's around one-off costs, interest, and tax. So you have to take off the one-off costs, the interest, and tax to get to the number, which then feeds into that pre-tax number. The underlying profit position in Water Plus is pretty much in line with our expectations.

Guy MacKenzie: Are you looking to start [indiscernible]?

Russ Houlden: We're not separately disclosing that. What we did say previously, if you recall, was that we thought the pro forma number was about GBP10 million PBT, on an ongoing basis. And so that's a reasonable indication of expectations.

Guy MacKenzie: Thanks very much.

James Brand: James Brand, Deutsche Bank. Two questions, please. First, just on retail, you've mentioned, expectation, it will be a fairly active market. Obviously, we'll find out more when it actually starts. But I'm wondering whether you could share any expectations you might have in terms of pricing, and what kind of margins might be sustainable, whether the base margin allowed by Ofwat might be a good starting point, or whether you think that might be competed away. And second question is, obviously, we've had Brexit and a new government coming in, so potentially some changes to the water sector. I was wondering whether you've had any early discussions with new minister and whether there are any signs of early changes in thinking towards the water sector at all, or is it too early days? Thanks.

Steven Mogford: I think when you look at retail, undoubtedly, I suppose you look at the experience in Scotland, and in Scotland it was principally one incumbent and a separate retailer with very few early entrants into the market. And I think the market development was very slow, and probably only really accelerated once you saw English companies moving into Scotland, ahead of competition in England, and not many new entrants, and, again, until relatively recently. And when I talk about new entrants, it's the people that are either fresh into the water market or are looking coming from energy or telecoms, or those sorts of areas. I think when you look at the run up to the English market opening, it's a very different picture. We've obviously seen changes in position with some of the incumbents as to whether they want to stay in retail or not, so people like us that are doing the joint venture. And then you've got others, like Thames, who've decided to exit. But there are a lot of new entrants coming in. And so I think at the last count, we were up to something like 40 players in that retail market, all obviously with different strategies in terms of whether they were going to be generalists or approach particular sectors. It's very difficult to say where the margin will go. I think in a competitive environment margins only go one way. And so I think price is going to be a big differentiator in that market. And I think it's very hard to say, James, where that's going to go. But I think looking forward and understanding that, that was the developing situation. That's why Water Plus, for us, was an important development, because it gave us a completely fresh start in establishing a new business. We recruited teams into that. We were able to put low-cost back office and best-in-class customer relations systems. Because I think cost is going to be a big driver. But where margins will go, your view is probably as good as mine. I think on Brexit, it's interesting, actually there. Clearly, it's difficult to say where Brexit's going to go. We're not clear yet on what form Brexit will take. I think it's probably fair to say, though, that for the water sector, probably, the biggest implication around Europe is around environmental legislation and things like water framework directives, and bathing water directives, and shellfish directives, and things of that sort, which tend to drive a lot of the expenditure. And I think, probably, in that area it would be fair to expect little change, because most of that legislation is now enshrined in English law. And we've got something like 10 to 20 years -- or 10 to 15 years of ongoing work in the sector to achieve compliance with laws that already exist in the framework and I don't sense there's any desire to reverse back out of that, in terms of what it would mean, in terms of environment. So I think, probably, you would say that if there is going to be any implication, and I can't see it at the moment, then it's certainly not in the short term. And my sense is, as well, that's the same on water. The water regulations that we currently operate are consistent across Europe. But I don't think anybody's going to reduce water standards or -- they demand 100% perfection. So I'm not sure that we can do much more with that. I think in that sense, long way to go. Obviously, we've got to see. But at the moment, I would suggest probably very little change in the short term.

Lakis Athanasiou: Lakis Athanasiou from Agency Partners. Two questions, please. One on your pension surplus; could you give an implication of what it would have looked like had you not had your asset hedging in place? Essentially, I'm asking you, if you -- nearest £100 million maybe, what benefits you're getting this period from your asset hedging in the pension. Secondly, now you've got a bit more experience about setting up standalone non-household business entity can you talk a little bit about your view on scalability, in terms of if you were to lose 5% of your customers could you then lose 5% of the operating costs, or 10%, or whatever? And the reason I'm asking that is obvious, I think.

Steven Mogford: Okay, yes, absolutely. I think, first -- well, I'll give you time to think about pension surplus, and while you're asking that I'll go out for a coffee. But on scalability, yes, it's very much a consideration. I think when you're looking at the way that you set these businesses up is that you get your fixed costs as low as possible, and then the scalability, in terms of how you're dealing with it, is largely the front office; it's the numbers of agents that you've got. And so, we've been -- we recognize that we wanted a capability that we could scale up as well as scale down, and have reasonable amounts of flexibility. So, I think scalability is an issue. You've seen, in Scotland for example, if you look at the performance there, the incumbent has lost an enormous amount of market share, really, in the last couple of years. And, obviously, they've had to do quite a lot of work in that regard in terms of up-scaling. So I think we're very much with that in mind. I think Guy asked, as far as the domestic market is concerned, would we look at Water Plus? We haven't had that conversation. Clearly, it will be a consideration at the point at which we come to any decision around where the domestic market is going to go. But I think scalability is important. And largely your cost space is your IT and people and there's very little else, quite honestly. And the IT itself is largely fixed in [indiscernible], other than the number of desks that you've got to operate and things like license charges. But it's mostly about people.

Russ Houlden: Right, Lakis always asks very difficult questions, which I never fully answer. But, hopefully, slide 23 gives you a bit of indication, because what we've shown there is the assets and the liabilities. And so you can see that whilst the liabilities have increased because of the lower interest rates, the assets have also increased. The assets increased by circa, just reading off the chart, GBP700 million. And I think in order to gauge the impact of that the thing is to do is to look at companies that don't have an matching asset liability and matching approach, and what you'll see is that quite a lot of them have had a either small deficit turning into a much bigger deficit, or a surplus turning into a deficit. I think you'll find that those without that asset liability matching would not have had those assets rising in line with the liabilities.

Unidentified Analyst: [Indiscernible] So Ofwat have said that there'll be no mandatory sharing of planning consent given. Do you get a sense that still, however, once the sectors act voluntarily [technical difficulty].

Steven Mogford: [Indiscernible] that we have they would do that. But we're very much in the minority. And I think it is down to choice as to whether companies choose to use outperformance either as further investment, or as bill reduction. And they leave that entirely to company discretion. I think the issue for us, if you look at us back in the last cycle, we had significant financing outperformance, operation outperformance, over that period, and we elected to use some of that in terms of enhanced operational capability and customer service. So we used it in a number of ways, and it was about GBP280 million that we reinvested. But in doing that, we always have an eye to where the shareholder benefit in doing as well? Because you want to ensure that it's not just customers but shareholders benefit from outperformance. So, I think it's a choice. It is a choice, as to what you do. I think, for us, it's a case of let's see what that outperformance is and it's a future decision as to whether we do anything or not.

Russ Houlden: Okay, on the subject of how does RPI feed through into the P&L and into financing outperformance, as you know, the P&L doesn't show the whole story. But the P&L impacts of increasing RPI are higher revenues, and higher cost of finance. Generally, the way that tends to flow through is that in year one of higher RPI you'd see a fall in your profit; in year two, it'd be roughly neutral; and in year three, it would be positive. So that sort of nets out. The second impact, of course, is through RCV. RCV growth is clearly positive for shareholders, and so there's an impact there. And then, in terms of judging financing outperformance, we think the best way to judge financing outperformance is to look at the two buckets that we have of financing, roughly half of our financing being index linked. And, as we said in the slides, today, the average cost of that is now 1.4% real, against 2.59%, as the regulatory allowance, and so you can pretty quickly multiply that out to find out the financing outperformance there. And then, the nominal portion is at 3.6% locked in. So if inflation rises that gives you a bigger financing outperformance. When you take the 2.59% real allowance, you add the higher inflation that will give you a bigger financing outperformance on the nominal portion.

Ashley Thomas: Ashley Thomas, SocGen. Just two follow ups. You mentioned the Ofwat review of the KPIs. Obviously, they also have the RoREs in there. Can I ask, are you comfortable with Ofwat's methodology now, and do you feel it's being applied on a consistent basis? And second question is just on pensions. Obviously, you've given us IFRS. I assume, for most companies the actuarial position will be bit more conservative, or potentially a deficit. Can I ask, are you making any deficit repair contributions over and above those already allowed by Ofwat in this price control?

Russ Houlden: Okay, I can do both of those, if you like. Let's do the deficit repair point first, because that's pretty straightforward. We've making deficit repair contributions of around 40 million a year through this regulatory period. The regulatory allowance is half of that, because that's what they said they would do, so it's about 20 million. The regulator has been very clear that after this period there's no further allowance, except for, perhaps, one or two of those which have got an agreement which goes one or two years beyond that. But basically, the regulatory allowance for this is finished at the end of this AMP. On RoRE, you'll recall that at the full year results I expressed the view that analysts would be wise not to take RoREs at face value. Because at that stage there had been five definitions of RoRE, and even the fifth definition was not clear enough to ensure that all companies reported on a consistent basis. We continue to engage with Ofwat on the topic, and, therefore, since that there have been three more definitions. We're now on definition number eight. And the publication that went out yesterday was meant to be in line with definition number eight. What that has flushed out is that I was right to express some skepticism at the full year, because, for example, Pennon's RoRE has come down by 2%, from 13.8% to 11.8%, in the latest publication. Ours is unchanged, because the methodology was in line with our interpretation. Severn Trent's was also unchanged, although Ofwat note that there remains an error in the Severn Trent number. Therefore, we won't really know the Severn Trent number until next year, when they've promised to do it in line with the new definition. You then asked the question, am I now happy with the definitions?

Steven Mogford: You're going to be here for some time, by the way.

Russ Houlden: I think the answer is I'm a lot happier than I was in May, because we've flushed out some of the bigger inconsistencies. However, there are still some points that are open to interpretation, and I would continue to encourage Ofwat to resolve those areas of uncertainty as to what their definition means. And just to give you three examples, they are smaller than the big ones that I was banging on about in May. But three examples of things which are not totally clear is when you allow for RPI do you allow for the year-end RPI, or do you allow for the year average RPI? That's not totally clear. When you calculate your financing outperformance should you do on a one portfolio or a two portfolio method? The one-portfolio method would look at the whole bucket, and two portfolio method would look separately at your index-linked debt versus your nominal debt. And it does matter how you do that. And a third example of an area which is not totally clear is when you apply tax to some of the calculations should you apply the headline corporation tax rate, or should you apply your actual tax rate, or should you apply your actual tax cash rate? So there are further details of refinement that I think are needed, but I think we're in a lot clearer position than we were last May.

Ashley Thomas: Thank you.

Steven Mogford: I think, for me, the key issue there is that Ofwat are engaged in that, and very constructively, and actually make changes. So I think it's a positive development since the full year presentation.

Dominic Nash: Dominic Nash, Macquarie. Two questions, please. Firstly, on the JV, I see you've booked a GBP20 million profit on disposal into the JV. Could you just let us know what the book value of that JV is? Secondly, going back to this RPI issue, could you just give us some color? I think CPI has been dropped out of your license ages ago. Are you seeing, do you think that your construction and your CapEx program will broadly match RPI? Or do you think that it might diverge away?

Russ Houlden: The book value of the JV, I think we'd want to take up with offline, if we may, because it depends a bit whether you’re talking about the fixed assets or working capital, whatever. So it's quite a complicated topic, so I'd like to take that one up with you offline. On RPI and CPI, I think that we feel that construction prices are edging up. But that the innovation, that Steve talked about, is what we're using to drive out the cost saving that we need against the regulatory allowance. Because, if you recall, we had to actually deliver about GBP400 million of cost savings just to hit the regulatory allowance. And things like the DfMA, and the other innovations Steve talked about, will help get us there, notwithstanding the rise in construction prices.

Steven Mogford: Dominic, we tend to, we're constantly re-measuring, if you like, what our budget translates to with the impact of inflation. I you can imagine at the beginning of the period, when inflation was very low and the whole of the price review had been done, I think, at an average of 2.5%, you sit there and say, well, just, hang on a minute, when you're running at below 1% the outturn number that we're trying to hit has just gone down quite a lot. So you're then sitting there actually looking at what you can do to drive it. And things like DfMA are areas to do it. Obviously, we're seeing that reverse out to an extent. My approach to that would be to stick to the number that I had at low inflation and drive out a benefit, obviously. But I think we're always projecting an outturn and trimming ourselves accordingly as we start -- as we see how inflation varies.

Iain Turner: Thank you, Iain Turner from Exane. You said in the presentation that there was a £46 million loan out to the JV, how should we think about that? Does that represent -- presumably, before the JV you were funding all the working capital in your non-household retail position. Does that £46 million represent extra working capital that's now needed, or extra investment in the IT systems, over and about what was there before the JV was formed?

Russ Houlden: I don't think we should think of it as related to the IT systems; you should think of it as related to the working capital. And it's related to the regulatory model which is being set up in terms of how much that working capital needs to be financed by the retailer, and how much needs to the financed by the wholesaler, and where should the risk lie. Ofwat has set some rules on that. And we've, in order to match those rules, allowed a facility at the moment of up to £75 million from each parent. And so, the £46 million was getting towards the drawdown of that facility required to finance the working capital of the JV. There is still some sort of working capital in the parent, because part of the risk is still -- is borne by wholesale into the JV. And so, it's not a total elimination; there's some risk being borne by the retailer, and some risk being held by the wholesaler.

Iain Turner: It's a zero sum gain, effectively?

Russ Houlden: Zero sum gain in terms of the external [indiscernible], yes.

Iain Turner: So, some debt in there?

Russ Houlden: No, it's just the financing as between the retail and the wholesaler.

Steven Mogford: We had a big debate right throughout the preparations to would effectively there be a credit position to a retailer from a wholesaler in terms of payment terms? And that settled, where essentially both parties would take some of that credit risk during -- associated with trade. But when you're dealing with what effectively is a JV that used to be you, there's a zero sum gained in terms of the overall picture.

Verity Mitchell: Verity Mitchell, HSBC. Yes, just two questions. The first one is just on your triennial actuarial pension review, just the timing of that. I know Ofwat flagged that quite a few companies are undergoing it at the moment. That's just an easy one. And the second one is just how we should think, Russ, about the now change in your fair value versus the book value of your debt?

Russ Houlden: Right, on the actuarial review, yes, you're quite right, we are doing a normal triennial valuation in conjunction with the pension scheme trustees. We expect that to reach a conclusion in the middle of 2017. Secondly, on the fair value versus book value point, I'm not surprised that you've highlighted that, because there is an increase, a significant increase, in the gap between fair value and book value. Just to clarify, for those who haven't yet spotted it, at September 30, the fair value of our net debt, including derivatives, was 7.74 billion and the carrying value was 6.47 billion, a difference of 1.26 billion. This compares with a difference between book and fair value of 480 million at March 31. So there's about a 780 million increase in the difference; and that's largely caused by the significant fall in underlying yields, particularly index-linked gilts, following the Bank of England's announcement in early August that it would increase QE. So it's just driven by the underlying interest rates on index-linked gilts. It's, of course, all part of our hedging policy. And our hedging policy is designed to achieve financing outperformance and stability no matter what happens, really. The key thing, I think, is to focus on the financing outperformance, where, as I said earlier, we will beat the regulatory allowance of 2.59% real on the index-linked portion, it will be at about 1.4% and we'll beat the 2.59% plus RPI --. [Call Ends Abruptly]