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Pennon CFO on the challenges of water management

Finance chief of the parent of South West Water reveals the complexities of running a utility as the prospect of nationalisation looms.

When Susan Davy became the CFO of FTSE 250-listed Pennon Group she was fully aware of the act of brinkmanship needed to run a major water company.

As well as delivering a strong return to shareholders and ensuring that customers get good services and reasonably-priced bills, the expectations of a whole range of other stakeholders need to be met- especially around environmental concerns.

Arriving as finance director of its subsidiary South West Water in 2007, from Yorkshire Water-owner Kelda, Davy says: “It looked like an interesting challenge. At that point South West Water was known for the highest bills in the country, and a lot of investment had gone in in the form of a clean sweep to improve bathing water in the region.”

Added to the fact that Pennon is one of the highest employers in the region, and you can see the weight of responsibility that comes with running finance at the group.

Since her elevation in 2015 to CFO of Pennon, the group which also encompasses waste recycling business Viridor, she has seen her role expand to address operational, financial, customer and stakeholder perspectives: “It’s all about getting the frameworks and governance in place.

“You have a role within the business, driving the financials and delivery and how you’re making sure that’s happening, but there’s a whole new aspect to governance, risk and assurance and interaction with the board on strategy- that was new,” says Davy.

She says that the nature of running a business such as a water company means strategy needs to be considered over a very long time frame. “For a water company it is about looking at the next five, 10, 20, 25 years and being able to translate that strategy and say here are the different scenarios and this is what they translate into- this is what it could look like,” says Davy.

“When you’re investing in infrastructure you’re investing for the long term, so there are investment decisions that you’re making, assets that will have lives of 40,50, 60 years. Some of our network is 100 years-plus in terms of the length of time those assets will be around for, so you’re making decisions that are going to make a difference,” she adds.

Upward trend

Right now, Pennon looks to be in a good place in financial terms. Last year’s pre-tax profits at South West Water rose by 4.7 per cent, to £180.5m and at the group’s energy recovery business Viridor, profits jumped 17.2 per cent to £70.8m.

Pennon is investing £1.5bn to bring on stream 12 energy recovery facilities, while at the same time reducing customer bills has become a priority, says Davy, who points to the fact they are lower than they were nine years ago.

To gain investor support for long term growth, Davy says that her efforts are focused on giving investors a clear description of the merits of backing Pennon’s long term strategy. Because the water industry pricing is highly regulated the means to reducing costs is consolidation- hence the acquisition of Bournemouth Water in 2015. “It makes sense for customers and it makes sense for investors because they get to share the efficiencies we make and the returns on that investment, so it works on both levels,” says Davy.

In the context of growing demands for corporate transparency, Davy says openness is fundamental for a utility company when seeking legitimacy from customers and other stakeholders. “If you’re making the right decisions that add shareholder value and deliver great services to customers at prices that are appropriate, then that transparency should be there, whatever you’re doing in your overall strategy- be it your financing or tax strategy,” she says.

There is also a balancing act to be had between short term financial priorities and long term sustainability expectations, says Davy who says Pennon has delivered its second integrated report focusing on non-financial information. “It’s about making sure you are investing for the long term such as developing energy recovery facilities, while achieving short term deliverables,” she says.

In this respect Davy is seeking to develop a profile for the group that sets high standards for ESG (environmental, social and governance) factors to attract sources of capital such as green funds that want to invest in companies with a sustainability agenda. “We can attract investors who are looking to support those objectives through this framework,” she says.

As part of a wider push for accountability, Davy says that in recent years the water sector has increasingly sought to understand the needs of its customers “to deliver what the priorities are for them, because they’re the ones paying the bills and they’re the ones who have in their mind what their priorities are.”

She says data from a variety of sources including social media flows into the group’s business planning process and ultimately its business model- where risk and reward are carefully mapped. “What we’re coming up with as a business model is fact based on that information and data,” Davy reveals.

The result has been Pennon’s affiliation to the WaterShare initiative, in which an independent panel scrutinises the group’s performance, and assesses how financial benefits from better-than-expected results are shared with customers. “It says we’re going to track our performance every six months, and when we report to the City we’re also going to report to customers to say this is how we’ve out performed and your share of it is X amount and there is a mechanism for you to get lower bills,” she reveals.

A committee formed of customers from across the region can then decide to give more backing for lower bills or to invest more in other services or to do something community-related. “So its transparency but also it is giving them that financial stake, and that ability to have that licence to operate,” says Davy.

Risk management

But while Pennon embraces energy recovery, Davy says the current recycling system which features a variety of different methods across the UK is proving to be challenging for companies in the space. It was the reason why Pennon closed a recycling plant in 2016.

Davy says reform is required to create incentives for producers to work effectively in making recyclable packaging, and investment to improve the recycling process. “As local authorities change their methods of collection or reduce the black bin waste collections, what we’ve been seeing unfortunately is an increase in contamination of recycling coming in,” she says.

Change from government, in the form of a resources and waste strategy due later this year, is what Davy and her colleagues are hoping for. “We’re expecting changes for standardised collections, so that rather than the 400 methods, we go down to one or two, and more producer responsibility-so the material going on the shelves is recyclable. A few things like that will stimulate the market,” she adds.

Another big challenge on the horizon, comes in the form of political risk. The shadow chancellor, John McDonnell, has pledged total, “permanent” and cost-free renationalisation of the water, energy and rail industries if Labour wins power at the next election.

In February he attacked the privatised water industry, accusing companies of paying out a “scandalous” sum of £13.5bn in dividends to shareholders since 2010, while claiming huge tax breaks and forcing up water bills by 40 per cent in real terms since privatisation of the industry in 1989.

Davy says that although Labour was publicly talking about full nationalisation, she had noted a more emollient position during discussions with the party. “They’re pretty consistent in the way they’re talking about it in the media. But behind the scenes we’re beginning to see a bit more differentiation in how they’re talking about it.

“What’s interesting to us in the nuances of the Labour policy is that they are now drilling down much more. Their preference seems to be moving towards what we would call mutualisation, where you have some sort of model that allows customers to be owners. That’s where we can have a much more informed conversation,” she says.

Davy says the water industry was seeking to impress on Labour the fact that the large majority of shareholders in water companies are owned by the public. “When you look at our model, and that of United Utilities and Severn Trent as well, 70 per cent of our shareholders are pension funds, charities, employees – all in the UK,” she says.

Davy says Pennon is aligned to Labour’s position, regarding greater public say in how water is managed through its affiliation to the WaterShare initiative. “From our perspective, what we are already achieving is a long way to what they want,” she says.

The cost of nationalisation would be a significant hurdle, said Davy, referencing the think tanks Social Market Foundation and the Centre for Policy Studies that recently quoted the cost of water nationalisation of £90bn and £86bn respectively.

“We’re building a body of evidence so they [Labour] can really understand where we’re coming from, rather than us just saying we don’t like the idea of nationalisation,” Davy adds.

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