Financial review
We have in the past year, moved from a “credit crunch” through a deep economic recession. Our prompt action in early 2009, to pre-fund our investment and cash needs for the following 24 months, meant that we retained a sound financial position throughout the year. We were, however, not immune to the economic stresses that our customers and markets were experiencing. We have seen a rise in bad debt charges in our regulated business Severn Trent Water and a slowdown in sales at Severn Trent Services in the early part of the year.
Against this background, the financial performance of the group has continued to show progress and, as described elsewhere, the business areas have invested much time, effort and money to improve their base operations. These improvements are backed by a continuing drive to sustain a strong liquidity position at the lowest possible cost.
We enter the new five year regulatory period and address new opportunities for Severn Trent Services in a strong financial position.
Group financial performance
Group turnover was £1,703.9 million (£1,642.2 million), an increase of 3.8% over last year. The growth in turnover was mainly due to the price increases in Severn Trent Water, partially offset by the impact of lower consumption across our measured commercial income base, which reduced year on year revenues by around £1.6 million, less than initially expected due to a stabilisation of volumes over the year.
| Financial highlights | 2010 | 2009 | % change |
|---|---|---|---|
| Turnover (£m) | 1,703.9 | 1,642.2 | 3.8 |
| Profit before interest, tax and exceptionals (£m) | 557.1 | 469.9 | 18.6 |
| Profit before interest and tax (£m) | 507.4 | 451.0 | 12.5 |
| Profit before tax, exceptionals and IAS 39 (£m) | 338.4 | 273.5 | 23.7 |
| Profit before tax (£m) | 334.4 | 167.6 | 99.5 |
| Earnings per share before exceptionals, IAS 39 and deferred tax (p) | 122.8 | 92.7 | 32.5 |
| Earnings/(loss) per share (p) | 105.6 | (24.6) | n/a |
| Final dividend (p) | 45.61 | 41.05 | 11.1 |
| Interim dividend (p) | 26.71 | 26.29 | 1.6 |
| Total dividend for the year (p) | 72.32 | 67.34 | 7.4 |
Group profit before interest, tax and exceptional items (underlying PBIT) increased by 18.6% to £557.1 million (£469.9 million). Operating costs before exceptional items decreased by £25.5 million. The main components of this reduction are described in the commentary on Severn Trent Water and Severn Trent Services below. There were net exceptional costs of £49.7 million (£18.9 million). Group profit before interest and tax was £507.4 million (£451.0 million).
The following table shows a segmental analysis of turnover and underlying PBIT.
| Segmental analysis of results | 2010 £m | 2009 £m | % change |
|---|---|---|---|
| Turnover | |||
| Severn Trent Water | 1,385.3 | 1,324.9 | 4.6 |
| Severn Trent Services | 336.5 | 339.3 | (0.8) |
| Intra-group sales | (17.9) | (22.0) | |
| 1,703.9 | 1,642.2 | 3.8 | |
| Underlying PBIT | |||
| Severn Trent Water | 541.3 | 456.0 | 18.7 |
| Severn Trent Services | 28.7 | 30.5 | (5.9) |
| Corporate and other | (14.2) | (16.2) | 14 |
| Consolidation adjustments | 1.3 | (0.2) | |
| Profit before interest tax and exceptional items | 557.1 | 469.9 | 18.6 |
Turnover in Severn Trent Water increased by 4.6% in 2009/10, to £1,385.3 million. Sales prices increased by 5.3% (including inflation) from 1 April 2009, with the previously noted decline in commercial consumption reducing revenues by around £1.6 million.
Profit before interest, tax and exceptional items increased by 18.7% to £541.3 million. As well as the increase in turnover, a number of factors impacted underlying PBIT. Employee costs decreased by £5.6 million as a result of lower pension costs; hired and contracted services were £8.3 million lower and there was an increase in the bad debt charge of £3.3 million with the incidence of bad debt as a proportion of turnover increasing marginally to 2.5% from 2.3% at the end of the previous year. Depreciation increased by £12.5 million due to the growing asset base. There was also a reduction in infrastructure renewals expenditure of £25.6 million as spending had peaked in the prior year.
During the financial year, Severn Trent Water invested £644.8 million (gross, UK GAAP) in fixed assets and maintaining and improving its infrastructure network. Included in this total was net infrastructure renewals expenditure of £104.5 million which is charged to the income statement under IFRS.
Adjusting for minor timing differences and modifications to the AMP4 capital programme (notified to Ofwat through the change control process) we successfully completed the five year programme with capital expenditure, net of grants, contributions and other income (UK GAAP) of around £2.6 billion.
Severn Trent Services
Turnover in Severn Trent Services was £336.5 million in 2009/10, down 0.8% on 2008/09. Underlying PBIT decreased by 5.9% to £28.7 million.
| 2010 £m | 2009 £m | Increase / (decrease) % |
|
|---|---|---|---|
| Turnover | |||
| Services as reported | 336.5 | 339.3 | (0.8%) |
| Apliclor SA – acquired May 2009 | (6.7) | - | |
| Meters business and CCM – sold May 2009 | (1.0) | (8.9) | |
| 328.8 | 330.4 | (0.5%) | |
| Impact of exchange rate fluctuations | - | 19.9 | |
| Like for like businesses in constant currency | 328.8 | 350.3 | (6.1%) |
| 2010 £m | 2009 £m | Increase / (decrease) % |
|
|---|---|---|---|
| Underlying PBIT | |||
| Services as reported | 28.7 | 30.5 | (5.9%) |
| Apliclor SA – acquired May 2009 | (0.3) | - | |
| Meters business and CCM – sold May 2009 | (0.9) | 0.9 | |
| 27.5 | 31.4 | (12.4%) | |
| Impact of exchange rate fluctuations | - | 1.3 | |
| Like for like businesses in constant currency | 27.5 | 32.7 | (15.9%) |
After adjusting for the impact of exchange rate fluctuation and the effects of small acquisitions and disposals, turnover on a like for like constant currency basis was down 6.1%, and underlying PBIT measured on the same basis was down 15.9%.
Return on invested capital was 13% (15%).
Corporate and other costs
Corporate overheads amounted to £12.7 million (£12.7 million). Our captive insurance company and other businesses generated an underlying loss of £2.9 million (loss of £3.7 million). The group’s captive insurance company insures Severn Trent group risks only and does not write any external business.
Exceptional items
We incurred a net exceptional charge in the year to 31 March 2010 of £49.7 million (18.9 million) comprising:
- In Severn Trent Water, restructuring costs of £42.1 million from the programme to restructure and realign the business. This included redundancy and pension curtailment costs amounting to £16.2 million arising from the reduction in central functions posts and a further £5 million from redundancies arising from previously announced initiatives. Costs relating to the implementation of SAP were £9.9 million including accelerated amortisation of £5.9 million. Provisions for onerous leases and other costs relating to Severn Trent Centre amounted to £6.8 million; and
- In Severn Trent Services, a charge of £5.9 million from its restructuring programme and a loss of £1.7 million on disposal of businesses.
Net finance costs
Our net finance costs were £218.8 million, compared to £196.4 million in the previous year. The increase was largely due to the higher average net debt during the year. Net finance costs on pension obligations were also higher as the expected return on pension assets was lower which in turn was due to the lower value of investments in the opening balance sheet in 2010 compared to 2009. The effective interest rate for 2010 was 5.6% (5.6%).
Profit before tax
Group profit before tax, exceptional items and gains/losses on financial instruments increased by 23.7% to £338.4 million (£273.5 million). Group profit before tax was £334.4 million (£167.6 million).
Taxation
The total tax charge for the year was £82.9 million (£223.6 million including exceptional deferred tax charge of £185.6 million). The current tax charge was £40.7 million (£52.1 million) and the deferred tax charge was £42.2 million (credit of £14.1 million before exceptional charge).
The effective rate of current tax excluding prior year settlements and exceptional items calculated on profit before tax, exceptional items and gains/(losses) on financial instruments was 22.6% (24.7%). The decrease in effective rate is a result of increased capital allowances in Severn Trent Water and agreement of a number of uncertain tax positions during the year rendering further provisions for these items unnecessary.
Going forward, we expect the effective current tax rate for 2010/11 to be in the range of 25% to 27%.
Profit for the period and earnings per share
Profit for the period was £251.5 million (loss of £56.0 million).
Basic earnings per share were 105.6 pence (loss per share 24.6 pence). Adjusted basic earnings per share (before exceptional items, gains/losses on financial instruments and deferred tax) were 122.8 pence (92.7p).
| 2010 £m | 2009 £m |
|
|---|---|---|
| Cash generated from operations | 708.0 | 643.5 |
| Net capital expenditure | (487.8) | (465.0) |
| Net interest paid | (194.2) | (173.9) |
| Tax (paid)/received | (53.8) | 1.1 |
| Other cash flows | (1.6) | (1.3) |
| Free cash flow | (29.4) | 4.4 |
| Acquisitions and disposals | (11.0) | - |
| Dividends | (159.7) | (158.8) |
| Net issue of shares | 2.4 | 6.2 |
| Change in net debt from cash flows | (197.7) | (148.2) |
| Net fair value adjustments | 11.4 | (1.6) |
| RPI uplift on index linked debt | (13.6) | (19.1) |
| Foreign exchange | (0.3) | 5.9 |
| Other non-cash movements | (1.3) | (3.7) |
| Change in net debt | (201.5) | (166.7) |
| Net debt at 1 April | (3,559.9) | (3,393.2) |
| Net debt at 31 March | (3,761.4) | (3,559.9) |
Free cash flow
Cash generated from operations increased by £64.5 million over 2008/09 due to increased profits in Severn Trent Water. Capital expenditure net of contributions and proceeds of sales of fixed assets was £487.8 million (£465.0 million). The increase arose from Severn Trent Water’s capital programme. Tax paid was £53.8 million whereas in 2008/09 a net refund of £1.1 million was received due to refunds received on the closure of computations for the years 2004/05 – 2005/06. Net interest paid increased due to the higher average net debt in the year.
Net debt
After payment of dividends of £159.7 million (£158.8 million) and net proceeds on share issues of £2.4 million (£6.2 million) the net cash outflow for the year increased net debt by £197.7 million (£148.2 million). Fair value adjustments on debt denominated in foreign currency and the related cross currency swaps decreased net debt by £11.4 million (increased by £1.6 million). The principal amount of our index-linked debt is adjusted by the change in RPI on a biannual basis. This increased net debt by £13.6 million (£19.1 million). Currency impacts on cash and debt held by overseas subsidiaries increased net debt by £0.3 million (decreased by £5.9 million). Other non-cash movements, mainly the reversal of fair value adjustments on maturing debt and currency swaps, increased net debt by £1.3 million (increased by £3.7 million).
Net debt at 31 March 2010 was £3,761.4 million (£3,559.9 million). We now include cross currency swaps that convert the proceeds of debt raised in foreign currency to sterling in net debt because together, the debt and the swap give a better representation of our sterling debt obligations. At the year end balance sheet gearing (net debt/net debt plus equity) was 80% (79%). Net debt expressed as a percentage of Regulatory Capital Value (RCV) was 59.2% (57.4%) based on RCV of £6,347 million (£6,198 million). Our net interest charge, excluding gains/losses on financial instruments, was covered 4.0 times (3.7 times) by profit before interest, tax, depreciation, amortisation and exceptional items and 2.7 times (2.4 times) by profit before interest, tax and exceptional items.
Liquidity
The group has a European Investment Bank facility of £150 million which has to be drawn on or before April 2011 and has an undrawn £500 million committed bank facility that matures in 2012 and 2013.
The maturity profile of our debt is shown in the chart below:
Treasury policy and operations
Our treasury affairs are managed centrally and in accordance with our Treasury Procedures Manual and Policy Statement. The treasury operation’s primary role is to manage liquidity, funding, investment and our financial risk, including risk from volatility in interest and (to a lesser extent) currency rates and counterparty credit risk. The board determines matters of treasury policy and its approval is required for certain treasury transactions.
Our strategy is to access a broad range of sources of finance to obtain both the quantum required and lowest cost compatible with the need for continued availability. Our principal operating subsidiary, Severn Trent Water, is a long term business characterised by multi year investment programmes. Our strategic funding objectives reflect this and the liquidity position and the availability of committed funding are essential to meeting our objectives and obligations. We therefore aim for a balance of long term funding or commitment of funds across a range of funding sources at the best possible economic cost.
Our policy for the management of interest rate risk is that no less than 45% of our borrowings should be at fixed interest rates, or hedged through the use of interest rate swaps or forward rate agreements. At 31 March 2010, interest rates for some 82.4% of our net debt of £3,761.4 million were fixed, with a weighted average interest rate of 5.9% for a weighted average period of 10.9 years.
We use financial derivatives solely to manage risks associated with our normal business activities. We do not hold or issue derivative financial instruments for financial trading.
Except for debt raised in foreign currency, which is fully hedged, our business does not involve significant exposure to foreign exchange transactions. We have investments in various assets denominated in foreign currencies, principally the US dollar and the euro. Our current policy is to hedge an element of the currency translation risk associated with certain foreign currency denominated assets.
We have entered into energy swaps that fix the cost of substantially all of Severn Trent Water’s expected net electricity consumption for the first three years of AMP5. The price fixed in these swaps is lower than the amount assumed in the Final Determination.
Gains/(losses) on financial instruments
We borrow in foreign currency under our EMTN programme and use cross currency swaps to convert the proceeds to sterling. The effect of these swaps is that interest and principal payments on the borrowings are made in sterling and so the currency risk is eliminated. The foreign currency notes and swaps are recorded in the balance sheet at their fair values and the changes in fair values are included in gains/losses on financial instruments in the income statement. Since the terms of the swaps closely match those of the underlying borrowing, these changes tend to be broadly equal and opposite. The changes in fair value of debt are shown in the reconciliation of movements in net debt in note 35.
We hold interest rate swaps with a net notional principal amount of £835 million under which we pay fixed interest and receive floating rate interest to reduce our exposure to changes in interest rates. These swaps are carried at fair value and are revalued at each balance sheet date. The changes in fair value are included in gains/losses on financial instruments in the income statement. During the year there has been an increase of £41.7 million in the fair value of these instruments because market interest rates were higher at 31 March 2010 than at 2009.
It is important to note that we intend to, and typically do, hold these swaps to maturity and the changes in fair value are non-cash movements. Over the lives of the swaps, these changes will net out because the swaps will have a zero fair value when they mature.
Credit ratings
Our long term credit ratings are:
| Long term ratings | Severn Trent Plc | Severn Trent Water Limited |
|---|---|---|
| Moody’s | Baa1 | A3 |
| Standard and Poor’s | BBB- | BBB+ |
Further details of our borrowings, investments and financial instruments are contained in note 21 to the group financial statements.
Pensions
We have two defined benefit pension schemes, of which the Severn Trent Pension Scheme (STPS) is by far the largest. Formal actuarial valuations were last undertaken for the STPS as at 31 March 2007. The actuarial valuation as at 31 March 2010 is currently underway.
On an IAS 19 basis, the estimated net position (before deferred tax) of our defined benefit pension schemes was a deficit of £354.9 million as at 31 March 2010 (deficit of £233.0 million). The funding level at 31 March 2010 was 80% (82%) and our defined benefit pension schemes had total assets of approximately £1,393 million and total liabilities of approximately £1,748 million. Note 28 to the financial statements gives details of the year on year movement in the schemes’ assets and liabilities.
During the year ended 31 March 2010 inflation expectations have increased and this has resulted in higher gross undiscounted liabilities. Increasing inflation is usually accompanied by increasing interest rates and so the higher undiscounted liabilities would normally be offset by an increase in the discount rate. However, corporate bond rates, from which the discount rate is derived, have fallen during the year and so rather than mitigate the effect of increasing inflation the discount rate has exacerbated the impact. Whilst there has been some recovery in equity markets this has been insufficient to compensate for the impacts of inflation and the discount rate.
Total cash contributions to the schemes in the year were £39.6 million (£42.0 million).
| The key actuarial assumptions were: | 2010 | 2009 |
|---|---|---|
| Price inflation | 3.6% | 2.9% |
| Salary increases | 4.1% | 3.9% |
| Discount rate | 5.7% | 6.7% |
| Pension increases in payment | 3.6% | 3.0% |
| Expected return on equities | 8.0% | 8.0% |
| Age to which current pensioners aged 65 are expected to live | ||
| Men | 85.3 | 85.1 |
| Women | 88.6 | 88.2 |
| Age to which future pensioners currently aged 45 are expected to live | ||
| Men | 86.5 | 85.9 |
| Women | 89.6 | 88.9 |
The discount rate used in the actuarial calculations and the assumptions for price inflation and life expectancy can significantly impact the value calculated for the pension deficit. The following table summarises the estimated impact on scheme liabilities resulting from changes to these key actuarial assumptions whilst holding all other assumptions constant.
| Assumption | Change in assumption | Impact on scheme liabilities |
|---|---|---|
| Discount rate | Increase/decrease by 0.1% | Decrease/increase by £34 million |
| Price inflation | Increase/decrease by 0.1% | Increase/decrease by £34 million |
| Life expectancy | Increase by 1 year | Increase by £40 million |
Accounting policies and presentation of the financial statements
Our consolidated financial statements are prepared in accordance with International Financial Reporting Standards that have been endorsed by the European Union.