Thames Water results: Five things we learnt

Thames Water has published its eagerly-awaited annual results, following a fortnight of speculation about its financial health.

The publication of the 2022/23 results came as a surprise to many, with several financial experts predicting Thames would delay it in light of recent uncertainty.

The headline figures show revenue grew by 4% to £2.3 billion during the past year but EBITDA dropped 3% to £1.1 billion.

Also within the 183-page document were revelations about bonus payments, environmental provisions and shareholder commitments.

Shareholders commit fresh cash but go without dividend

Alongside its annual accounts, Thames Water announced that its shareholders have committed to provide £750 million in new equity funding over the next three years on condition that a “more focused” turnaround plan is developed.

The investors have also acknowledged that an extra £2.5 billion of fresh equity support will be needed for the second half of the decade.

However, Thames’ annual report adds that “the nature and amount of such medium-term support will depend on finalisation of the new focused turnaround plan and the regulatory framework that will apply to the AMP 8 period”.

The annual report also shows that for a sixth year in a row, Thames shareholders did not receive a dividend. It adds: “The board concluded that it was not appropriate to declare dividends to enable any external dividend to shareholders for 2022/23, the sixth year in succession.”

Poor performance was cited as the main reason why a dividend was not paid out.

The report adds that “overall company performance […] was short of expectations”.

It adds that last summer’s drought and the freeze-thaw event in December “significantly affected” overall performance. In addition, the annual report adds that performance was undermined by a “relatively small but significant number of large operational events which highlighted the underlying fragility of some of our assets and the need for investment to better manage the impact of climate change and population growth”.

In particular, the board noted that:

• Customer service remains poor, despite a c.28% reduction in complaints the company remains in 17th place (of 17) in C-Mex in FY23. Performance was impacted by extreme weather
• The company missed key regulatory targets including those relating to leakage, supply interruptions, water quality, main repairs, internal sewer flooding and pollutions.
• The company met targets relating to unplanned outages, sewer collapses and priority services.
• Overall the company delivered 26 of its 52 performance commitments and will therefore receive a net ODI penalty of £82.3 million this financial year (excluding C-Mex and D-Mex).

Bonus pay shake-up

Thames also unveiled a new bonus structure, with top executives able to earn up to 240% of their salaries for hitting certain targets.

That is down from the current maximum level of 320%, which Thames annual report says demonstrates “remuneration restraint throughout the turnaround period”.

Under the new Performance-Related Pay Plan, Thames employees will be renumerated for hitting targets relating to customer satisfaction, environmental performance and financial resilience.

Employees will receive 65% of the maximum bonus opportunity for hitting their targets, which will increase to the full amount if they hit or exceed the “stretch” targets.

Thames has also removed the minimum threshold for target-based bonusses, meaning performance-related pay can still be paid out even if targets are missed. Its annual report adds: “This enables the company to continue to motivate colleagues to deliver performance improvement when absolute targets are missed due to circumstances outside their control.”

For more on the new bonus framework, and reaction to it, click here.

Provisions and liabilities foreshadow legal battles

Thames has set aside more money to cover environmental issues over the coming year.

In total, the firm has allocated provisions of £192.7 million, up from £182 million set aside during the previous year’s accounts.

Of that, £78.7 million relates to “environmental matters”, up almost 50% from the £53.6 million allocated in 2022.

The annual report adds that the provisions do not include money set aside in relation to “investigations being separately led by Ofwat and the Environment Agency into compliance with conditions of environmental permits and sewer overflows”.

It adds: “The outcome of these investigations and the existence of any possible future financial obligations, or other consequences, is unable to be reliably determined at this time.”

Instead, Thames report states: “The evidence obtained supported the inclusion of these matters as contingent liabilities.”

Thames is also currently defending five court proceedings which the annual report adds “are considered still at too early a stage to provide further commentary on the merits or otherwise of them or any effect on the financial position”.

The report adds: “Provisions recognised are based on both legal guidance of expected outcomes for incidents being prosecuted and based on historical data for incidents which are early on in the legal process.

“The group is separately subject to investigations being led by Ofwat and the Environment Agency into compliance with conditions of environmental permits and sewer overflows. […]

“The [Audit, Risk and Reporting] committee concluded that the provisioning methodology, estimates and judgements management applied were reasonable.

“The committee considered the reasonableness of disclosures made in respect of contingent liabilities. Management were challenged as to whether a provision should be recognised in the financial statements instead of disclosures proposed.

“The committee concluded that in these cases provision recognition criteria had not been met and, therefore disclosure as contingent liabilities was the most appropriate approach.”

Bad debt mounts

Thames bad debt pile grew by almost a third during the past financial year.

In total, the level of bad debt now stands at £90 million, up from £67 million last year.

Thames annual report adds that “this increase was primarily due to the impact of a decline in real wages due to high inflation leading to lower cash collection rates”.

The bad debt charge is split between bad debt relating to current year bills (amounts that are not expected to be collected when invoiced) of £68 million, which is shown as a deduction in revenue, and bad debt relating to bills from prior years of £22 million, which is shown as a cost within operating expenses.

The report adds: “We are working hard to reduce bad debt and have implemented several initiatives to reduce the overall charge as a percentage of appointed revenue.”

It adds that “given the economic uncertainty associated with various macro factors such as a decline in real wages, a reduction in economic activity and inflationary pressures on operating costs” the company has worked up “a severe but plausible downside case […] where the ability of household customers to pay their bills has been adversely affected.”

It continues: “This would result in lower collection rates, higher bad debt charges and lower billable volumes in the non-household sector due to reduced consumption.”

Even under the severe but plausible downside scenario, Thames reports that “the business remains compliant with the relevant financial covenants and shows liquidity headroom for a period of at least 12 months from the date of signing of the financial statements”.

Gearing down but still high

Within its annual report, the company points out that its gearing level is at the lowest level for 10 years.

Now standing at 77.4%, Thames has reduced its high gearing level by 3.2 percentage points in the past year.

To put that into context, that still puts Thames’ gearing ratio above any other water company’s declared gearing level in 2022, with the weighted sector average last year at 68.5%.

The report states that the “decrease in gearing reflects a number of factors including the impact of higher inflation on RCV (Regulatory capital values)”.

It adds: “To improve gearing, the company would reprofile and/or delay capex spend, limit distributions and seek further cash injections sourced from raising incremental debt at the holding company level, namely from Kemble Water Finance Limited.”