ANNUAL REPORT AND FINANCIAL STATEMENTS 2009

Delivering strong group results

Sections within this page:

Financial review
Investment income and finance expense
Earnings per share
Dividends per share
Cashflow
Debt finance and interest rate management
Liquidity
Underlying profit

Financial review

United Utilities has delivered a strong set of financial results for the year ended 31 March 2009. Revenue from continuing operations rose three per cent to £2,435 million. Underlying profit before tax1 increased by 12 per cent to £532 million and underlying operating profit1 was up by 10 per cent to £742 million.

Regulated activities have delivered strong growth this year with operating profit up 11 per cent. This result primarily reflects the price increase allowed by the regulator and tight cost control. This price increase helps fund the high levels of essential investment in our assets, which allows the business to meet strict environmental standards and deliver an improved service for customers.

Capital expenditure in the regulated water and wastewater business amounted to £740 million during the year, including infrastructure renewals expenditure. This high level of spend is consistent with the planned investment profile and reflects the peak phase of the current 2005-10 capital expenditure programme. Overall, the group remains in line with regulatory assumptions on both expenditure and outputs.

United Utilities’ business improvement initiatives are delivering benefits and the group remains broadly on track to meet regulatory efficiency targets across this price review period, although cost pressures in areas such as power and bad debts are expected to continue through 2009/10. In particular, the early progress of the workforce management project, which has been successfully implemented on time and below budget, is encouraging. This integrated system is a key initiative in increasing productivity by using real time data across the workforce to enable more effective work scheduling. The system should improve both efficiency and customer service. Cost savings in the order of £7 million per annum are expected by 2010.

Non-regulated activities have delivered good underlying operating profit growth of nine per cent. This principally reflects the planned increase in activity on the Scottish Water contract, an increase in contribution from the group’s international operations and a benefit realised from foreign exchange rate movements. Overall, the performance across our non-regulated contract portfolio is pleasing. The group’s order book remains strong at over £6 billion in revenue and United Utilities continues to be the leading utility infrastructure outsourcing business in the UK.

The group has returned £1.5 billion to shareholders as planned and continues to benefit from a robust financing position, with headroom to cover its projected financing needs through to mid-2011. During the year the group enhanced its liquidity, raising over £1 billion of debt finance, via a £400 million 12-year term loan facility with the European Investment Bank, a £375 million 6.125 per cent, seven-year bond and a £275 million 5.75 per cent, 13-year bond. In addition, this was supplemented through the arrangement of additional bank facilities and renewal of core relationship banking facilities which matured during the period. This provides good flexibility in terms of when and how to raise further debt finance.

Investment income and finance expense

Finance expense of £271 million was £61 million lower than the prior year. This expense included a £24 million net fair value loss on debt and derivative instruments, compared with a £43 million net fair value loss in the previous year. This volatility in financing expense reflects the fact that, in order to provide a hedge of the interest cost implicit in the regulatory period, the group fixes interest rates for the duration of each five-year review period for the majority of its debt using interest rate swaps. IAS 39 limits the use of hedge accounting for these commercial hedges, thereby increasing the potential volatility of the income statement. In addition, the impact of changes in credit spread on debt accounted for at fair value through profit or loss can result in significant additional volatility. However, this volatility in fair values has no cashflow impact. Interest expense on swaps and debt under the fair value option was £8 million, £33 million lower than the comparative period, primarily due to the derivative contracts associated with a €1 billion 6.625 per cent bond, which matured in November 2007.

Investment income was £66 million, compared with £147 million in the previous year, principally reflecting a reduction in cash following the return of approximately £1.5 billion to shareholders and repayment of debt, including the repayment of a $500 million bond on 1 April 2008. The underlying cost of net borrowings for continuing operations of £196 million was £11 million lower than the prior year. This reflects a reduction in the group’s average net borrowing rate from around 5.8 per cent to 4.7 per cent partly offset by a higher average net debt, primarily due to the return of approximately £1.5 billion to shareholders in August 2008. The group’s redemption of a €1 billion 6.625 per cent bond in November 2007 contributed to the reduction in the underlying cost of net borrowings. RPI inflation during the previous year and the first half of 2008/09 initially increased the cost of the group’s index-linked debt. However, the benefit of lower RPI began to impact the group’s interest expense during the second half of the year, with further benefits on interest expense expected in 2009/10. In the event of RPI deflation, the principal amount of the index-linked debt would be adjusted downwards, reducing interest expense in the income statement. During 2008/09 indexation of the principal of index-linked debt amounted to a charge of £28 million compared with a charge of £55 million in 2007/08.

Profit before taxation

Profit before taxation increased by 11 per cent to £530 million. Underlying profit before taxation1 was £532 million, 12 per cent ahead of the results for the year ended 31 March 2008. This underlying measure adjusts for the impact of one-off items, fair value movements in respect of debt and derivative instruments, interest on swaps and debt under fair value option and the short-term interest benefit associated with the cash proceeds from the sale of United Utilities Electricity (UUE) prior to the £1.5 billion return to shareholders.

Taxation

The current tax charge relating to continuing operations was £139 million and the current tax effective rate was 26 per cent compared with 19 per cent in the previous year. The increase in the current tax rate principally relates to fair value movement in derivatives, the cessation of deductions for the 2005 pension prepayment and a net reduction in capital allowances claimed, partly offset by the reduction in the corporation tax rate from 30 per cent to 28 per cent. These timing differences are matched by equal and opposite movements in deferred tax.

The group has recognised a one-off deferred tax charge of £206 million relating to the abolition of industrial buildings allowances. This one-off item has resulted in a significant increase in the effective tax rate for the year ended 31 March 2009. However, the cash impact will be spread over a period of approximately 20 years.

The total deferred tax charge relating to continuing operations is £210 million compared with a deferred tax credit in the prior year of £27 million, which reflected the restatement of the opening deferred tax liability following the reduction in the corporation tax rate from 30 per cent to 28 per cent with effect from April 2008.

An overall tax charge of £349 million relating to continuing operations has been recognised for the year ended 31 March 2009. Excluding the impact of the abolition of industrial buildings allowances and the change in corporation tax rate in the prior year, the total tax charge relating to continuing operations would be £143 million or 27 per cent compared with a £144 million charge or 30 per cent in the prior year. It is expected that the group’s effective tax rate for 2009/10 will be broadly in line with the mainstream UK corporation tax rate of 28 per cent.

Earnings per share

Basic earnings per share relating to continuing operations decreased from 61.2 pence to 26.5 pence, principally reflecting the one-off deferred tax charge of £206 million relating to the abolition of industrial buildings allowances (equivalent to 30.3 pence per share). Basic earnings per share in the previous year were positively impacted by a one-off deferred tax credit of £82 million (equivalent to 12.0 pence per share), reflecting the reduction in the corporation tax rate from 30 per cent to 28 per cent with effect from April 2008.

Basic earnings per share are calculated based upon 681 million ordinary shares (the prior year has been re-presented based upon 680 million ordinary shares), reflecting the group’s capital reorganisation implemented on 28 July 2008.

Dividends per share

The board has proposed a final dividend of 22.03 pence per ordinary share in respect of the year ended 31 March 2009. Including the interim dividend of 10.64 pence per share, which has already been paid, the total dividend for 2008/09 is 32.67 pence per share. As explained previously, this is a 30 per cent reduction compared with the 2007/08 dividend per share, to reflect the revised composition of the group following the sale of UUE and the return of £1.5 billion to shareholders.

The group’s revised dividend policy is intended to target a sustainable and growing level of dividends. The new target real growth rate of RPI+2 per cent will be applied from 2009/10 to the 2008/09 dividend per share. In line with this policy, the board expects to grow dividends for 2009/10 by five per cent. This incorporates an inflationary increase of three per cent, which is based on the RPI element included within the allowed regulated price increase for UUW for the 2009/10 financial year (i.e. the movement in RPI between November 2007 and November 2008).

The final dividend in respect of 2008/09 is expected to be paid on 3 August 2009 to shareholders on the register at the close of business on 19 June 2009. The ex-dividend date for the final dividend is 17 June 2009.

Cashflow

Cash generated from the group’s continuing operations for the year ended 31 March 2009 was £911 million, compared with £877 million in the prior year. High levels of capital expenditure have continued, principally in the regulated water and wastewater investment programmes. The group’s capital expenditure on property, plant and equipment for the year was £675 million, excluding infrastructure renewals expenditure which is treated as an operating cost under IFRS.

Net debt, including derivatives, at 31 March 2009 was £4,895 million, an increase of £1,992 million compared with 31 March 2008. This movement principally reflects the return to shareholders of approximately £1.5 billion, along with expenditure on the regulatory capital investment programme, payment of dividends and payments of interest and tax, partly offset by operational cashflows.

Debt financing and interest rate management

As expected, gearing (measured as group net borrowings divided by UUW’s regulatory capital value) increased to 66 per cent at 31 March 2009, compared with 39 per cent at 31 March 2008, following the return of approximately £1.5 billion to shareholders in August 2008. Adjusting for the group’s non-recourse joint venture debt of £230 million, gearing is 63 per cent. The board continues to target an A3 credit rating for United Utilities Water PLC. At the year end, United Utilities Water PLC had stable long-term credit ratings of A3/A- and United Utilities PLC had stable long-term credit ratings of Baa1/BBB+ from Moody’s Investor Services and Standard and Poor’s Ratings Services respectively.

During the year, United Utilities repaid a $500 million 6.45 per cent bond and a €600 million 4.875 per cent bond from existing cash resources. Cash and short-term deposits on the balance sheet at 31 March 2009 amounted to £299 million. United Utilities has a long-standing relationship with the European Investment Bank and during the year enhanced its liquidity further via a new £400 million term loan facility for UUW to support the remainder of the company’s current capital investment programme. In addition, UUW issued a £375 million 6.125 per cent, seven-year bond, a £275 million 5.75 per cent, 13-year bond and £35 million of floating rate Japanese Yen notes, maturing in 2017. In total, the group raised over £1 billion of term funding during the financial year.

The group has access to the international debt capital markets through its €7 billion medium-term note programme which provides for the periodic issuance by United Utilities PLC and United Utilities Water PLC of debt instruments on terms and conditions determined at the time the instruments are issued. The programme does not represent a funding commitment, with funding dependent on the successful issue of the debt securities.

Long-term borrowings are structured or hedged to match earnings and assets, which are largely in sterling, indexed to UK retail price inflation, and in the case of revenues, subject to regulatory price reviews every five years.

Very long-term sterling inflation index-linked debt is the group’s preferred form of funding as this provides a natural hedge to earnings and assets. At the year-end, approximately 40 per cent of the group’s net debt was in index-linked form, representing around 27 per cent of UUW’s regulatory capital value, with an average real interest rate of 1.8 per cent. The long-term nature of this funding also provides a good match to the group’s long-life infrastructure assets and is a key contributor to the group’s average term debt maturity profile which is in excess of 25 years.

Where debt is raised in a currency other than sterling and/or with a fixed interest rate it is generally swapped to create a floating rate sterling liability for the term of the liability. The group’s policy is to seek to match the debt service costs to regulatory cashflow which is impacted by the general interest rate environment at the time of each price control determination and is then fixed for the five-year period of that price control. To hedge the exposure to each price control determination, the group enters into interest rate swaps, around the time of each price control determination, to fix interest costs for a substantial proportion of the group’s debt for the duration of that price control period. The group does not undertake any speculative trading activity.

The group enters into joint ventures with consortium partners. The financial and legal structure of joint ventures is designed to limit the group’s exposure to the extent of the equity investment and loans provided by the group, with no further recourse should the joint venture default. All joint venture arrangements have been incorporated into the group’s results on a proportionate consolidation basis.

Liquidity

Short-term liquidity requirements are met from the group’s normal operating cashflow and its short-term bank deposits. Further liquidity is provided by committed but undrawn credit facilities. This liquidity supports the group’s €2 billion euro-commercial paper programme.

In line with the board’s treasury policy, United Utilities aims to maintain a healthy headroom position. Available headroom at 31 March 2009 was £935 million based on cash, short-term deposits and medium-term committed bank facilities, net of short-term debt. This headroom is sufficient to cover the group’s projected financing needs through to mid-2011.

United Utilities believes that it operates a prudent approach to managing banking counterparty risk. The group does not have any cash (or cash equivalents) invested in money market funds. Its cash is held in the form of short-term (generally no longer than three months) money market deposits with prime commercial banks.

United Utilities operates a bilateral, rather than syndicated, approach to its core relationship banking facilities. This approach spreads maturities more evenly over a longer time period, thereby reducing refinancing risk and providing the benefit of several renewal points rather than a large single refinancing requirement.

Underlying profit

In considering the results for the year, the directors have adjusted the group’s statutory measures for fair value movements on debt and derivative instruments, interest on swaps and debt under fair value option and those significant items identified as non-recurring. Operating profit and profit before taxation from continuing operations are reconciled to underlying operating profit from continuing operations and underlying profit before taxation from continuing operations as follows: