Profits flow at AWG

How would you describe the financial performance? Can you just run
through the numbers?

We’re building on the half-year results. We delivered a good, strong set of
full-year results within the business, with all main operating divisions showing
improved performance over the prior year. Underlying operating profit was up 28%
to £378m.

Now you’ve managed to hedge against rising
energy costs, when does that hedge run out? And what are the longer-term

We fixed our energy costs quite some time ago, using forward contracts for an
18-month period, which takes us through to October 2006. Since that time, we’ve
seen substantial rises in wholesale electricity prices and increasing volatility
in those prices.

To eliminate the exposure to that volatility, we recently contracted for a
further 12-month period from October 2006, at favourable prices for our energy
costs, albeit those prices are a lot higher than they were a year ago.

Consequently, I would expect our energy costs to be about £10m higher for the
2006/07 year than the current financial year. But we should see that being
mitigated to a large extent, given the ongoing efficiency drives that we’ve put
into place within the water business.

And what about those efficiencies? Where are further efficiencies
going to come from?

We’ve delivered a very good start to our efficiency programme, delivering
sustainable savings through the workforce restructuring programme, by
re-tendering some of our high service cost expenditure, such as IT and
telecommunication requirements, and we’ve also looked at specific supply chain
cost initiatives.

There is a lot more that we can do and the focus this year will be on more
centralised management of our operations to improve productivity in the field.
We are looking at using new technology to reduce our bio-solid treatment costs
and associated by-product transportation costs. In the short to medium-term,
we’re also looking at ways to reduce our energy consumption.

At the time of the sale of the Morrison construction services and PFI
businesses, you wrote off most of the goodwill associated with that. Why did you
do that?

When AWG acquired the Morrison business back in 2000, it was a very different
business to what it is today; the major component of the business at that time
was construction. Consequently, the major proportion of the purchased goodwill
was allocated to the construction business.

Over the last two years, we’ve been focusing on a performance improvement
programme within the Morrison business and that’s primarily been on growing the
support services business.

Within the construction business, the focus has been on stabilising that part
of the business, and returning it to profit.

Now, when you come to sell that business, you have to write off (as part of
the bookkeeping for the disposal) any original purchase goodwill associated with
it. But what that means is that we’re left with a larger, growing, more valuable
support services business, with a much smaller proportion of goodwill associated
with it.

But you are left with all its pension liabilities. Why is that a good
deal for AWG?

That was clearly the right economic decision to be made in order to retain
the Morrison construction pension obligations.

The price any buyer would have demanded to take on those pension liabilities
would have been far, far higher than our own actuarial or accounting
obligations. That becomes all the more clear when we see how gilt rates have
moved since we completed the transaction. And that has reduced the amount of
that pension liability.

So, clearly, it would not have been in AWG’s interest to overpay at the wrong
time to remove that pension obligation.

The strong financial performance this year gives you tough
comparators for next year, doesn’t it?

We did benefit from a number of factors in the current financial year. We saw
an increased seasonal demand for water last summer and that improved revenues by
around £8m. And, as I mentioned, we would expect our energy costs to increase by
about £10m in the coming financial year.

On top of that, our price increases for 2006/07 will be limited only to an
inflationary factor of 2.4%. So I think it would be reasonable to assume there
will be a slight reduction in operating profit for the 2006/07 period. But as we
move beyond that and start to see the regulatory pricing formula increasing
revenues, I would expect to see stable growth over the successive future years.

And what would you regard as a normalised tax rate going forward?

The underlying effective rate for this year, when you exclude prior year tax
credits, was 32% and that’s slightly down on the 34% in the prior period. If we
strip out deferred tax from that, and just focus on the current tax rate, that
was 17.5% for the current year, up significantly on the 2004-05 period.

That was as expected, due to recent changes in tax legislation that removed
first-year capital allowances on certain above-ground infrastructure investment.
But the important thing is that this was factored into the regulatory pricing
formula, so we are seeing revenues to compensate for that additional tax burden.
Looking forward, I would expect the current tax rate to remain quite constant at
that level.

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