South East Water Limited

Condensed group financial statements

for the six months ended 30 September 2024

Chair and CEO joint report

We are pleased to present our interim report for the six months ended 30 September 2024. It has been a more stable six months compared to the extreme weather challenges faced in 2023 and this has allowed us to focus on getting back on track in some key areas of performance, including leakage. However, we are concerned that Ofwat's Draft Determination risks undoing the positive progress we have recently made.

Draft Determination

Despite this positive progress, significantly more investment is needed to improve our resilience to the challenges of climate change and population growth in a water-stressed area. Our new business plan (PR24) is the most ambitious we have ever produced, aiming to restore resilience to our operations and improve our financial resilience. The plan has a strong focus on improving and increasing network connectivity and localised storage to tackle the growing threat from external climate change and the extreme weather risks that have severely impacted our business and our performance since 2020. To ensure we can deliver our ambitious business plan, we are currently in dialogue with Ofwat over the Draft Determination which, in its current state, will significantly impact on the water security of our region by reducing our proposed resilience and Water Resources Management Plan investment. We have provided more evidence to Ofwat to substantiate the need for the level of investment we proposed in our business plan and we will continue to engage and negotiate positively with Ofwat to achieve a more balanced Final Determination in December. This in turn will help us to deliver an improved level of resilience and performance for our customers and better environmental outcomes.

Ofwat investigation into supply resilience

We continue to cooperate fully with Ofwat's investigation into our supply resilience which was launched in November 2023 following the exceptional high demand events and supply interruptions experienced in 2022 and 2023. We submitted an action plan to Ofwat in May which demonstrates how investment and operational changes have been prioritised that improve supply resilience, service delivery and support to customers in areas that were most affected by the high demand events in Kent and Sussex. We have continued to provide additional evidence to the investigation and an updated action plan, while reinforcing the need for adequate future investment to enable us to address the root causes of these supply resilience issues, as outlined above. We would welcome a swift resolution to this investigation.

Ofwat Water Company Performance report

We are pleased to report that Ofwat has recognised improvements across a broad set of measures, made by the company in the last 12 months. In the recently published Water Company Performance Report, our economic regulator has upgraded the company's performance from 'lagging' to 'average'. It should be noted that no water company achieved 'leading' status in this latest annual report. Our performance on priority services, drinking water quality, mains repairs and unplanned outage all exceeded our business plan commitments. We are particularly pleased to have this upgrade recognised, reflecting the hard work that many teams across the business have made to improve our performance over the last 12 months.

Financing

The group has improved its liquidity position in the last six months. £50 million of index linked debt was raised in August. In December the maturity date of the £120 million loan was extended to June 2026, from December 2025. Also in December, in recognition of Moody's revised guidance on gearing, our shareholders have invested £75 million of equity, which brings our gearing to 75 per cent at March 2025, consistent with an investment grade credit rating under Moody's revised guidance.  The investment by shareholders in the company reflects the desire to maintain an investment grade credit rating, but does not alter our conclusion as set out in our Draft Determination response to Ofwat that we do not consider the Draft Determination to be financeable.

The directors are aware that the outcome of the PR24 Final Determination could trigger further rating downgrade action across the sector, if it does not contain a material reduction in the risk of operational underperformance relative to the PR24 Draft Determination. Further downgrade action could lead to possible difficulty for the group in refinancing beyond the 12 month going concern period and may include agreeing undertakings with Ofwat. Although this does not affect the liquidity of the group over the going concern period, the risk of a future downgrade does represent a material uncertainty that may cast significant doubt on the group's ability to continue as a going concern.

Securing the future of water

It is clear that strengthening resilience is key to our operation in a water-stressed area with a growing population. We published our revised Water Resources Management Plan (WRMP24) in October, following its approval by Defra in August. WRMP24 sets out how we will provide our customers with safe, reliable water supplies over the next 50 years while enabling the natural environment to thrive. The plan focuses on managing and reducing demand for water by cutting leaks, and through smart metering and water efficiency programmes. It also takes into account a range of possible scenarios depending on the impact of population growth and climate change over the lifespan of the plan. We are grateful for the scrutiny of the plan by our Customer Challenge Group earlier this year.

Our recovery plan for leakage is beginning to reduce the backlog caused by last year's extreme weather events and by August we had completed 7 per cent more repairs than over the same time period last year. The Environment Agency has recently acknowledged that our performance on leakage is better than the national average, with a leakage percentage of 18.6 compared to the industry average of 19.4 per cent. We know there is still a long way to go on leakage but this is a positive step in the right direction.

Improving infrastructure and service

Ongoing investment in our network is essential to provide the security of our water supply for the future. At any given time we have around 600 live engineering projects across our operating area in different gateways and at different stages of progress. We completed a critical £7 million upgrade to Barcombe Water Treatment Works (WTW) in Sussex in April. This strategically important project took years of precision planning and a monumental effort from our colleagues to complete a repair on a drinking water storage tank successfully. Work is also progressing well on our brand new state-of-the-art WTW on the old Aylesford Newsprint site near Maidstone. This £39 million facility will provide up to 20 million litres of treated drinking water per day to the local area when it becomes operational in the summer of 2025. The Butler site is the first new water treatment works to be built in Kent for 18 years. An £80 million investment to create a more resilient water supply network across East Sussex continues at pace too. We are increasing and upgrading our infrastructure in the area and this will provide greater flexibility to move water around the network and improve water quality too.

We have spent time engaging with the 36 new Members of Parliament across our operating area since the General Election on 4 July to bring them up to speed on our operations and investments while also discussing the future challenges we face as a business, an industry and as a water-stressed area with a growing population.

Ensuring our environment thrives

We have to balance our operational requirements and investments with ensuring we protect and enhance the environment. In May, we were proud to showcase the progress we are making with H25 - our industry- first 25 Year Environment Plan. We invited environmental leaders, current and future partners and stakeholders who helped shape the plan, to hear about the steps we've taken since we launched the plan in 2023. The results of chalk stream and smart metering pilots as well as water efficiency programmes were discussed, as well as how all organisations have a part to play in ensuring raw water quality and quantity for the future.

Our biodiversity work continues to go from strength to strength and we have an award-winning catchment management programme. We continue to lead the field in the way that we proactively manage our land and Sites of Special Scientific Interest, and we remain on track to exceed our corporate target for biodiversity net gain this year. It has been recognised that 73 per cent of our company-owned SSSIs are now managed to a favourable condition, compared with a water industry average of 16.4 per cent.

Low-carbon sustainable future

We're also continuing a number of discussions about solar and battery storage projects to provide more resilience to power outages. Moving forward, we need to secure the necessary funding from Ofwat in order to fulfil our other net-zero plans, including the replacement of 70 per cent of our commercial transport fleet with low-carbon alternatives.

Supporting customers and society

In June 2024 we published our new and far-reaching 2025 to 2030 draft Vulnerability Strategy which builds on all the industry-leading work we've done in this area to date. The strategy has been developed with our customers, stakeholders and partners and uses the very latest industry insight, data and modelling. It sets out how we will strengthen our existing services and introduce new ones to make sure we meet the current and future needs of our customers who are most in need through tailored financial or non-financial support that is easy to access. We'll publish a final version in 2025 once we have received feedback from our customers, stakeholders and partners. A customer-friendly version of the strategy is available on our website and we welcome feedback on our approach.

We've collaborated with Wealden District Council to develop an emergency plan that places vulnerable customers at the forefront of our response during any disruptions to water supplies. Key information about care homes, hospitals and other vulnerable non-residential customers has been shared to create a contingency plan that guarantees the delivery of as much drinking water as possible in the event of a supply issue. We hope to expand this approach with further collaborative partnerships in the future.

Our Priority Services Register aims to provide support to all those who need extra help and we work hard to reach more customers who need our assistance, either temporarily or longer term. Over the first six months of this year we grew our PSR by almost 14 per cent to 114,805 people. The number of customers on our affordability tariffs has also grown by 3.8 per cent to 69,120 during the same time period. A second phase of our new customer incident management system tool will also ensure we communicate more effectively with all our customers during supply interruptions and incidents and ensure we deliver bottled water to those in need as efficiently as possible. Feedback on our new AquAlerter communications platform remains positive. The system was a Finalist in the Customer Initiative of the Year Award at the 2024 Water Industry Awards in July.

Although we did not experience the extreme summer weather we saw in 2023, we did run a summer communications campaign to encourage customers to make 20 simple changes to help us save water. Demand for water peaked at around 638 million litres per day on 25 June - nearly an additional 100 million litres of water a day compared to our normal daily demand of around 544 million litres. The campaign which included social media and radio advertising, garden-focused emails and customer newsletters, helped to flatten some of the peaks in demand over the summer. In addition, we have given away more free water-saving devices than ever before - 78,474 up to the end of September, that's a 6.6 per cent increase on the number we gave away in the same six-month period in 2023.

Building a future-ready business

People remain very much at the heart of our business and we are excited to have launched a new careers section on our website to showcase the range of opportunities available right across our business. Work is also progressing on building our major new HR IT system which will go live in March 2025. We are driving a culture of high performance through our succession planning and talent development programmes and seeking to bring more women into operational roles. A major shift pattern review is under way as part of this goal.

Safety of our colleagues, customers and contractors is always at the forefront of our minds in our industry and we continue to place the highest priority on driving up safety standards and increasing awareness of risks to safety. We have seen an encouraging reduction in the number of Lost Time Injuries from four in 2023 to a single occurrence in the six months to the end of September. Numerous initiatives are in place which will ensure there is no complacency in terms of safety, including our new mini safety stand-downs and our new ANMEL reporting tool.

More details about these initiatives and other developments can be found later in this report.

Results and key financial performance indicators

The results published in this statement summarise our performance for the six months ended 30 September 2024. The financial statements are prepared under International Financial Reporting Standards ("IFRS") and incorporate the performance of South East Water Limited and its subsidiary, South East Water (Finance) Limited.

Revenue

Revenue for the period was £151.1 million (2023: £147.1 million). The additional £4.0 million of revenue was due to tariff increases of £6.3 million, partially offset by £2.5 million of lower consumption experienced this period when compared to the same period in the previous year. Other revenues showed a modest increase of £0.2 million year on year.

Operating expenditure

Operating costs, excluding bad debt, were £118.4 million for the six months to 30 September 2024. This compares to costs of £115.4 million in the corresponding period for the previous year.

The increase in costs of £3.0 million was driven by increased employee costs of £2.4 million, due to annual pay awards, an increase in employee numbers plus higher underlying overtime. Depreciation charges in the period increased by £0.7 million and the transition to cloud computing arrangements gave rise to additional operating costs. Contractor costs increased by £1.9 million due to the provision of water in response to operational incidents, higher sludge removal charges and additional meter reading activity. Other cost increases, partly inflationary driven, were £1.0 million. There was a reduction in costs incurred due to exceptional weather-related incidents. During the period no such costs were incurred, compared to £3.0 million in the first half of last year.

Profit from operations

Operating profit for the six months period was £37.1 million (2023: £35.9 million), an increase of £1.2 million as detailed above.

Finance expenses

Finance expenses for the period were £35.4 million (2023: £54.8 million). The decrease of £19.4 million largely reflects lower indexation charges on our index linked loans of £21.2 million, due to lower inflation over the period. Interest on our index linked loans has increased by £0.7 million due to the higher balances outstanding.

Interest on our variable rate loan has increased by £0.3 million due to the higher SONIA rate. Other finance costs, including bank charges and interest on retailer deposits, are £0.3 million higher.

In August 2024 we entered into a new £50.0 million index linked loan, which was used to part repay our revolving credit facility ("RCF"). The balance on the RCF at 30 September 2024 was £82.0 million (2023: £53.0 million). The higher average balance on the RCF over the period, together with the higher SONIA rates, has resulted in increased interest charges on the RCF of £1.7 million.

Interest capitalised in the period is £1.3 million higher than in 2023, reflecting an increase in the capital programme.

Finance income

Finance income for the six months to 30 September 2024, comprising interest earned on bank deposits and returns on pension scheme assets, was £0.9 million (2023: £0.8 million).

Profit before taxation

The profit before tax for the six months to 30 September 2024 was £2.6 million (2023: loss of £18.1 million) largely as a result of lower finance expenses in the period.

Taxation

The group's tax credit for the period was £5.2 million (2023: £5.2 million). The current tax charge in the period was £nil. The deferred tax credit was generated primarily by the deferral of capital allowances for future use.

Profit after taxation

The group has recorded a profit after tax of £7.8 million for the period (2023: loss of £12.9 million).

Net debt and cash flow

During the six months to 30 September 2024, cash generated from operations was £64.4 million (2023: £67.0 million). Net payments in respect of capital activities in the period totalled £73.5 million (2023: £61.5 million). Net payments in respect of interest and other finance income and costs were £21.5 million (2023: £19.1 million).

The higher net interest paid in the period is due to higher interest rates in the period and additional borrowing on our RCF (see above).

As mentioned above, the group entered into a new loan arrangement in the period for £50 million index linked to CPI with a nominal interest rate of 3.5 per cent. This loan matures in September 2040.

Dividend

No dividends were paid during the six months ended 30 September 2024 (2023: £2.3 million).

Going concern

We continue to comply with our financial covenants under the terms of our securitised financing arrangements and continue to hold credit ratings from Standard & Poor's and Moody's consistent with the requirements of our instrument of appointment. The company's credit rating as at 31 March 2024 was BBB (stable outlook) with S&P and Baa2 (stable outlook) with Moody's. On 12 November 2024 S&P placed South East Water on CreditWatch with negative implications, reflecting potential revision to regulatory framework support. On 13 November 2024 Moody's downgraded South East Water to Baa3 with the rating under review for downgrade. Moody's carried out this rating action at the same time as changing their assessment of stability and predictability of the regulatory environment for the UK water sector under Moody's rating methodology to A from Aa. As a result, the company is now in cash lock-up under its instrument of appointment and unable to pay a dividend without Ofwat's approval. The company retains two investment-grade credit ratings.

There is positive financial headroom across all covenant ratio thresholds that would result in an Event of Default for the going concern period in the base case. There is limited financial headroom against the adjusted interest cover ratio and average adjusted interest cover ratio. Breaching these ratios would result in a Trigger Event.

The group's business activities together with the factors likely to affect its future development were set out in the strategic report included in the group's annual report for the financial year ended 31 March 2024. The group finances its working capital requirements through cash generated from operations and committed facilities that can be called upon as required. The group's liquidity position and cashflow projections are closely monitored and are updated each month. When necessary, mitigating actions are identified and implemented.

In preparing the financial statements the directors considered the group's ability to meet its debts as they fall due for a period of one year from the date of this report. The directors believe that it is appropriate to adopt the going concern basis of accounting in preparing the financial statements, notwithstanding the material uncertainty discussed below. The consolidated financial statements for the six months ended 30 September 2024 have therefore been prepared on the going concern basis.

The directors have assessed the going concern review that has been completed for the group. That assessment considered the output of the viability assessment for the year ended 31 March 2024 and performance since that date compared with budget. As part of the going concern assessment, the directors have also considered the budgeted and forecast cash flows over the 12 months to December 2025, the capital structure of the group and the financing needs for the period. This period has a greater degree of uncertainty as it includes the first nine months of the new regulatory period, AMP8, and the Final Determination has not yet been issued. The cash flows for the period to 31 March 2025 have been based on the latest forecasts and those for April to December 2025 have been based on the Draft Determination for PR24 published by Ofwat including Ofwat's assumptions on WACC and ODI targets.

The group has a significant level of planned expenditure over the remainder of this year and into AMP8 to continue to improve resilience and operational performance and to enhance its assets. The group continues to face the effect of higher operating costs as a result of the direct and indirect impact of higher power prices, higher demand for water leading to additional costs, and the impact of climate change including recovering from a number of extreme weather events over the last few years.

As a result of higher operating costs and additional capital expenditure, the group has forecast a net cash outflow position before financing inflows over the going concern period of 12 months to December 2025. The group has raised sufficient additional liquidity to cover the going concern period as required. In August 2024 we secured a new loan of £50 million. In December we agreed with our lenders to extend the maturity of a £120 million loan to June 2026, from December 2025. Also in December 2024, our shareholders provided £75 million of additional liquidity to reduce gearing and enable the extension of the£120 million loan.

Following the provision of additional equity, the directors believe that the group has sufficient liquidity over the going concern period to December 2025 to deliver its business plan, and to meet its regulatory obligations and financial commitments as they fall due.

In adopting the going concern basis of preparation for these financial statements, the directors have assessed the group's overall financial position and the latest cash flow forecast shared with the board. The directors have also noted that the group has no debt maturities until June 2026.

The directors have also considered the recent rating action by Moody's and the prospect of further downgrades across the sector, if the PR24 Final Determination does not contain a material reduction in the risk of operational underperformance relative to the PR24 Draft Determination.

A future downgrade of one of South East Water's credit ratings could make it harder for the group to raise financing in future periods, beyond the 12 month going concern period and may include agreeing undertakings with Ofwat. While this does not affect the liquidity of the group over the going concern period, nor its ability to meet its debts as they fall due, the risk of a future downgrade does represent a material uncertainty that may cast significant doubt on the group's ability to continue as a going concern.

Condensed group income statement

for the six months ended 30 September 2024