National Grid plc
Q4 2018 Earnings Call Transcript

Published: 17 May 2018

[Aarti Singhal:]

Good morning, everyone, and welcome to the National Grid full year results presentation. As always, we are going to start with safety. There are no planned fire alarm tests this morning, so if you hear an alarm, you do need to leave the building and gather outside at Paternoster Square. Second important thing is the cautionary statement. I would like to draw your attention to that, which is included in your packs. And warm welcome also to those of you who are watching online. All the material is available on our website. And as usual, there will be Q&A after this presentation by John and Andrew. So with that, I'd now like to hand you over to John Pettigrew. Thank you.

[John Pettigrew:]

So thank you, Aarti. And good morning, everyone. So as usual, Andrew and I are joined this morning with Nicola Shaw and Dean Seavers, who'll be on hand to assist us with any questions. So let's start with a review of our performance in '17/'18. It's been a busy time for the group, and I'm pleased to report we've had a good year. Let me start with our financial highlights, where we've included Cadent on a like-for-like basis to help the comparisons with the prior year. On an underlying basis, that is excluding the impact of timing and major storms, operating profit increased by 6% at constant currency to £3.5 billion, mainly reflecting the strong performance of our U.S. business. During the year, we made significant investment of £4.3 billion in critical infrastructure, representing an increase of 14% at constant currency. When combined with year-end inflation, this capital spend drove core asset growth of 6%, in the middle of our stated range of 5% to 7%. And importantly, we achieved that whilst delivering strong returns on equity at 12.3% for the group. Finally, in line with our dividend policy, the board has recommended a final dividend of 30.44 pence per share, bringing the proposed full-year dividend to 45.93 pence. This represents an increase of 3.75%, reflecting last year's average U.K. inflation. So as you can see, it's been a good year of financial performance with strong organic growth. Turning now to our safety and reliability performance. Last year, we continued our relentless focus on safety with our ambition to ensure that all our employees and contractors go home safely at the end of each day. To achieve this, I believe the most important thing is to have a culture where safety underpins everything that we do not just at the operational sites, but right across the organization. And it's delivering consistently on that culture that has enabled us to achieve an employee lost time injury frequency rate of 0.1, which is consistent with world-class safety performance. Across both our U.S. and U.K. networks, reliability has also remained strong. We achieved excellent performance for both our gas and electric networks with near 100% reliability in the U.K. In the U.S., we faced a unique winter with major storms across all our jurisdictions. In October, we restored over 530,000 electric customers following one of the most severe storms in recent years. And in March, we were challenged again with three-back-to-back nor'easters, which is unprecedented. As always, our crews worked around-the-clock, restoring the vast majority of affected customers within 72 hours. And almost all of the restoration costs of around £140 million will be recovered through our existing regulatory mechanisms. Now moving to the key achievements and developments during the year, starting with the U.S. where we've made significant progress. We now have around 80% of our distribution businesses operating under new rates. This was following the successful filing of Massachusetts Electric, our KEDLI and KEDNY businesses and most recently Niagara Mohawk. The NiMo agreement, which was completed in March, allows a return on equity of 9% and a $2.5 billion of capital investment over three years. With the KEDNY and KEDLI settlements, that means over the next three years total investment in New York will be more than $5 billion. In addition, in November, we submitted rate cases for our Massachusetts Gas and Rhode Island businesses; and expect to have updated rates in place by October. Combined, we've asked for $81 million of additional revenue and $800 million of annual capital allowances, with a 10.5% return on equity for Massachusetts Gas and a 10.1% return on equity for Rhode Island. Both filings are progressing well, with the hearings for Massachusetts due to conclude later this month and the hearings for Rhode Island starting in June. With the completion of these rate filings, we'll have new rates for our entire U.S. distribution business, which will contribute to improvements in performance and allow us to achieve returns as close to the allowed level as possible. One of the commitments we made last year was to continue our recent trend of improved returns, with a goal to deliver 90% of the allowed return on equity. I'm delighted to say we achieved more than this delivering 95%, with strong asset growth of over 7%. Operationally we've also continued to make good progress. With a significant increase in the levels of capital investment, we've now established a capital delivery function similar to that, that we have in the U.K. And this function is already helping us to deliver projects much more efficiently. A good example of this is the Metropolitan Reliability Infrastructure project. It's a five-year $280 million gas project running through the heart of Brooklyn. When complete, this project will significantly improve the reliability of our network. And I'm pleased to say we're on budget and ahead of the initial construction schedule. And finally, we responded quickly to the U.S. tax reform that was announced in December, adjusting our rate filings for NiMo, the Massachusetts Gas and Rhode Island to reflect the lower tax rates and reducing our total revenue requests, including FERC, by $180 million. And Andrew will discuss this in more detail shortly. So turning now to the U.K. regulated businesses and starting with our Cadent investment. As you know, we entered into an option agreement with Quadgas for the potential sale of the remaining 25% stake. We're expecting the cash proceeds from the potential sale to be approximately £1.2 billion and for these proceeds to be retained for reinvestment in the business to deliver on our growth strategy. Operationally, both our Electricity and Gas Transmission businesses have continued to deliver high levels of performance. In the five years since RIIO was introduced, we've now generated approximately £540 million of customer savings, which will help to reduce bills over a number of years. Last year, we're able to deliver 200 basis points of outperformance through efficiency and performance optimization. For example, we completed the first phase of the London Power Tunnels, generating more than £80 million of efficiency savings. In addition, we progressed a number of important regulatory topics in the U.K., which I'll cover in more detail later in the presentation. Turning next to National Grid Ventures, where the major area of activity has been our interconnectors where again we've made good progress. All three of the interconnectors we currently have under construction, that's Nemo, North Sea Link and IFA2, are on track. And we reached a significant milestone on Nemo with the completion of the initial cable laying quite recently. These three interconnectors represent £1.3 billion of investment and will contribute over £150 million of EBITDA when operational. And our Property business also continues to make good progress, in particular with our site at Battersea which will deliver almost 1,000 new homes in London when it's completed. And next year will be an important year for our Property business, when we expect to transfer into our joint venture our 17-acre Fulham site, subject to the relevant planning approvals. So in summary, I'm pleased to report another year where we made good strategic progress whilst delivering strong operational and financial performance for the group. National Grid is in good shape, and I expect further progress next year as we continue to evolve the group for the changing needs of the industry. So more on that shortly, but first, just before I hand over to Andrew to discuss the financial performance in more detail, I wanted to say thank you to him. As you'll have read, this will be his last results presentation. Andrew has brought strong leadership and financial discipline in his eight years at National Grid, and I've personally valued the guidance and support he's given me since I became CEO. Andrew leaves with National Grid having a very strong foundation for the future and with all our best wishes. And I'm really pleased that Andy Agg, who is the group Treasury and Tax Director, will be taking over as Interim CFO. Andy, who is here today, is highly experienced and has been with National Grid for well over 10 years. So with that, I'll hand over to Andrew.

[Andrew Bonfield:]

Thank you, John. And good morning, everybody. As John has highlighted, our financial performance was strong. All of our key metrics showed progression. At constant currency, underlying operating profit was up 6%, and pro forma earnings per share up 4%. Our strong operational performance was reflected in the 12% growth in value added and a 60 basis point improvement in return on equity. Asset growth is now at the middle of the range, driven by increased capital investment and the reshaping of the portfolio. The dividend of 45.93p per share is 3.75% higher, in line with our policy. Now let me walk you through each of the segments. UK Electricity Transmission delivered another year of strong operational performance, achieving a 13.1% return on equity. We continued to focus on innovation and efficiency to deliver totex outperformance of 180 basis points, which was broadly consistent with the prior year. Other incentive performance of 40 basis points was lower, mostly driven by the reduced BSIS incentive opportunity under the arrangements for 2017/'18. Additional allowances added 70 basis points of performance. Underlying operating profit of £1.1 billion was down 15% largely due to higher MOD adjustments, increased depreciation and lower BSIS income. Capital investment was £1 billion, which was broadly in line with the prior year. This investment, along with inflation-linked growth in RAV, increased the year-end regulated asset value by 4.5% to £13 billion. Moving to Gas Transmission, which delivered a return on equity of 10%. As I highlighted at the half year, returns were lower. This reflects the increased spend on asset health, which is required to deliver our RIIO-T1 outputs; and the end of legacy allowances. Other incentive performance remained strong as a result of the investment we have made to ensure the reliability and integrity of the network. Operating profit was up 12% on an underlying basis primarily due to increases in base revenues, including £47 million for Avonmouth. Again as I mentioned at the half year, we will be returning approximately £85 million of Avonmouth allowances in the current financial year. Capital investment increased by £96 million to £310 million. This increase is a result of our investment in the Feeder 9 and compressor projects and the step-up in asset health spend. And the regulated asset value grew by 4.5% to £6 billion. In the U.S. our return on equity was up 70 basis points to 8.9%, which is 95% of the allowed return, due to the new rate filings. In New York performance was 60 basis points better at 9%. Our downstate gas businesses benefited from the recent filings, and we also saw improved performance in our upstate business. As expected, performance in Massachusetts improved significantly. This was driven by the first full year of rates in the electric business, where we achieved a return on equity of 9%. We expect new rates in our gas business to be effective from October. Our Rhode Island business saw a reduction of 80 basis points due to inflation and of new rates which were expected in September. And our FERC returns have remained strong. Underlying operating profit increased significantly to £1.7 billion, up 20% at constant currency, driven by higher revenues, from -- the rate filings as well as the absence of one-off write-offs in the prior year. We increased investment in our U.S. networks to £2.4 billion or $3.3 billion, driven by the expansion of mains replacement programs and reliability and reinforcement investments. This meant rate base grew by 7.4% to $20.7 billion. National Grid Ventures performed well, making a £287 million contribution to the group, including the post-tax share of JVs and associates. As expected, the metering business continues to see a decline in revenue driven by a lower meter population. Our Grain LNG business delivered consistent levels of operating profit to last year. And profits at IFA reduced due to lower auction revenues and the impact of the sharing mechanism. Profits of BritNed were also lower, as the benefit we received from the levy exemption certificates last year, which drove higher price arbitrage and auction revenues, was not repeated. Capital investment has increased significantly to £363 million, reflecting the startup of construction at IFA2, the second French interconnector; and increased spend on Nemo, which is on track to be operational next year. Moving to other activities. Total group contribution was £111 million, up £34 million on the prior year. Operating profit in the Property business increased to £84 million as a result of asset disposals, including sites in Staines and York. Corporate center and other costs decreased year-on-year as a result of lower business change costs. The remaining 39% stake in Cadent made a £123 million post-tax contribution, down £21 million compared to last year's pro forma number. This was driven by a reduction in base revenues and adverse year-on-year timing. Financing costs increased by 2% at constant currency to £974 million. This was primarily due to higher U.K. RPI and increased debt. These factors were partially offset by the crystallization of gains on investments in our captive insurance company and the sale of our shares in Dominion. The effective interest rate increased from 3.9% to 4.6%, reflecting the higher RPI. The effective tax rate was 23.7%. This is 50 basis points lower as a result of lower U.K. and U.S. tax rates, partially offset by a higher profit mix towards the U.S. This gave rise to a charge of £589 million. Earnings increased to £2.1 billion. And as you've heard, underlying earnings per share increased to 60.4p per share. Operating cash flow was £4.7 billion, £250 million higher than last year. This mainly reflects one-off pension contributions that were made in the U.K. and U.S. last year. Closing net debt was £23 billion. This reflects £1.8 billion of business-as-usual cash outflow, the return of the £4 billion from the Gas Distribution sale and the benefit of £2.1 billion from the strengthening of sterling versus the dollar. We raised over £1.8 billion of new long-term financing. This includes a $400 million bond in our New England Power transmission business, which at a coupon of 3.8% is the lowest rate we've ever achieved for a 30-year bond in the U.S. Our RCF-to-debt ratio was 10.6% in a continuing basis, and FFO to date was 16.4%. Value added was £2 billion or 57.9p per share. This comprised to growth in group assets of £2.3 billion driven by increased CapEx and higher U.K. RPI; cash dividends and the repurchase of scrip shares, which totaled £1.5 billion, less this year's underlying growth in net debt of around £1.8 billion which I mentioned a moment ago. One of the benefits of value added as a measure is that it includes the movements in all our regulatory assets and liabilities, including our assets outside RAV and rate base. As we have discussed previously, IFRS earnings can be adversely impacted by regulatory adjustments such as the revenue mechanisms under RIIO. A great example of this is the recognition of allowances for Avonmouth in 2018 in our IFRS profits, which will reverse in the current financial year. The value-added measures takes this into account, these sorts of regulatory adjustments; and therefore it's a more effective way of capturing the real underlying performance of the business. We are seeing a step-up in the rate of organic growth. This is driven by the sale of Gas Distribution, which has reshaped the portfolio towards higher-growth businesses; the visibility of our U.S. growth profile due to the successful rate filings; and the investment in interconnectors in National Grid Ventures. We therefore expect asset growth to be sustained at the top end of the 5% to 7% range for the medium term and at least 7% in the near term. Now let's look at the organic growth opportunities in each of the businesses. In the U.S. the business is well advanced in its rate filing strategy. Each rate filing outcome has provided for increased investment to replace and reinforce aging infrastructure as well as provide funding to support each state's decarbonization agenda. We expect to invest at least $10 billion over the next three years in our U.S. business. We can also expect that the vast majority of this investment will be fully remunerated, benefiting earnings from the point the investment is made. These higher levels of investment are already impacting our rate base growth, which increased to 7.4% this year. This, plus the beneficial impacts of U.S. tax reform on rate base growth, means that we can expect the growth rate to remain at least 7% through 2021 and even higher in the near term. In the U.K. we have significant clarity of the investment profile, particularly now that we're 5 years into the RIIO-T1 price control. We spent £1.3 billion this year and expect to continue to spend around this amount through to March 2021. Assuming 3% RPI, this will deliver average asset growth of just under 5% per year over the remainder of the price control. In National Grid Ventures we have made very good progress on our interconnector projects. The CapEx on the 3 interconnector projects under construction totals approximately £1.3 billion. These projects are expected to complete in the early 2020s and, once operating, should generate EBITDA of over £150 million per annum. The proposed Viking project could add a further £850 million of CapEx and an incremental £100 million of EBITDA. So bringing it all together, we expect to spend around £13 billion of CapEx across the group over the next three years. Moving to U.S. tax reform. As you know, tax is a pass-through cost for utilities. The reduction in the corporate tax rate from 35% to 21% will be significantly beneficial to consumers and economically neutral to utilities. However, there are some implications on cash flow. The lower bill collections have little or no offsetting cash tax paid, as we are currently in a net operating loss position in the U.S. We have already reduced our revenue request by $130 million relating to the three operating companies undergoing rate filings and $50 million for our FERC businesses which operate under formula rates. In our remaining distribution businesses, we may be able to partially offset the bill reductions with faster recovery of regulatory assets or use the headroom created to fund further investment. We filed our Massachusetts Electric proposals earlier in the month and plan to file KEDLI and KEDNY over the summer. We will also return $2 billion of existing deferred tax liabilities, which represents historic tax collections at the higher rate of 35% over 20 to 30 years, as required by the legislation. Under U.S. GAAP, there is no impact at the operating company level on earnings or U.S. ROEs. Under IFRS, there will be a small impact associated with the return of the deferred tax balance, as the release of the $2 billion liability is reflected as an exceptional item in this year's accounts. Finally, rate base growth will increase due to the lower buildup of deferred taxes in the future as a result of bonus depreciation ending for utilities. Over time, this will be beneficial to cash flow, marginally offsetting the lower tax collections. National Grid has a strong balance sheet and efficient capital structure, which underpins the effective financing of the company's CapEx program. The group is now entering a period of stronger growth. We expect to fund this investment through a combination of internally generated capital delivered through continued strong returns and future cost efficiencies, capital arising from the disposal of the remaining 39% shareholding in Cadent and additional capital generated through the scrip dividend. As I've always said, we put in place the scrip to support the business in periods of higher growth. At this stage, we do not expect to buy back the shares in 2019 and 2020, unless we -- that we have higher-than-anticipated balance sheet capacity. We are confident in the strength of the balance sheet to finance this attractive level of growth, upon which we expect to earn strong returns. We are well positioned to deliver asset growth of 7% over the medium term and grow the dividend per share at least in line with RPI. As normal, I would like to summarize our technical guidance for 2018 and '19. And as ever, you can find more details in the statement. Overall, we expect our U.K. regulated businesses to continue to deliver 200 to 300 basis points of outperformance driven by traditional incentives in both businesses and totex outperformance in Electricity Transmission. In the U.S. returns are expected to be at a similar level to the current year. Revenues will benefit from new rates, but there will be a partial offset resulting from the introduction of IFRS 15 and the impacts of tax return. Other activities are expected to benefit from the transfer of our Fulham site into the JV with Berkeley Group, which is subject to completion of site works and appropriate planning consents. Our interest charge will increase, reflecting the growth in net debt and no investment gains, partially offset by lower inflation. The tax rate will be lower, offsetting the bill adjustments to customers from U.S. tax reform. So let me summarize. The financial performance across the group has been strong. Our asset growth rate has increased, and we expect 7% growth over the medium term. We have grown the dividend in line with U.K. RPI, and our financial strategy remains robust. Before I hand back to John, I would just like to say the decision to leave was very difficult, as I have thoroughly enjoyed the last eight years. And I am proud to have National Grid on my CV. I will continue to support the company and expect John and the team to take the business from strength to strength in the future. Now John will take you through the priorities and outlook for the coming year.

[John Pettigrew:]

So thank you, Andrew. As I said at the start, we got a full agenda in the last year, so let me now turn to our priorities for the year ahead and also the steps that we're taking for the longer term. As we just highlighted, we see significant capital investment and growth over the medium term. And I believe that, by focusing on four drivers that I've spoken about previously, we'll deliver this growth efficiently and earn attractive returns. To remind you, these drivers are putting our customer first, optimizing the performance of our core business, seeking out growth opportunities in a disciplined way and evolving the business for the future. And as I look to the year ahead, these will continue to guide our overarching strategic focus. So starting with our customers, whose needs continue to evolve and they expect more from us. Affordability remains top in the agenda, but we need to go beyond this to ensure that customers are receiving a world-class experience. In the year ahead, our teams in the U.S. and in U.K. will be undertaking new initiatives to enhance customer engagement; and drive a stronger, customer-centric culture in National Grid. For example, in the coming year, we'll be integrating our contact centers and customer portals into a single platform for a seamless experience no matter how customers contact us. In the U.K. we'll be seeing different customer types such as a storage operators, so we're making changes in how we interact with them. A recent example of this is the connections process, with re-listening to feedback and eliminating process inefficiency will reduce the time it takes to provide connections by 30%. Turning now to performance optimization, where the starting point as always is a strong focus on maximizing the performance of our core business. In the U.K. we expect to invest £1.2 billion of CapEx this year primarily to maintain the health of our networks. And we'll be progressing with major projects, such as the Richborough-to-Canterbury overhead line and substation upgrade and the replacement of Feeder 9 under the Humber estuary. And we're also not losing sight of the efficiency we can create from within the business, driving a sharper focus on our cost base. We are completing a review of our operating costs and considering options to simplify our organizational structure to speed up decision making and be more responsive to our customers. Ultimately all these steps will help to generate customer savings and enable us to meet our commitment of achieving U.K. outperformance in the 200 to 300 basis points range. So moving on to U.K. regulation, which will be right at the top of our agenda. As I said at the half year results, we are operating in a dynamic external environment. This is especially the case in the U.K. with the ongoing debates about the current regulatory framework and the political narrative on the ownership model. As you'd expect, we've been actively engaged with all our stakeholders to ensure that our track record of significant investment and strong operational performance is recognized and understood. In May, we'll be submitting our response -- in May, we submitted our response to the RIIO-T2 consultation document. It's important to remember that these are still early days in the RIIO-T2 time line, which won't take effect until April 2021. This consultation presented a wide range of possible options across multiple areas. We fully support Ofgem's proposals on giving customers a stronger voice. Their thinking is closely aligned with ours, namely to put stakeholder engagement at the heart of the approach for RIIO-T2. Our focus over the next three years is to ensure that the final package does three things

[John Pettigrew:]

So we'll have Mark first.

[Mark Freshney:]

Just two -- Mark Freshney from Crédit Suisse. Just two questions. Firstly, on the U.S. tax reform, what is the impact expected to be on operating cash flows? Because that's where the real adverse benefit is. And on the other side, what is the impact on overall asset base growth? Because that's where the value generation is.

[Andrew Bonfield:]

Yes. So Mark, on the inflows, cash flows effectively, at the moment it's about $180 million, we highlighted, which is the bill reduction because effectively there's no offset. There are other filings that are still to come through, so we need to wait and see what those are. And then there's also to deal with the $2 billion because none of that has been dealt with yet. At the moment, that $180 million is about 50 bps on the RCF-to-debt metric, which as we said was 10.6%, so still comfortably above that. And then as far as actually rate base growth, the bonus depreciation over the years has probably reduced, I think we've had this conversation before, by about 0.5% a year on U.S. rate base growth by buildup of deferred tax liabilities. So it could add about 50 bps to the U.S. growth rate.

[Mark Freshney:]

And just to be clear

[Andrew Bonfield:]

Yes. Yes, it is, yes.

[Iain Turner:]

It's Iain Turner from Exane. Does that make you think again about how you finance the U.S. business and about -- because obviously you've -- you do it all with debts at the moment and you don't pay much tax.

[Andrew Bonfield:]

Yes. I mean, Iain, the -- there's a couple of things. I mean obviously one which is around holdco interest deductibility, there is a question mark in the U.S., and that's still to be determined again about that. Ultimately, at the end of the day, we tend to look at debt as a whole; and so what you tend to look at is across the group and the gearing at the group level. Where it sits within the individual entities is dependent on what optimizes and also where you actually get the best financing rates. We may see over time more funding move more to a group level because that may be a more attractive place for us to fund, but that -- nothing has been determined on that yet.

[Deepa Venkateswaran:]

This is Deepa Venkateswaran from Bernstein. I have three questions. So on the U.S., I think, a year back, you had said that the IFRS EBIT growth from '17 was around 7% to 2021. Could you clarify maybe from 2018 what you expect the EBIT growth to be taking into account the tax changes? Second question is on the decision to discontinue the scrip dilution through buybacks. I was wondering are there any factors which might lead you to reconsider it? I don't know, FID decisions on interconnectors or otherwise, which might mean that you have more balance sheet capacity. So just any movements around that? And the third question is are you thinking of doing utility-scale renewables in the U.S. even when it's not part of the rate base. So are you thinking about solar or onshore wind, for instance? And are you slightly late to the game, at least on onshore wind, if that's the case?

[Andrew Bonfield:]

Okay, so do you want me to do the first two?

[John Pettigrew:]

Do the first two.

[Andrew Bonfield:]

Yes. So first of all, on operating profit growth, I mean, the underlying operating profit growth will remain in line with the 7% we talked about before. The impact of tax reform is just a bit -- this is a bit of a wild card at the moment because, although we've already done some reduction, effectively we don't know where it's going to end up through the rest of the rate filings, Deepa. So it's going be -- if we could just ask, actually probably by November, we'll probably be in a better position to indicate what those individual growth rates are. But the problem is, because we haven't done all the filings, it's a little bit early. And it -- we'll need those rate filings to be put in place to indicate where it is. Effectively, excluding rate -- excluding tax reform, the growth rate will remain at the 7% level. So that's that doesn't change. The fundamentals don't change. It's just, and don't forget, any reduction in billing is offset by a reduction in the tax rate, so effectively it's a one-for-one in the P&L. Secondly, on scrip, as we said, effectively given the level of growth and given the funding particularly of things like interconnectors, we are in a position where -- and if -- we are at the top, high end of that growth rate; and expect to be actually above the 7% for the next couple of years. That probably means that we are in a situation where the scrip is needed. We've always said consistently the 5% to 7% asset growth, you’d need the scrip at the top end. The last few years, we've actually been at the real -- bottom end. That's given us the capacity. So a couple of things would need to happen. One, growth rate would need to be lower. I don't think that's going to happen. And actually the growth we're investing in on things like interconnectors is really positive for the long term. I'll remind you that the interconnectors start to produce EBITDA in the 2020s onwards, which is at the point of time where we're coming through RIIO-2. So effectively that will help mitigate the -- any reduction in returns in the U.K. at that time. And then it's about performance. And it's really about do we generate the incremental performance over the next couple of years, which then gives us incremental cash flow opportunities. So those will be the biggest factors.

[John Pettigrew:]

Yes. And in terms of renewables, if you look at the last couple of years, we've been increasingly involved in investment both on a regulatory perspective and a nonregulatory perspective. So we're talking about 35 megawatts of solar in Massachusetts that we'll do at the end of the year, which is connected to the network. We've been doing some joint ventures for next year on Long Island for network-connected solar. And we're also looking at batteries as well on, as I said, Block Island but also in Long Island. So we've been looking at those types of investments. From our perspective, what we look to do is to invest in assets that have got a strong regulatory underpinning or regulatory characteristics that allow us to take advantage of capabilities, as I mentioned in the speech, around project management, engineering, financing and so on. And we think large-scale renewables have a lot of those characteristics. When you look at the U.S. market, it looks like a very large-scale market over the next few years. I don't think we're late to the game, but if there is the right opportunity, then we will certainly look at it very carefully but with the discipline in terms of investment that we always apply to all our investments.

[Dominic Nash:]

It's Dominic Nash from Macquarie. Two questions, please. Firstly, on the Hinkley Point-Seabank decision, you say you're exploring all options. Am I correct in believing it's really you've only got three options, which you -- either you accept it, you go down a judicial review or you go down a CMA referral? Or are there any others? And can you just give us what the pros and cons would be of the CMA versus the judicial review or others? And secondly, I'm sorry. I'm kind of bouncing a bit, but U.S. GAAP numbers

[John Pettigrew:]

Okay, so let me start with Hinkley-Seabank. So you will have seen in the response, because it's been published, that we felt very strongly that the returns that we've been proposed through what Ofgem calls proxy competition were not commensurate with the level of risk associated with a significant transmission project connecting a nuclear power station. So we've responded quite strongly to that. I think it's quite interesting that other parties in the industry, including supply chain, have also responded quite strongly to that. So we're now in the process of, as usual, the consultation with Ofgem in dialogue and discussions. We are hopeful that Ofgem will shift their view in terms of what's an appropriate return. Fundamentally given where we are with the project, I think we feel that strategic wider works is the right route. We received planning consent for Hinkley back in January 2016, so the project is under construction. So from our perspective, we're hoping that Ofgem will shift in terms of where their opt-in position was with consultation. And if they don't, you're right, there are three options. And we will consider those options depending where we get to in terms of discussions and the consultation. At the moment, we're in that dialogue, so we're not at the point where we've made a decision, but the options there available to us is to progress. We have a license obligation to do that, but we do have the option of going to the CMA and the -- and taking judicial review. I'm not going to get into the pros and cons of that because I don't think that we're at that point yet. That's way down the line, but those will be the options available to us.

[Andrew Bonfield:]

Yes. On the U.S. GAAP numbers, I mean I think, first of all, my team would probably lynch me if I promise that today and particularly given that I won't be here to have to deliver it. So yes. I promise it, Dominic, but I think the challenge there is actually around timing. And the problem, as I think I've indicated to you before, is if we do produce the EPS number at the same time as we're trying to do the audit of the group accounts that just is a little bit complex. We are looking still about how we can actually give you more transparency into the U.S. I think Andy and the team will be looking at that, and hopefully, they'll be coming back to you, giving you some more indications later this year.

[Nicholas Ashworth:]

It's Nick Ashworth at Morgan Stanley. Two from me. Firstly, just on the U.S., it's been a good year. ROEs have gone up, 95% of your allowances, which was I think a little bit ahead of the 90% that you were guiding for or hoping for. Is there any reason why going forward that number should change? And why shouldn't it get even a little bit better given that we seem to be now in a process where all cases are being filed? You have new plans in place, and presumably you can keep refiling as and when you want. So can you just -- a little bit more color around that and why -- what we should be really thinking about for ROEs in the U.S. in the medium term? And then just your comment on the U.K., and I don't know if this is something new or not

[John Pettigrew:]

Yes. I'll start with the U.S. So you're right. We've had a good, strong year. I think it reflects really the strategy we put in place a few years ago to start to do the -- what I call the drumbeat of regulatory filings. Through those filings, we've been able to get agreement in terms of an appropriate cost base as well as the strong investment that's been agreed with regulators. So on that side that regulatory drumbeat is working for us. We've still got another couple of rate filings to complete this year in Massachusetts and Rhode Island, but on the other side of the coin, I guess it's been driving the operational performance of the business as well. So as you hear, we've established a capital delivery function. So we're spending $3.3 billion of CapEx in the U.S. And we need to make sure that we're delivering as efficiently as possible, so it's really about having the right regulatory framework together with driving the efficiency. That will allow us to win those returns, to get them as close to the allowed as possible. We're delighted to get to 95% this year. It was ahead of our expectations. Our focus now is to get it as close to the allowed returns as possible, so we will continue to make sure we got the right drumbeat of regulatory filings. And that will continue at the end of the year with Massachusetts Electric. So we'll see the benefits this year of the filings we did last year and partial benefit from Massachusetts Gas and Rhode Island, but some of the other ones will start to tail off. So you've always got that challenge of how can you drive the efficiency to maintain those overall returns. And that will be the focus for us going forward.

[Nicholas Ashworth:]

But there's no issues with going back and refiling. You're happy with how the processes have been for this first situation you're at.

[John Pettigrew:]

Yes, we're very happy with the way the process has gone. And as I said in the speech, our aim is to drive the efficiency of the business. That allows you to then get as close to the allowed returns for as long as possible, but the point of which we feel we need to increase investment or the cost base is not being covered. We'll then go back in and do a rate filing. And that's the drumbeat that we now have in the U.S. And we have all the mechanics and processes to be able to do that. In terms of the U.K., the point I was making was we do want to -- we are looking at our operating costs. And we are looking at our processes and how we can use innovation to drive some of those system changes to drive efficiency. We're very conscious in the U.K. that affordability remains right at the top of the agenda from a political perspective, so everything that we can do to drive cost down for customers is helpful. And it also helps to deliver that 200 to 300 basis points in the first five years of RIIO. We've delivered on that 200 to 300 basis points, and we want to make sure we continue to do that right out to the end of RIIO-T1.

[Christopher Laybutt:]

Chris Laybutt from JPMorgan. Just one quick follow-on from Nick's question. Is 95% the new 90% in terms of the aspirational target? And Viking, Andrew, just a question in terms of the assumptions that you mentioned earlier. Is that CapEx included in the CapEx projections that you've already got internally? If that project goes ahead, will that be incremental to the growth that you've set out today? And just some more color around that, please.

[Andrew Bonfield:]

Yes. So as far as actually the £13 billion I mentioned, it will be incremental to spend over the period of time over the next three years. What we do incur over that period of time will be incremental.

[John Pettigrew:]

And in terms of the percentage to allowed, I'm going to make Dean smile here. So the challenge is to get as close, if not at, the allowed. We're not going to -- not satisfied by 95% or 90%. Our goal is to be as close to the allowed as possible.

[James Brand:]

James Brand from Deutsche Bank. Three questions, please. The first is just on the achieved ROE number you've given for the U.S., whether that includes a tax reform benefit in that, or not; and if so, what it is. Secondly, on the guidance that you've given for outperformance for the U.K. business or that you've reiterated at 2% to 3%. You've given that for a long time as a range looking through the period and looking at your portfolio of assets in the U.K., but obviously the Gas Distribution business is being sold off. You're averaging closer to 2% for the transmission business in the U.K. at the moment, so should we still see that range as it used to be as an average over the period and across the whole portfolio? Or should we see it as something more saying that you can at least achieve that 2% for the business that's remaining over the remaining years of the price control? And then thirdly, gearing is up to about 64% net debt-to-asset base here, and obviously you're flagging the scrip and retaining some of the proceeds from the remaining stake sale in Cadent. Should we see this kind of level of gearing of mid 60s as being a ceiling or close to a ceiling for you? And are there other metrics you look at as well other than gearing? But any comments on that will be of interest.

[John Pettigrew:]

So we'll let Andrew deal with the first and the third. Let me take the middle one. So in terms of outperformance, our focus is to continue to deliver 200 to 300 basis points of outperformance. That's always been irrespective of when we sold the Gas Distribution business. We set out, when we did, that we will continue with our commitment of 200 to 300 basis points. Within any particular year, you're always going to see variations on that. The opportunity to deliver that outperformance comes from delivering projects as efficiently as possible. There are more opportunities you see in some projects than others, depending on the engineering solutions, and therefore you're always going to get volatility within a year. But the commitment remains exactly the same

[Andrew Bonfield:]

Okay, on the first point, around the achieved ROE in the U.S. No, there is no benefit from tax reform, tax -- any tax changes or deferral. So it's actually just put up into regulatory assets and liability IOUs so therefore has no impact on the achieved return. So the reduction in the tax rate will actually be then hung up on the balance sheet as a reg liability. So in U.S. GAAP will have no impact. Secondly, on gearing, probably as we've always said, sort of mid-60s sort of percent gearing is probably the sort of high end of the gearing ratio range that sort of fits our credit metrics but also depends on what the metrics are and the cash flows associated with that. So the one we look at, as we always talk about, is RCF-to-debt. That's the most constrained metric that we normally have, which is the Moody's metric. So that's the one which will be the primary one. Gearing is secondary, but it does indicate whether there is balance sheet capacity as well. As far as, again, just to reiterate, when we're looking at the balance sheet and the balance sheet capacity, this is about making sure that we have sufficient ability to fund the growth that we're going to see over the next few years. And just to remind you again

[James Brand:]

So there's no benefit from the fact that the tax rate has come down, but there's a lag in terms of revenue...

[Andrew Bonfield:]

It impacts our IFRS accounts but has no impact on U.S. GAAP at all because it straight goes into a reg asset and liability account.

[Fraser McLaren:]

Fraser McLaren from Merrill's. Just three questions, please. The first is about your relationship with Ofgem and specifically if you think that a constructive dialogue on RIIO-2 might be hampered by the strong views which you both have on Hinkley. Secondly, on the disposal of the remainder of gas D, you've arguably struck the deal at a point of maximum uncertainty both from a regulatory and a political perspective. Do you think you might have achieved a better price by waiting? And then lastly, thinking about funding for growth, are you open to other disposals? I mean Isle of Grain has been mentioned in the past as one thing you might look at.

[John Pettigrew:]

Okay. So I'll start with the relationship with Ofgem. So as we always have had and we continue to have, we have a very conservative relationship with Ofgem. And I've directly had conversations with them at around making sure that actually they understand the rationale for why we're having a disagreement on Hinkley but we need to continue to have constructive dialogue on RIIO-T2. And that's exactly how it's playing out, so we feel very comfortable. You can't compartmentalize these things. So we're having a strong discussion on Hinkley, but actually I think it is a very constructive conversation we're having on RIIO-T2. Our response, which will be published in the next few weeks, will show that we're very supportive of large -- a large number of the elements that are in the framework. So we are very pleased to see that they're building on a lot of the good things from RIIO-T1. We're very pleased and in fact we're advocating for much more involvement from customers and consumers in the building of the business plans, so that aligns very much with our own thinking. There are, of course, areas that we disagree in terms of the ROE range, for example. So I'm very comfortable with the relationship. It's one thing which we can continue to have a constructive relationship on RIIO-T2 whilst we're having a challenging discussion on Hinkley. Second question was disposal struck at the right time. Do you want to take that one, Andrew?

[Andrew Bonfield:]

Yes. I mean I think there's always a -- that's a billion dollar question. I mean, with the benefit of hindsight, next week you can find something very different, but I think generally we are very pleased with the outcome. We think it's comparable to what we saw in the initial deal. There is -- there was a slight reduction relating to expectations of returns, but that is actually -- and a lot of control premium, but actually when we look at the outcome, we're very pleased with it. And it's very comparable to the round one.

[John Pettigrew:]

And in terms of the portfolio, our investment proposition is to grow the asset base by 5% to 7%. And our policy on dividend is to then to grow it by at least RPI for the foreseeable future. That's our investment proposition. We look at each business in the group to see how it's supporting, contributing to that. That was part of the rationale why we took the decision to sell the Gas Distribution business, but at this point in time we're very comfortable with the portfolio mix that we've got. It's obviously something the board will review on a regular basis, but it's always against that context of the investment proposition that we have.

[Maurice Choy:]

This is Maurice Choy from Royal Bank of Canada. Two questions. The first is just the guidance of at least 7% asset growth. Does that include, a, Viking? And b, in Slide 34 you've mentioned USD 10 billion of CapEx for the U.S., but only 90% of that is in rate plans. Does that include, I guess, the remaining 10% in your at least 7% guidance? And second question is just on messaging for, I guess, the capital that you're retaining from the scrip dividend. You mentioned this is only for the next couple of years. And I'm wondering why wouldn't you just go beyond those two years, especially given that, number one, you have most likely returns coming down FY '22? You've got U.S. tax reform, cash flow coming down once you assess all the other jurisdictions. And number three, obviously I assume you have more growth coming, especially on National Grid Ventures, so why just two years and not just go beyond?

[John Pettigrew:]

Yes, we'll let Andrew pick up the third. In terms of the first, I think Andrew referenced already. So it's not including Viking at the moment, so that will be incremental. In terms of the 90% of rate base, it's just really reflecting the fact that we've still got two rate filings going on this year. And as we look over a three-year period, actually we've only got two years left of our KEDLI and KEDNY rate filing as well. Our expectation is the investment will be similar level at the time we get to year three. And we may well have to do another rate filing for that. So it really reflects just the rhythm and the timing of all the rate filings that we've got in the U.S.

[Andrew Bonfield:]

Yes, and as regards why only for the next couple of years, we've highlighted for the next couple of years, firstly, because actually that's where we have the peak CapEx, over the next two years, and will -- above the top end of that 5% to 7% range. Obviously, we will need to look out, as we get closer to that time, if there is incremental investment in NGV. That may make decisions, but at this stage that's not part of our commitment from an asset growth perspective. So it's very trying to make that as clear as possible. Secondly, we also have obviously RIIO-2 coming through. We have no idea of what that will be and what that means from a cash flow perspective, so at this stage, to say we need to retain scrip for that, we don't know yet. So I think that will be wrong for us to say definitely no buyback because again it depends on resourcing and resources we have and the cash flows associated with the core business.

[John Pettigrew:]

Verity?

[Verity Mitchell:]

Verity Mitchell, HSBC. I've just got two questions. One is about Gas Transmission in the U.K. We continue to see totex overspend, and I just wonder what your thoughts were compared with the much more stellar performance in Electricity Transmission. And just secondly, on -- sorry, back to the U.S. and the debt situation. You've got negative outlook on three areas

[John Pettigrew:]

Great. So I'll take the first one, give Andrew the second. So in terms of Gas Transmission, I think we've said consistently actually that, when we entered into RIIO-T1, we knew it was a tighter price control in terms of the work that we would need to do from an asset health perspective. So we've always undertaken the investment that we believe will deliver the regulatory outcomes in terms of the norms but also ensuring that we are maintaining the integrity and the reliability of the networks. So that has required us to invest more than was the original allowances, which is why it's dragging down the returns. On the flip side, actually the incentives in Gas Transmission outside of totex have performed very strongly, which is offsetting some of that overspend in asset health. Clearly as we go into RIIO-T2, we will be working quite hard to make sure that we get the right capital investment plans approved by our customers and with Ofgem to make sure we've got the right levels of investment for asset health going forward.

[Andrew Bonfield:]

And Verity, on the impact on the individual opcos, firstly, KEDLI and KEDNY will -- downgraded one notch actually brings them in line with the other companies, so effectively that's brings them in line with all the other group companies. As far as actually negative watch, that slightly is helpful in your regulatory conversations because what it does mean is you can go into the regulator and say actually some of the headroom from the tax reform actually can be reinvested in the business and deal with some of the other regulatory assets and liabilities which may be on the balance sheet. The reason why in NiMo we gave it back straightaway is we actually were in an over-collected position. In KEDLI and KEDNY we have some significant reg assets sitting on the balance sheet which we can't have a discussion about. So that's part of that regulatory conversation.

[John Pettigrew:]

Any final questions? In which case, I'll say thank you very much, ladies and gentlemen. As you've seen, I think we're in good shape in National Grid. We've got strong organic growth going forward. And I look forward to seeing many of you at the September investor seminar with the U.K. business. Thank you very much, everybody.