Our Business Model and Investment Case

Our business model and investment case

December 2018 Our business model and investment case

As one of the largest FTSE 250 environmental infrastructure groups in the UK, Pennon has assets of around £6.2 billion and a workforce

ofPENNON around BRAND IDENTITY GUIDELINES5,000 people. 3 Our group of companies

As one of the largest environmental infrastructure groups in the UK, Pennon brings together Viridor, South West Water, Bournemouth Water Our vision and a number of business water brands. Our brands are one of our most valuable assets. We should never Bringing resources undervalueto life our design identity in terms of the huge contribution it can make to our organisation’s standing – it is often the first impression people get and can create a lasting image. Our values To ensure we consistently build and protect our brand profile, Trusted always followResponsible these brand identity design guidelines. Collaborative Progressive

We do the right thing for our We keep our promises to our We forge strong relationships, We are always looking for customers and stakeholders customers, communities and working together to make a new ways to improve and each other positive impact make life better Our businesses Water & Wastewater B2B Water Retailer Waste Management

Pennon business water brands. Separate identity guidelines for these brands are available from [email protected]

Viridor Identity MASTER 06.07.16 BW Identity WIP 25.07.16 ased on aibre od Pantone aibre ei od and eguar Pantone Pantone Pantone Water and wastewater services to a Delivering retail services to business and A leading UK recycling and residual waste population of c. 2.2m commercial customers processing and transformation company • Serves Cornwall, Devon, parts of Dorset, • PWS is our growing B2B water retailer currently • Serves more than 150 local authorities and © PENNON GROUP 2016 VERSION 1.0 – 18 NOVEMBER 2016 Somerset, Hampshire and Wiltshire serving > 160,000 customers nationwide major corporate clients as well as over 32,000 • Awarded enhanced status for its 2015-2020 • c. 10,000 new accounts won since customers across the UK Business Plan, and has the highest potential market opening. • Network of 300+ recycling, energy recovery returns in the sector. and waste management facilities, including 12 Energy Recovery Facilities (ERFs) (8 in operation, 3 in operational ramp up and 1 in construction).

Financial Revenue (£m) Capital investment (£m) 439.2

highlights 434.1 1,357.2 1,352.3 1,353.1 1,352.1 1,321.2 407.3 398.2 384.7 1,201.1 316.9

Water Waste Statutory Underlying Adjusted 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18

EBITDA (£m) Gross assets at 31st March (£bn) 562.3 546.2 6.2 514.3 511.1 5.9 508.4 486.0 5.7 475.3 5.4 465.9 456.9 448.4 438.2 5.0 433.0 421.6 411.0 407.3 4.8 401.6 394.8 289.9

02 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2013 2014 2015 2016 2017 2018 Dividend policy +7.3% Pennon has a sector-leading dividend policy of 4% year-on-year +7.1% +5.6% 38.59 growth above RPI inflation to 2020. +4.9% 35.96 +6.5% 33.58 +7.3% 31.80 This is underpinned by the highest potential Return on Regulated +7.6% 30.31 +9.3% 28.46 Equity in the water sector over K6 (2015-2020) and the growth in 26.52 24.65 earnings being delivered by Viridor’s portfolio of Energy Recovery 22.5p Facilities (ERFs).

Note: Full Year dividend in pence per share 09/10 10/11 11/12 12/13 13/14 14/15 15/16 16/17 17/18 18/19 19/20 Future dividends purely indicative

REVENUE PROFILE GROWING ASSET BASE FINANCIAL OUTLOOK

• Two thirds of revenues index-linked and • Water RCV growth of 21% over K6 • Water business outperforming the 2015-2020 long-term contracted • ERFs – portfolio on-stream by 2020/21, Final Determination. 2020-2025 Business Plan • c. 80% of ERF portfolio volumes (and 8 operational submitted and preparations underway for the (1) new regulatory period associated price) contracted long-term • 3 new ERFs in 2018 – Glasgow, Beddington • 25-year rolling licence for water (South London) and Dunbar all processing • ERF portfolio continues to deliver significant growth in EBITDA • Remaining one third of revenues ensuring waste viable long-term market, seeking appropriate • Avonmouth construction on track for • Moving towards a more consistent risk profile risk/reward balance. completion 2020/21 across the Group • Increased holding in Runcorn 1 ERF • Driving value through efficiency – cost (November 2018). reduction plans, shared services and Bournemouth Water synergies.

STRONG LIQUIDITY EFFICIENT FINANCING KEY DRIVERS OF PERFORMANCE

• Cash / committed in facilities of £1,171m at • Diversified funding mix • Average availability of 92% in operational ERFs 31 March 2018 • Significant finance leasing with long maturity in 2017/18 • Pioneering a new sustainable financing and secured margins • Return on Regulated Equity (RoRE) – framework – linked to ESG measures • Average debt maturity 20 years. cumulative 11.8% to 2017/18 • Group fully funded for ERF buildout and into • Optimising landfill gas output and site closures the next regulatory period. • Recycling EBITDA margin improving through self-help measures.

Capital investment Revenue profile(4) 5.5 Water Competition(5) Recyclate ERF power 4.5 and landfill gas

Recycling, Long-term 3.5 landfill, contracted collections and contracts

2.5

ERF – gate fees 1.5 Contracts ERF – Water 10/11 11/12 12/13 13/14 14/15 15/16 16/17 17/18 18/19 19/20 gate fees Viridor asset base (2) Water RCV (3)

(1) Excluding Avonmouth (2) Includes NBV of PPE assets, JV Shareholder Loans and IFRIC 12 financial assets (3) South West Water RCV, plus Bournemouth Water RCV from 2015/16 onwards (4) Adjusted to include share of JV revenue and excluding landfill tax, IFRIC 12 construction revenue and revenue subject to natural offset within the Group (i.e. power and recyclate purchase costs) (5) Non-Regulated and Non-Household Retail Revenue (excluding wholesale charges)

Pioneering a new sustainable financing framework Sustainability linked financing £350m – in 2018

• Framework allows Pennon to access future funding opportunities aligned with the At the vanguard – green loan principles, green bond principles and social bond principles integrating sustainability performance into • Framework certified by DNV GL – a leading sustainability verifier • Commitment to continuous annual improvements in sustainability ratings and KPIs debt financing – Linked to Pennon Group’s annual ESG performance – Linked to South West Water sustainability KPIs • Can lead to improved Interest rate margins • Supporting capital investments in our environmentally sustainable projects.

Sector-leading SWW 2017/18 3.5% finance costs Pennon 3.7% Sustainable and efficient financing Water industry 2017/18 average interest rate on net debt

Source: Pennon calculation based on company Annual Reports – 2017/18 published July 2018 Average Basis: Net interest payable (excluding 4.9% pensions net interest) / average net debt

Pennon outperforming the market since privatisation*

5,5,000 000 Pennon Severn Trent 4, 500 United Utilities FTSE 100 4,4,000 000 FTSE 250

3, 500 *Share price data as at 2 June 2017 3,3,000 000

2, 500

2,2,000 000

1, 500

1,1,000 000

500

0 1989198919901990199119911992199219931993199419941995199519961996199719971998199819991999200020002001200120022002200320032004200420052005200620062007200720082008200920092010201020112011201220122013201320142014201520152016201620172017 Pennon Severn Trent United Utilities FTSE 100 FTSE 250 04 Water & Wastewater Strategy Key facts South West Water South West Water is focused on providing • 2.2 million total population served (of which services in the most efficient and sustainable 0.5 million are water-only) way possible. Innovation, new technologies • 1.0m customers and the pioneering of an holistic approach • 23 raw water reservoirs underpins our commitment to delivering service improvements and long-term value. • 18,233km of drinking water mains network • 685 treatment works with 70 ultraviolet (UV) We provide water services to a population of treatment facilities c. 2.2 million in Cornwall, Devon and parts of Dorset, Somerset, Hampshire and Wiltshire, • 17,439km wastewater mains network* Bournemouth Water as well as wastewater services to c. 1.7 million • 1,200 wastewater pumping stations* (in Cornwall, Devon and parts of Somerset • 144 designated bathing waters and 24 and Dorset). shellfish waters*

* South West Water region only

Longham Lakes

Price Review 2019 Key messages Financial highlights

Delivering what we promise – a solid base for performance Targeting sector leading services • c. £300m of totex outperformance forecast £1 billion(1) K7 capital investment programme • 13% reduction in retail costs Two new water treatment works in Bournemouth • On track to deliver our business plan commitments by 2020 Expansion to the Isles of Scilly A balanced and well evidenced plan – supported by 88% (2) of customers RCV growth of 11% to 2025 (2) Ambitious customer service and environmental commitments South West Water bills in 2025 lower than they were 15 years ago Empowering our customers Fair returns for excellent performance – potential for doubling • Giving customers a stake and a say base RoRE • Receive additional powers through customer AGM Evolutionary WaterShare+ sharing mechanism proposal • Unique customer share ownership scheme – funded by 2015-2020 outperformance • Continued sharing of outperformance with customers to 2025

3 Sept 2018 WaterFuture Customer Panel report submitted 1 March – 31 July 2019 South West Water business plan submitted Draft determinations published

Ofwat initial assessment of plan 31 Jan 2019 1 Sept – 31 Dec 2019 Ofwat publish assessment of business plans Final determinations published

(1) 2017/18 prices (2) Nominal prices

Outperforming in every area – highest returns across the industry

South West Water RoRE performance Cumulative industry RoRE performance to 2017/18

11.8% 11.1% 12% Financing Financing 2.8% 2.9% ODIs Totex 0.3% 8% Base return ODIs 0.3% Totex(1) 2.0% 2.6% 4%

Base 6.0% 6.0% returns 0%

-4% 2017/18 2017/18 IN YEAR CUMULATIVE THAMES ANGLIAN SOUTHERN YORKSHIRE DWR CYMRU DWR SEVERN TRENT WESSEX WATER WESSEX NORTHUMBRIAN UNITED UTILITIES SOUTH WEST WATER

£177m OF CUMULATIVE K6 TOTEX SAVINGS DELIVERING NET ODI REWARDS

• Totex largest element of potential operational outperformance • £8.1m cumulative rewards for 2017/18 • Focus on efficiency benefits customers by lowering bills • On track to deliver all our business plan commitments by 2020

Unique WaterShare(2) mechanism in place • Unique mechanism to share transparently Customer Shareholder outperformance in the regulatory period • Significant benefits identified for customers to Cumulative to 2017/18 Cumulative to 2017/18 date £m £m • Reinvestment in services and future lower bills 58 Net totex savings (3) 74 • Independent WaterShare panel guiding priority area investments. 8 ODIs 8

13 Other items (4) –

79 Total Value Benefit 82

(1) Totex RoRE outperformance calculated after sharing rate and the impact of tax. Phasing of actual expenditure compared to the planned programme is reflected prior to calculating Totex savings. Outperformance includes a reduction in the RCV run-off for the RCV element of Totex outperformance calculated based on the Final Determination PAYG. Tax impacts reflect actual effective tax rates. (2) WaterShare relates to South West Water region performance (3) Gross Totex savings (inclusive of retail), net of tax for sharing and performance purposes 06 (4) Other items including market movements on new financing returned to customers and the impact of new legislation ror en 001 ased on aibre od Pantone Pantone

Waste recycling & Energy Recovery Facilities (ERF) Strategy Key facts Viridor remains at the forefront of • Eight energy recovery facilities in operation, three processing waste the resource sector focused on and one under construction across the UK Operational UK recycling and residual waste facilities • Viridor’s ERFs produce enough energy to power over 330,000 homes processing and transformation, raw materials, providing services • Over 150 local authority and major corporate clients, as well as over to more than 150 local authorities 32,000 customers across the UK and major corporate clients as well • Network of 300+ recycling, energy recovery and waste management as over 32,000 customers across facilities the UK. • 7.0 million tonnes of waste material inputs each year and 1.4 million tonnes of recyclate traded • 600 waste collection vehicles securing materials for our network of assets.

All businesses well-positioned

LANDFILL & LANDFILL ENERGY RECYCLING ERF

• Maximising value from landfill with continued • Continued under capacity in the waste market • 8 operational ERFs performing well with >90%(1) demand forecast – 5 sites with capacity 2030+ in the UK average availability in 2017/18 • Extracting value from sites – maximising • Favourable market dynamics – public • Glasgow, Beddington (South London) and opportunities for existing grid connections perception driving Government support for Dunbar are processing waste • Optimising landfill gas output recycling • Avonmouth construction on track for 2020/21 • 96MW of landfill gas capacity. • Investing to improve output quality and focus • c. 80% of ERF portfolio volumes (and on cost efficiency associated price) contracted long-term(2) • Contracts renegotiated to share risk / • Outperforming the original business case. opportunity with clients.

(1) Forecast average ERF availability is weighed by site capacity, includes 100% and joint venture, excludes Bolton EBITDA (2) Excluding Avonmouth profile 2017/18 2013/14 EBITDA £150.2m EBITDA £76.3m

ERFs Landfill Landfill Gas Recycling Contracts, Collections and other

Almost two thirds Only 2% of EBITDA of EBITDA from ERFs from ERFs

ERF portfolio delivery

Avonmouth Delivering sustainable Dunbar long-term returns Glasgow (IFRIC12) Beddington Glasgow Dunbar (IFRIC12) IFRIC 12 Interest ERFs under construction receivable ERFs in operational ramp up Share of ERFs operational JV EBITDA Adjusted EBITDA

£167m

EBITDA

Beddington

2017/18 2020/21 Avonmouth

UK ERF capacity gap continues 3030 to 2030 and ERF C ap ac ity Viri dor ERF C ap ac ity Un derc ap ac ity beyond 2525 ERF capacity Viridor ERF capacity UK Combustible 2020 Under capacity Residual Waste

Market (mT) (mT) 1515

1010

55 UK Combustible Residual Waste Market Source: Tolvik, Defra, SEPA, NRW, - MSW and Viridor analysis 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

Long-term 100% contract base, 5% covering c.80% Recovered metals of capacity* 25% Power output Pennon – natural hedge (one third)

70% Balance of short and medium-term contracts (Municipal and Commercial & Industrial) Waste fuel input (gate fees)

De-risking – long-term contracts secured

Long-term contracts at the start of the ERF programme

* Excluding Avonmouth ERF 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

Outperforming base case expectations(1) 2017/18 Outperformance Peterborough Runcorn II Runcorn I Trident Park Ardley Pennon initial base case performance Exeter (1) Adjusted EBITDA on operational sites Lakeside normalised for the profile of maintenance on operational assets, adjusted for impact of the residual value contract (RVC) on 08 TPSCo, includes share of joint ventures Principal risks and uncertainties The Pennon Group plc principal risks and uncertainties are reported on pages 55 to 60 of the Annual Report and Accounts 2018. A summary of Pennon Group’s principal risks is detailed below. These principal risks have been reconsidered against a continued back drop of broader macro political and economic uncertainties; including the potential renationalisation of the water industry in the event of a change in Government and ongoing negotiations between the UK and the EU on any withdrawal agreement. Specifically, the Board has considered the potential implications of a ‘no deal’ scenario between the UK and the EU on the Group’s principal ERFs under construction risks, which was informed by guidance documentation issued by the UK Government. Appropriate mitigation strategies have been developed ERFs in operational ramp up in order to minimise any potential impact on the Group. ERFs operational LAW, REGULATION AND FINANCE

Changes in government policy may fundamentally impact our ability to deliver the Group’s strategic priorities, impacting shareholder value.

Reform of the regulatory framework may result in changes to the Group’s priorities and the service we provide to our customers. It may have a significant impact on our performance which can impact shareholder value.

The Pennon Group is required to comply with an ever increasing range of regulated and non-regulated laws and regulation across our water and waste businesses. Non-compliance with one or a number of these may result in financial penalties, a negative impact on our ability to operate effectively and reputational damage which could affect shareholder value.

Failure to maintain sufficient funding requirements could lead to additional finance costs and put our growth agenda at risk. Breach of covenants could result in the requirement to repay certain debt.

A breach of health and safety law could lead to financial penalties, significant legal costs and damage to the Group’s reputation.

Non-compliance may result in financial penalties, legal costs and reputational damage. Furthermore, the perception that Pennon’s overall tax contribution is inadequate could have a detrimental impact on the reputation of the Group.

The Group could be called upon to increase funding to reduce the pension deficit, impacting our cost base.

MARKET AND ECONOMIC CONDITIONS

Potential impact on revenue as a result of reduced customer debt collection, particularly with regards to vulnerable customers and affordability.

Challenges such as continued local authority austerity, reduced global demand for our recycled commodities and decreases in power prices have a direct impact on the revenues generated by our recycling business.

OPERATING PERFORMANCE

Failure of our assets to cope with extreme weather conditions may lead to an inability to meet our customers’ needs, environmental damage, additional costs being incurred and reputational damage.

Poor customer service has a direct impact on South West Water’s delivery of the PR14 business plan and the ability of both Viridor and PWS to retain and grow market share.

Operational failure in our Water business could mean that we are not able to supply clean water to our customers or provide safe wastewater services. This has a direct impact on the successful delivery of the PR14 business plan. Additionally, business interruption caused by defects, outage or fire could impact the availability and optimisation of our ERFs and recycling facilities.

Failure to have a workforce of skilled and motivated individuals will detrimentally impact all of our strategic priorities. We need the right people in the right places to share best practice, deliver synergies and move the Group forward in the new ‘shared services’ structure.

BUSINESS SYSTEMS AND CAPITAL INVESTMENT

Inability to successfully deliver our capital programme may result in increased costs and delays and detrimentally impacts our ability to provide top class customer service and achieve our growth agenda.

Failure of our information technology systems, due to inadequate internal processes or external cyber threats could result in the business being unable to operate effectively and the corruption or loss of data. This would have a detrimental impact on our customers and result in financial penalties and reputational damage for the Group.

Disclaimer This document contains certain “forward-looking statements” with respect to Pennon Group’s financial condition, operations, performance and plans and objectives for the future. By their very nature forward-looking statements involve risk and uncertainty because they relate to events and depend on circumstances that will or will not occur in the future. Important risks, uncertainties and other factors that could cause actual results and developments to differ materially from those expressed or implied by these forward-looking statements include, among other things, the principal risks set out in this document. The forward-looking statements made reflect knowledge and information available at the date of preparation of this document. The forward-looking statements made reflect the knowledge and information available at the date of preparation of this document and no representation, assurance, guarantee or warranty is given in relation to them including as to their accuracy, completeness, or the basis on which they are made. They are not to be considered as profit forecasts. Pennon Group may or may not update these forward-looking statements. This document is not an offer to sell, exchange or transfer any securities of Pennon Group or any of its subsidiaries and is not soliciting an offer to purchase, exchange or transfer such securities in any jurisdiction. © Pennon Group plc 2018 09 For further information: Sarah Heald Director of Corporate Affairs & Investor Relations + 44 (0)1392 443401 [email protected] Jennifer Cooke Investor Relations Officer + 44 (0)1392 443168 [email protected]

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Pennon Group plc Registered in England No 2366640 Registered Office: Peninsula House, Rydon Lane, Exeter, EX2 7HR