National Grid - Earnings Call - H2 2018

Transcript

Operator (participant)

Good morning, everyone, and welcome to the National Grid full-year results presentation. As always, we're 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. 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 (CEO)

Thank you, Arti, and good morning, everyone. As usual, Andrew and I are joined this morning with Nicola Shaw and Dean Seavers, who will be on hand to assist us with any questions. I want to start with a review of our performance in 2017-2018. 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 with 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 GBP 3.5 billion, mainly reflecting the strong performance of our U.S. business. During the year, we made significant investment at GBP 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%-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 GBP 30.44 pence per share, bringing the proposed full-year dividend to GBP 45.93 pence. This represents an increase of 3.75%, reflecting last year's average UK 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 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. Almost all of the restoration costs of around GBP 140 million will be recovered through our existing regulatory mechanisms. Now, moving to the key achievements and developments during the year, starting with the US, 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 KEDLI and KEDNY settlement, 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 there are 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 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 US tax reform that was announced in December, adjusting our rate filings for NiMo, Massachusetts gas, and Rhode Island to reflect the lower tax rates and reducing our total revenue request, including FERC, by $180 million. And Andrew will discuss this in more detail shortly. So turning now to the UK 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 GBP 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 GBP 540 million of customer savings, which will help to reduce bills over a number of years. Last year, we were able to deliver 200 basis points of our performance through efficiency and performance optimization. For example, we completed the first phase of the London Power Tunnels, generating more than GBP 80 million of efficiency savings. In addition, we progressed a number of important regulatory topics in the UK, 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 NiMo, North Sea Link, and IFA2, are on track, and we reached a significant milestone on NiMo with the completion of the initial cable laying quite recently.

These three interconnectors represent GBP 1.3 billion of investment and will contribute over GBP 150 million of EBITDA when operational. And our property business also continues to make good progress, in particular at 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've 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 the 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's 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 (CFO)

Thank you, John, and good morning, everybody. As John has highlighted, our financial performance was strong. All of our key metrics show 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 GBP 45.93 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 continue to focus on innovation and efficiency to deliver Totex outperformance of 180 basis points, which is 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 2017-2018. Additional allowances added 70 basis points of performance. Underlying operating profit of GBP 1.1 billion was down 15%, largely due to higher MOD adjustments, increased depreciation, and lower BSIS income. Capital investment was GBP 1 billion, which is 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 GBP 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 GBP 47 million for Avonmouth. Again, as I mentioned at the half-year, we will be returning approximately GBP 85 million of Avonmouth allowances in the current financial year. Capital investment increased by GBP 96 million to GBP 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. The regulated asset value grew by 4.5% to GBP 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 had new rates, which are expected in September. Our FERC returns have remained strong. Underlying operating profit increased significantly to GBP 1.7 billion, up 20% to 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 US networks to GBP 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 GBP 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 at 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 GBP 363 million, reflecting the start-up of construction on IFA2, the second French interconnector, and increased spend on NiMo, which is on track to be operational next year. Moving to other activities, total group contribution was GBP 111 million, up GBP 34 million from the prior year. Operating profit in the property business increased to GBP 84 million as a result of asset disposals, including sites in Staines and York. Corporate centre and other costs decreased year-on-year as a result of lower business change costs.

The remaining 39% stake in Cadent made a GBP 123 million post-tax contribution, down GBP 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 GBP 974 million. This was primarily due to higher UK RPI and increased debt.

These factors were partially offset by the crystallisation 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%-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 GBP 589 million. Earnings increased to GBP 2.1 billion, and as you've heard, underlying earnings per share increased to GBP 60.4 pence per share. Operating cash flow was GBP 4.7 billion, GBP 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 GBP 23 billion.

This reflects GBP 1.8 billion of business-as-usual cash outflow, the return of the GBP 4 billion from the gas distribution sale, and the benefit of GBP 2.1 billion from the strengthening of sterling versus the dollar. We raised over GBP 1.8 billion of new long-term financing. This includes a $400 million bond in our New England power transmission business, which had a coupon of 3.8%, as the lowest rate we've ever achieved for a 30-year bond in the U.S.

Our RCF to debt ratio was 10.6% on a continuing basis, and FFO to debt was 16.4%. Value Added was GBP 2 billion, or GBP 57.9 pence per share. This comprised the growth in group assets of GBP 2.3 billion, driven by increased CapEx and higher UK RPI, cash dividends, and the repurchase of scrip shares, which totaled GBP 1.5 billion. This year's underlying growth in net debt of around GBP 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 2017-2018 in our IFRS profits, which will reverse in the current financial year. The Value Added measure takes this into account, these sorts of regulatory adjustments, and therefore is 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 US growth profile due to the state 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%-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 US, 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 US 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 impact of US 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 UK, we have significant clarity over the investment profile, particularly now that we're five years into the RIIO-T1 price control. We spent GBP 1.3 billion this year and expect to continue to spend around this amount through to March 2021. Assuming 3% RPI, this would 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 three interconnector projects under construction totals approximately GBP 1.3 billion. These projects are expected to complete in the early 2020s and, once operating, to generate EBITDA of over GBP 150 million per annum. The proposed Viking project could add a further GBP 850 million of CapEx and an incremental GBP 100 million of EBITDA. So, bringing it all together, we expect to spend around GBP 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 offset in 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 that were 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 have 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 years-30 years, as required by the legislation.

Under US GAAP, there is no impact at the operating company level on earnings or US 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 build-up 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 spend 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 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 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'd like to summarize our technical guidance for 2018-2019, and as ever, you can find more details in the statement. Overall, we expect our UK regulated businesses to continue to deliver 200-300 basis points of outperformance, driven by traditional incentives in both businesses and Totex outperformance in electricity transmission. In the US, 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 adoption of IFRS 15 and the impact of tax return. Other activities are expected to benefit from the transfer of 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 US 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 line with UK 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've 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 (CEO)

So thank you, Andrew.

As I said at the start, we've had 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've 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 of 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 the 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 UK, we'll be seeing different customer types, such as storage operators, so we're making changes in how we interact with them. A recent example of this is the connections process, where through listening to feedback and eliminating process inefficiency, we 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 UK, we expect to invest GBP 1.2 billion of CapEx this year, primarily to maintain the health of our networks. 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. 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're 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 UK performance in the 200-300 basis points range, so moving on to UK regulation, which we rate at the top of our agenda. As I said at the half-year results, we're operating in a dynamic external environment. This is especially the case in the UK, with the ongoing debate 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 resubmitted our response to the RIIO-T2 consultation document.

It's important to remember that these are still early days in the RIIO-T2 timeline, 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. It provides an appropriate balance between risk and reward. It drives innovation and efficiency through incentivization, and it ensures financiability of our networks and ultimately benefits all parties. The next steps on the road to 2021 will be Ofgem's decision on the framework this summer and the publication in the autumn of the methodology for sector-specific price controls.

We will, of course, keep everybody updated as we see significant developments. The second area of regulatory focus for us will be Hinkley-Seabank. In January, we expressed our disappointment with the financial parameters for the project that were proposed by Ofgem. While the annualized CapEx for this project is relatively small, we do not view Ofgem's position as one that fairly balances the risk and reward for this complex project. Ofgem is expected to announce its decision on this consultation in the summer, and depending on the final decision, we'll then consider all the options available to us. The third area of regulatory focus will be agreeing funding for certain projects that were uncertain at the time of RIIO-T2, in particular projects in our gas business. We've made our submission for these projects to Ofgem and are expecting a decision in September.

So moving now to performance optimization in the U.S., where we have the challenge of ensuring that we continue the high levels of reliability we've seen recently while delivering on a major capital investment program. Given our large distribution presence in the U.S., this means delivering on thousands of small to medium-sized projects in addition to the larger projects to modernize and expand our networks. To deliver this work, we're reviewing all our end-to-end processes to remove inefficiency, and we're strengthening the jurisdictions with greater operational support to enable the organization to deliver this significant CapEx in the most effective way. As you heard from Andrew, we expect to invest $10 billion over the next three years, 90% of which is already reflected in our rate plans.

This growth is driven by a number of factors: mandated spend to remove older gas mains that are prone to leaks, storm hardening for our electric networks, and other initiatives to modernize our networks and to provide new connections for both gas and electric customers. While we continue to deliver these capital projects, we must work hard to make sure that the regulatory environment and the returns we get are attractive. By doing so, we optimize the frequency of rate filings. Currently, the next rate case to be filed will be Massachusetts Electric, which we expect to do toward the end of this calendar year. Having considered performance optimization, I'd now like to discuss growth in the context of the portfolio as a whole. Over the last two years, we've been on a journey migrating the portfolio toward higher growth.

Today, Andrew and I have talked in detail about the significant CapEx we're set to deliver. This CapEx enables us to deliver growth at the top end of our 5%-7% range, leading to core asset base that is over 20% larger in 2021 compared to last year. The growth that we're delivering is of high quality. It's growth driven by customer needs that is funded through regulatory arrangements, with a risk-reward balance that is consistent with our investor proposition and that will generate attractive returns for our stakeholders. It's this quality growth, combined with efficient balance sheet, that underpins our long-term investment proposition of sustainable asset and dividend growth for our shareholders. As I look to next year and beyond, I believe we have a great opportunity to deliver much more for our customers whilst creating significant value for our shareholders.

So finally, I want to cover the fourth driver: evolving National Grid for the future. As we know, the U.S. and the U.K. both continue to decarbonize at pace. 2017 was the greenest year ever for the U.K., with over half electricity generation last summer coming from low-carbon sources. And similarly, many states in the U.S. remain committed to aggressive CO2 targets. The economics for solar, wind, and storage are becoming increasingly attractive, with further demand for clean energy coming directly from U.S. corporates through PPAs. There is no doubt that the ongoing significant growth in large-scale renewables is set to continue into the long term. So for all those reasons, National Grid is actively engaged in the renewable space, which is creating new opportunities for us. In the U.K., for example, we currently have around 100 connections in the pipeline from a range of new solar and storage customers.

Similarly, in the U.S., at the distribution level, we continue to connect renewables for our customers. In addition, utility-scale renewables also offer attractive opportunities. For example, we connected the first offshore wind farm in the U.S. off Block Island, and we're in the process of installing a 6 MW battery on the island in Nantucket. And the strong ongoing growth in large-scale renewables is likely to generate further opportunities for incremental investment. The long-term contracted nature or regulatory underpinning makes them well-suited to the risk-reward profile of our portfolio, and they leverage many of our core capabilities in engineering, project development, asset management, and finance. And the transition to renewables is likely to be closely followed by the electrification of transport, with many forecasters now predicting price parity with petrol and diesel cars by the early to mid-2020s. This brings with it some fantastic opportunities for National Grid.

For example, we've been in discussions with the government in the U.K. about how network investment will help to address consumers' concerns about range anxiety. And I look forward to updating you on the progress on this in the near future. We're also active in the debate in the U.S., with more than 150 public charging stations already installed and submissions made to our regulators in each of our states for EV investments. And National Grid Ventures has also set up a technology and innovation team based in Silicon Valley that's assessing new technologies across the energy sector as it migrates towards more decentralized and digitized solutions. So overall, I believe the trend of decarbonization provides multiple and exciting opportunities for National Grid. So in summary, last year we delivered strong financial and operational performance.

We delivered 95% of our load return in the U.S. with significant regulatory progress, and we achieved outperformance of 200 basis points in the U.K. National Grid is in great shape, and we're well-positioned to capitalize on the significant growth that we see in the medium term. We continue to focus on efficient delivery and on creating value for our customers and shareholders while being a leader in the energy transition. Now, just before I move on to questions, I'm pleased to announce that we'll be hosting an investor seminar on the U.K. business in September, where Nicola and her leadership team will review the business and also update you on the latest developments in the RIIO-T2 process. The event will take place on the 21st of September in London and on the 24th of September in Boston for our U.S.-based investors.

Thank you very much for your attention, ladies and gentlemen. Now, Andrew, Dean, Nicola and I will be happy to take any questions. Mark Freshney.

Mark Freshney (Analyst)

Thank you. Just two questions. Mark Freshney, from Credit Suisse. Just two questions. Firstly, on the US 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-based growth? Because that's where the value generation is.

Andrew Bonfield (CFO)

Yeah. 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 basis points 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-based 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 US rate-based growth by build-up of deferred tax liabilities. So it could add about 50 basis points to the US growth rate.

Mark Freshney (Analyst)

And just to be clear, that's included within your slightly above 7% guidance for rate-based growth for the group?

Andrew Bonfield (CFO)

Yes, it is. Yeah.

Mark Freshney (Analyst)

I'm seeing a sign from Exane. Does that make you think again about how you finance the US business and about, because obviously you do it all with debt at the moment and you don't pay much tax?

Andrew Bonfield (CFO)

Yeah. I mean, there, there's a couple of things.

I mean, obviously one, which is around HoldCo interest deductibility, there is a question mark in the US, 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 optimises and also where you actually get the best financing rates. You 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 nothing's been determined on that yet.

Deepa Venkateswaran (Analyst)

Thank you. 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 2017 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? Thank you.

Andrew Bonfield (CFO)

Okay. So first two. 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 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 to 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 will need those rate filings to be put in place to indicate where it is. Effectively, excluding tax reform, the growth rate will remain at the 7% level. So that doesn't change.

The fundamentals don't change, 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, given the funding, particularly of things like interconnectors, we are in a position where, and we're 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%-7% asset growth, you would need the scrip at the top end. The last few years we've actually been at the 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. Actually, the growth we're investing in and things like interconnectors is really positive for the long term. Remind you that interconnectors start to produce EBITDA in the 2020s onwards, which is at a point in time when we're coming through T2. So effectively that will help mitigate any reduction in returns in the UK at that time. Then it's about performance, and it's really about do we generate incremental performance over the next couple of years, which then gives us incremental cash flow opportunities. So those would be the biggest factors.

John Pettigrew (CEO)

Yeah. And in terms of renewables, if you look over the last couple of years, we've been increasingly involved in investment, both on the regulatory perspective and non-regulatory perspective.

So we've got about 35 MW of solar in Massachusetts or will do by the end of the year, which is connected to the network. We've been doing some joint ventures with NextEra 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's the right opportunity, then we will certainly look at it very carefully, but with a discipline in terms of investment that we always apply to all our investments.

Dominic Nash (Analyst)

Hi. It's Dominic Nash, Macquarie. Two questions, please. Firstly, on the Hinkley-Seabank decision, you say you're exploring all options. Am I correct in believing this? Really, you only got three options, which is either you accept it, you go down a judicial review, or you go down a CMA referral, or are there any others? And could 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 kind of bang on a bit to my bit, but US GAAP numbers.

You've alluded in the past that you might be prepared to come up with a group US GAAP EPS number to add to the other EPS numbers. And either for the group or maybe as a standalone US division, is that something you still have planned to do later this year?

John Pettigrew (CEO)

Okay. Let me start with Hinkley-Seabank. So you would have seen in the response, because it's been published, that we felt very strongly that the returns that were being 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 have responded quite strongly to that. I think it's quite interesting that other parties in the industry, including the supply chain, have also responded quite strongly to that.

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 the Strategic Wider Works is the right route. We received planning consent for Hinkley back in January 2016, so the project is under construction. From our perspective, we're hoping that Ofgem will shift in terms of where their opening position was as a consultation. If they don't, you're right, there are three options, and we will consider those options depending on where we get to in terms of the 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 that are 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 taking it for 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 a way down the line, but those would be the options available to us.

Andrew Bonfield (CFO)

Yeah. On the US GAAP numbers, I mean, I think, first of all, my team would probably lynch me if I promised that today, particularly given that I won't be here to have to deliver it. So that would. Sorry. Yes, I promised 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 US. 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 (Analyst)

Thank you. Morning. It's Nick Ashworth at Morgan Stanley. Two from me. Firstly, just on the US, 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 it shouldn't 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 be a little bit more clear around that and 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.

You were talking about the outperformance in the U.K. and looking at operating costs and what you're doing there to drive further outperformance. Is this something new? Is this something that was already baked in? I just wanted to get a bit more clear around that as well, please.

Andrew Bonfield (CFO)

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 that we put in place a few years ago to start to do 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 refilings to conclude this year in Massachusetts and Rhode Island. But on the other side of the coin, I guess, is driving the operational performance of the business as well. So as you've heard, we've established a capital delivery function. So we're spending $3.3 billion of CapEx in the U.S.

We need to make sure that we're delivering it as efficiently as possible. So it's really about having the right regulatory framework together with driving the efficiency that allows us to earn those returns that go as close to the low as possible. We're delighted to get to 95% this year. It was ahead of our expectations. Our focus now is to get as close to the low returns as possible. So we will continue to make sure we've 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 for 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 efficiency to maintain those overall returns, and that will be the focus for us going forward. But there were no issues with going back and refiling.

Nicholas Ashworth (Analyst)

You're happy with how the process has been for this first iteration, if you like.

Andrew Bonfield (CFO)

Yeah. 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 low returns for as long as possible. At the point at which we feel we need to increase investment or the cost base is not being covered, we then go back in and do a rate filing, and that's the drumbeat that we now have in the U.S.

We have all the mechanics and processes to be able to do that. In terms of the UK, the point I was making was we do want to - we are looking at our operating costs, and we are looking into our processes and how we can use innovation to drive some of the system changes to drive efficiency. We're very conscious in the UK that affordability remains right at the top of the agenda from a political perspective. So everything that we can do to drive costs down for customers is helpful, and it also helps to deliver that 200-300 basis points. In the first five years of RIIO, we've delivered on that 200-300 basis points, and we want to make sure we continue to do that right out to the end of RIIO 2021.

Christopher Laybutt (Analyst)

Thank you. Good morning. Chris Laybutt from J.P. Morgan.

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 (CFO)

Yeah. So as far as actually the GBP 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 (CEO)

In terms of the percentage to a load, I'm going to make Dean smile here. So the challenge is to get as close, if not at, the load. So we're not satisfied with 95% or 90%.

Our goal is to get as close to the load as possible.

James Brand (Analyst)

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 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 of 2%-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, with the gas distribution business being sold off, you're averaging closer to 2% for the transmission business in the U.K. at the moment.

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? Then thirdly, gearing up to about 64% net debt to asset base here. 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? Are there other metrics you look at as well other than gearing? Any comments on that would be of interest.

John Pettigrew (CEO)

I'll let Andrew deal with the first and the third. Let me take the middle one.

In terms of our performance, our focus is to continue to deliver 200-300 basis points of outperformance. That's always been there. Irrespective of when we sold the gas distribution business, we set out when we did that we would continue with that commitment of 200-300 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 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 to focus on 200-300 basis points.

Andrew Bonfield (CFO)

Okay. On the first point around the achieved ROE in the U.S., no, there is no benefit from tax reform. Any tax change is a deferral.

It's actually just put up into regulatory assets and liability IOUs. Therefore, it has no impact on the achieved return. The reduction in the tax rate will actually be then hung up on the balance sheet as a reg liability. On US GAAP, it will have no impact. Secondly, on gearing, probably as we've always said, sort of mid-60s sort of % 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. The one we look at, as we always talk about, is RCF debt. That's the most constrained metric that we normally have, which is the Moody's metric. 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, the interconnector value of the interconnector returns, they are very good high-returning businesses, but they don't have a cash flow associated with them. So unlike regulatory investment, which has an immediate cash return, there is the lag. That is the bit that puts the pressure on the metrics over the next couple of years. But it's good investment.

James Brand (Analyst)

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 (CFO)

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

Fraser McLaren (Analyst)

This is McLaren from Merrill. Good morning. Just three questions, please. The first is about your relationship with Ofgem, and specifically, if you think that a constructive dialogue on RIIO-T2 might be hampered by the strong views which you both have on Hinkley. Secondly, on the disposal of the remainder of Cadent, 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 that you might look at. Thank you. Okay.

John Pettigrew (CEO)

I'll start with the relationship with Ofgem. As we always have had, and we continue to have, we have a very constructive relationship with Ofgem. I've directly had conversations with Dermot 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. That's exactly how it's playing out. We feel very comfortable you can compartmentalize these things. We're having a strong discussion around Hinkley. 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 a large number of the elements that are in the framework.

We are very pleased to see that they're building on a lot of the good things from RIIO-T2. We're very pleased. And in fact, we've been advocating for much more involvement from customers and consumers in the building of the business plans. That aligns very much with our own thinking. There are, of course, areas that we disagree in terms of the ROE range, for example. I'm very comfortable that the relationship is one in which we can continue to have a constructive relationship with RIIO-T2. Whilst we're having a challenging discussion on Hinkley.

The second question was, disposal struck at the right time. Do you want to take that one, Andrew?

Andrew Bonfield (CFO)

Yeah. I mean, I think there's always a that's the million-dollar question. I mean, with the benefit of hindsight, next week you can find something very different.

But I think generally we're very pleased with the outcome. We think it's comparable to what we saw in the initial deal. There was a slight reduction relating to expectations of returns, but that is actually a lower 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 (CEO)

In terms of the portfolio, our investment proposition is to grow the asset base by 5%-10%, and our policy on dividend is to inflate by at least RPI for foreseeable future. That's our investment proposition. We look at each business in the group to see how it's supporting and 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.

Maurice Choy (Analyst)

Thank you. And good morning. This is Maurice Choy from RBC Capital Markets. 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 $10 billion of CapEx for the US, but only 90% of that is in the 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 2022.

You've got US 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? Thank you.

John Pettigrew (CEO)

I'll let Andrew pick up the third. In terms of the first, I think Andrew referenced it already, so it's not including Viking at the moment, so that would 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 investments will be similar level at the time we get to year three.

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 US.

Andrew Bonfield (CFO)

Yeah. And as regards why only for the next couple of years, we highlighted for the next couple of years, firstly, because actually that's where we have the peak CapEx over the next two years, and we're above the top end of that 5%-7% range. Obviously, we'll 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 that's us trying to make that as clear as possible. Secondly, we also have obviously RIIO-T2 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 the 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.

Verity Mitchell (Analyst)

Thank you Verity Mitchell HSBC. I've just got two questions. One is about gas transmission in the UK. We continue to see Totex overspend. And I just wonder what your thoughts were compared with a much more stellar performance in electricity transmission. And just secondly, sorry, back to the US and the debt situation. You've got negative outlook on three areas, NiMo, KEDLI, and KEDNY. How do you think about it from a bottom-up, top-down basis?

Will you be looking at the rate filings to try and fix the tax-related downgrade that you had from Moody's in KEDLI and KEDNY? And how should we think about that?

John Pettigrew (CEO)

Okay. I'll take the first and then go down to the second. 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. We've always undertaken the investment that we believe will deliver the regulatory outcomes in terms of the norms, but also ensuring that we're maintaining the integrity and the reliability of the network. 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 on 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 (CFO)

Very clear on the impact on the individual opcos. Firstly, KEDLI and KEDNY will downgrade one notch actually brings them in line with the other companies. So effectively, that 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 NiMo, we gave it back straight away, 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 have a discussion about. So that's part of that regulatory conversation.

John Pettigrew (CEO)

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.

I look forward to seeing many of you at the September investor seminar with the UK business. Thank you very much, everybody.