Pennon Group Plc

Viridor has transformed itself over the last decade from a traditional waste management company with significant landfill operations into a progressive resource management business with a growing focus on recovering the value in waste through recycling and by using waste as a source of renewable energy.

In 2010/11 some 46% of our profits came through recovering the value in waste, compared with 16% ten years ago. Over the same period we have seen our profits grow at an average rate of 20% per annum and our workforce from under 500 to over 3,200. This is a clear indication of the way in which embracing the environmental agenda has been an effective driver of growth; put simply, being green is good for business. We are confident that this focus on recycling and renewable energy will continue to drive long-term growth and value for Viridor and its stakeholders.

This highly significant shift in emphasis has involved a major cultural change for our business. For their essential contribution to this change, we congratulate our management and employees who have continued to deliver organisational and profit growth every year throughout this period of significant evolution.

During the financial year we continued, and further emphasised, these twin themes of profit growth and cultural change. It saw our company continue to grow through a number of strategic, in-fill acquisitions in the recycling industry and through the returns from two highly significant recent investment projects, the 25-year Greater Manchester Waste PFI contract and the Lakeside Energy from Waste (EfW) plant.

In addition it was a year in which we continued to make major long-term investments in the future capabilities and strength of our business which will, on completion, deliver significant additional growth in profits from 2014 onwards. Since last summer we have achieved planning permissions for four major EfW facilities at Cardiff, Dunbar, Ardley and Avonmouth (the Secretary of State’s decision is subject to challenge on the latter two). These planning permissions underpin our strategic momentum.

During the year Viridor’s reputation as a progressive force in our sector was recognised, and further boosted, when we were named the ‘Recycling and Waste Management Business of the Year’ at the National Recycling Awards.

We consider this to be recognition for the hard work, professionalism and commitment of all our employees. Viridor’s Chief Executive had the opportunity to experience first-hand the creativity and energy of our workforce when he took part in Channel 4’s ‘Undercover Boss’ primetime TV programme, which was broadcast in August 2010. Our employees’ commitment to the company was apparent in the programme and showed the extent to which their ideas help develop our business and how they contributed to what was another successful year for Viridor.

Strong financial performance

The last financial year has shown another robust financial performance as we delivered revenues of £712.0 million and an operating profit (including joint ventures) of £82.6 million to continue Viridor’s record of increasing its profit by an average 20% year-on-year since 2001. This was despite the fact that, as we had flagged to shareholders at the beginning of the year, our profits from landfill gas power generation were lower than in the previous year due to the ending of a contract in which prices had been fixed at a historic market peak.

The strength of our financial performance during 2010/11 was driven by our recycling businesses and the impact of our two major recent investments, the Greater Manchester Waste PFI and the Lakeside EfW plant.

Recycling

Recycling continued to grow well, both in volume (reflecting both healthy organic and acquisition-driven growth) and through continued strong prices for recycled materials. The prices we achieved for recyclates were the direct result of our investment in ensuring the highest possible quality of output. This strength is leading to beneficial long-term relationships with customers via a global trading platform which also allows us to respond quickly to changes in market conditions.

During the year, we saw the volumes of recyclate traded increase to over 1.7 million tonnes, representing growth of 22% over the previous year’s total of 1.4 million tonnes.

Of this growth the existing business contributed around 200,000 tonnes, an increase of 13%.

Growth was also driven by the acquisition of five privatelyowned high-quality recycling businesses for a combined consideration of nearly £50 million, comprising seven Materials Recycling Facilities (MRFs) in East Anglia, the Midlands, the North West and the South West of England. These acquisitions reinforce our position as the UK’s leading operator of MRFs, placing us at the forefront of a fast-growing business segment that continues to receive encouragement from government at both UK and European levels.

The businesses were acquired for the significant operational synergies that their geographic locations and services offer the company and for the additional capability to produce high quality recyclate for sale through our international distribution network. The noticeably better value of high-quality recyclate, when compared to virgin materials, is increasingly making it the first choice for manufacturers across the world. During the year these acquired businesses contributed a little over 100,000 tonnes of recyclate.

Strategically the shift to recycling is important to us due to the significantly higher profit we realise per tonne, compared with our landfill returns, which are reducing. This gap will increasingly widen as the UK Government seeks to discourage further landfill through the application of an £8 year-on-year increase in tax on each tonne of waste sent to landfill. This will raise landfill tax from its current level of £56 per tonne (from 1 April 2011) to £80 per tonne by 1 April 2014. This stance adopted by the Government strongly reinforces the long-term logic of our focus on recycling and energy recovery as the best methods for waste management which will also result in delivering enhanced value to investors.

Greater Manchester

2010/11 was the second year of operation of the 25-year Greater Manchester Waste PFI contract, a joint venture which is the UK’s largest-ever combined waste and renewable energy project. We have now completed 31 of the 42 collection, recycling and renewable energy facilities that comprise the PFI contract. By the time the programme is complete, it will divert 75% of Greater Manchester’s waste from landfill and recycle or compost over 50%.

A second major aspect of the Greater Manchester PFI contract is the construction of a Combined Heat and Power (CHP) EfW plant, Runcorn Phase I, which is on schedule to open towards the end of 2012/13. During the year we also commenced construction of Phase II of the Runcorn plant, a Viridor project, which is targeted at the North West market more generally. When this comes on stream in 2014/15 the combined plant will have a total waste capacity of 750,000 tonnes per annum and a CHP capacity of 120MW making it one of the largest and most efficient plants in Europe. The plant will operate alongside the existing EfW facility at Bolton which has a generating capacity of 9MW of electricity through the use of 120,000 tonnes of waste as fuel.

In Greater Manchester we have also received planning permission to build four Anaerobic Digestion (AD) plants with a capacity of up to 8MW of electrical power. The first plant was fully commissioned just after the year-end and the others are under construction.

Lakeside

This year saw us also make significant early returns on one of our largest recent investment projects, the Lakeside EfW plant near Heathrow airport, which delivered its first full year of operation in 2010/11. This important joint venture with Grundon Waste Management has the capacity to treat 410,000 tonnes of waste each year, with an electricity generation capacity of up to 37MW.

EfW prospects

We also have a very strong pipeline of further opportunities in the EfW sector including a new PPP contract signed in March 2011 with Oxfordshire County Council to build a new CHPenabled plant at our site at Ardley, Oxfordshire. This major project is expected to result in the capacity to treat 300,000 tonnes of waste each year with an electricity generation capacity of 25MW. (As noted previously, the Secretary of State’s decision to grant planning permission has been appealed against by a local group.)

Alongside a number of other potential sites for EfW and AD plants we already have planning permission in place for four further EfW sites at Exeter, Cardiff, Dunbar and Avonmouth (the latter also subject to challenge) that between them will be capable of annually treating over one million tonnes of waste with a generation capacity of 103MW of electricity and heat.

Landfill gas power generation

In another aspect of our renewable energy operations, we also saw continued volume growth in our landfill gas and power generation business which expanded its total operational capacity by 8% to reach 108MW during the year. As already mentioned the prices we received in 2010/11 were lower than in the previous year by some 9%. This was due to the ending in March 2010 of a highly profitable electricity forward sale contract at prices that reflected values achieved at the peak of the market in May 2008. We are confident that prices will firm up again in the years to come.

Renewable energy summary

We believe that future growth in our power generation volumes will be driven by our EfW and AD activities. We currently have a total renewable electricity production capacity (including landfill gas plants) of 136MW. With our current investment projects underway and our healthy pipeline of further PPP opportunities we are confident of growing our capacity to over 300MW in five years’ time. We estimate that this will be around 0.5% of the UK’s total electricity generation or between 3% and 4% of the country’s total renewable energy capacity at that time.

We have called upon the Government to set a target for 6% of the UK’s total electricity production to be generated from waste, by whatever technology, by 2015. We regard this target as being achievable, albeit challenging. We believe it is common sense, not just because of the need to divert waste from landfill and the positive implications for the UK of utilising its residual waste to generate energy, but also as a practical solution to increase the diversity of supply sources in a period of increasing uncertainty regarding future energy supplies.

Other business sectors

Our landfill business has seen volumes decline in recent years as recycling has increased in the UK and the move to generating energy from waste has gathered momentum, which are positive offsetting trends for Viridor. By the end of the last financial year, our total landfill capacity was 69 million cubic metres, which is 8 million m3 less than we operated at the end of 2009/10 and is in line with Viridor’s strategy to focus its activities on recycling instead of landfill.

Our collection services remain strong as we have targeted controlled growth in industrial and commercial collection within areas which provide the right service and geographic synergies with other areas of our business, such as providing materials for our recycling and EfW operations.

Key relationships

All waste and recycling facilities in England and Wales require environmental permits, or waste management licences or PPC permits in Scotland. These are issued and monitored by the Environment Agency and the Scottish Environment Protection Agency respectively. Viridor maintains a positive working relationship with the regulators via proactive liaison and issues management, at both a site specific and strategic level.

Local authorities are the largest single customer group accounting in total for 34% of the company’s revenue. No individual authority accounts for more than 11%. Viridor’s ROC contracts account for 6% of revenue primarily with one customer. No supplier accounts for more than 3% of Viridor’s revenue. The company sources from competitive markets.

Our employees

The success of Viridor’s continued expansion and development is as a direct result of its professional and motivated workforce; these attributes are embedded in our Mission Statement. We ensure that every support and protection is afforded to our employees through robust health and safety systems; and timely and focused training and personal development opportunities through our highly trained staff who provide support, guidance and advice to all our employees. New employees joining us via acquisitions receive particular attention to ensure that they are quickly and effectively assimilated into Viridor to ensure their health, safety and welfare and to allow them to contribute to the company’s continued success. We are justifiably proud of our employees’ achievements.

Looking ahead

We await with interest the Government’s forthcoming waste policy review and believe strongly that the current marketfriendly approach to recycling and generating energy from waste should be actively encouraged.

We believe that Viridor is well placed to build further on the successes that the approach of the Government’s policy regime for waste has enabled over the last 20 years, which has been highly encouraging and progressive. These successes include a 58% reduction in the amount of CO2 produced by the waste industry since 1990 (the best of any sector in the UK), a six-fold growth in energy produced from waste over the same period, and growth in municipal recycling from under 10% a decade ago to over 40% today.

These are outstanding achievements, driven by a regulatory environment in which Viridor has been able to take an action-orientated, entrepreneurial approach to environmental issues (proving that being green is good for business). As we target further growth, particularly in our recycling and EfW businesses, we believe it is important that the current lighttouch, market-friendly approach is maintained to give us the operational freedoms we need for the benefit of our clients, for the environment at large and for our investors.

Looking ahead we intend to continue our current strategy of working hard to deliver what local and national government are seeking to achieve from recycling and waste management. Our profit profile in the next couple of years is likely to be driven by our recycling operations. Our healthy list of EfW and PPP prospects underpins our medium-term profit momentum.

In the long-term we are confident of continuing to deliver strong growth in shareholder value through continuing to lead the way in exploiting opportunities arising from the Government’s landfill diversion, recycling and renewable energy targets.

Page last updated: June 2011