Network Rail Limited

This year, the railway started a major programme of change and modernisation to put rail on a sustainable footing for the future

19 July 2022

Network Rail today published its annual report and accounts for the 12 months to 31 March 2022.

Andrew Haines, chief executive, said: "It is no exaggeration to say that Covid-19 has resulted in the largest crisis in our industry's history. Passenger numbers fell dramatically, posing an unprecedented challenge to the railway and requiring Government to provide an additional £16 billion in support for the sector. Against this backdrop, delivering on our vital national mission to get people and goods where they need to go has required us to work more flexibly, creatively, efficiently, and collaboratively as one industry than ever before."

"Such significant Government support can only be sustained if we make the most out of every pound, becoming more efficient and better value for money. We beat our target for operational efficiencies for the year by £10m, taking us to £840m for the year, with £1.9bn achieved so far in CP6 set against our £4bn target. Our record in delivering against our efficiency plans has now been publicly acknowledged by the Department for Transport, by the Office of Rail and Road and by the Public Accounts Committee.

Looking ahead, we have started a major programme of change and modernisation across our organisation. Delivering and implementing these changes over the coming months will be essential to put rail on a sustainable footing for the future."

"Our fundamental commitment to passengers and freight users is to deliver a safe, punctual, and reliable service. By the end of the year, new revenue initiatives had helped passenger demand recover to around 75 per cent of pre-pandemic levels, with particularly strong growth in leisure markets which now exceed their level pre-pandemic."

"I am proud of what we have achieved this past year thanks to the hard work and commitment of our railway family. I look forward to working together over the coming year to create an efficient railway that's fit for the future and provides the best possible service for passengers and freight users."

Financial highlights for the year include:

·    Investment was £6.1bn compared with £5.9bn last year due to an increase in enhancements (£0.2bn) in line with our business plans.

·    Revenue remained at £9.6bn.  There were increases in retail income from shop units at stations as we emerged from the pandemic offset by less train performance regime income, mainly as a result of more congestion on the network, as the timetable returns to a more normal service.

·    Operating costs increased from £6.4bn to £6.6bn as inflationary pressures were largely absorbed

·    Profit before tax was £0.3bn (2020/21: £1.6bn). The profit is used to fund our railway investment programme. The decrease relates to increases in the value of legacy Retail Price Index (RPI)-linked bonds previously issued to fund the railway.

·    Operating profit was £3.0bn, compared to £3.2bn in 2020/21.

·    Net debt increased to £56.1bn from £54.7bn due to increases in the valuation of RPI-linked bonds.

Commenting on the financial results, chief financial officer, Jeremy Westlake, said:

"The continued support provided to our direct customers, the passenger and freight operating companies, by the Governments in Westminster and Holyrood has meant that they have been able to continue to pay amounts owed to Network Rail as they fall due. In addition, Network Rail has been able to use the risk funds available in the five-year spending plan to mitigate increased Covid 19-related costs. As a result, there has been no material change to our delivery plan and we remain on a firm financial footing."

Financial highlights

for the year ended 31 March 2022

Income statement

for the year ended 31 March 2022

Under section 408 of the Companies Act 2006 the group has elected to take the exemption with regard to disclosing the company income statement. The company's result for the year was £nil (2021: £nil).

Statement of comprehensive income

for the year ended 31 March 2022

Statement of changes in equity

for the year ended 31 March 2022

* Other reserves of £249m (2021: £249m) include the vesting reserve on privatisation.

There has been no movement in the current or prior year affecting the statement of changes in equity for the company.

Balance sheet

at 31 March 2022

Statement of cash flows

for the year ended 31 March 2022

*Balance includes the net interest on derivative financial instruments

Notes to the financial statements

for the year ended 31 March 2022

1.  General information

Network Rail Limited ('the company') is a company limited by guarantee which is incorporated and domiciled in Great Britain and registered in England and Wales under the Companies Act 2006. Network Rail Limited is an arm's length body of the Department for Transport.

The company registration number is 4402220.

The company's registered office is situated at 1 Eversholt Street, London NW1 2DN, United Kingdom.

The company's and its subsidiaries' (together 'the group' or 'Network Rail') principal activities are detailed in the 'About us' section on pages 15 to 19.

Network Rail is organised as a single operating segment for financial reporting purposes.

The Secretary of State is the sole member of the Company

Going concern

The group's business activities, together with the factors likely to affect its future development, performance and position are set out in the 'About us' section on pages 15 to 19, and 'Business unit summaries' on pages 31 to 72. The financial position of the group, its cash flows, liquidity position and borrowing facilities are described in the Chief Financial Officer's review on pages 26 to 30.

The Directors took into account the publication of the Williams-Shapps Plan for Rail Review and its plans to reform the rail industry.  This proposes that, commencing in late 2023, a new public body, Great British Railways, will integrate the railways, owning the infrastructure, collecting fare revenue, running, and planning the network, and setting most fares and timetables. It is planned that Network Rail will be absorbed into the public body to bring about single, unified, and accountable leadership for the national network.  At this stage it is not likely that this reform will involve the winding up of Network Rail Limited but in any event Great British Railways will assume the existing functions of Network Rail Limited as well as have a wider range of powers and functions. The transformation programme is dependent on further activities including legislation and will take time to fully deliver.

The group has considerable financial resources together with long-term contracts with a number of customers and suppliers. Network Rail does not expect to undertake any new borrowing in the next 12 months. Instead, its activities will be largely funded by grants from the Department for Transport and revenue from customers. Network Rail has secured a £31.9bn loan facility with the Department for Transport (DfT), which it intends to draw upon to specifically refinance its existing debt. This facility remains within its parameters.

Network Rail has eight separate grant agreements in place with DfT and Transport Scotland (TS) to fund activities in the next 12 months. These grants are: - with DfT - Network Grant; Enhancements Grant; British Transport Police Grant; Financing Costs Grant for DfT interest; Financing Costs Grant for external interest (bonds and swaps); and Corporation Tax Grant - with TS - Network Grant and Enhancements Grant.

Business plans and financial models are used to project cash flows and monitor financial risks and liquidity positions, forecast future funding requirements and other key financial ratios, including those relevant to our network licence. Analysis is undertaken to understand the resilience of the group and its business model to the potential impact of the group's principal risks, or a combination of those risks. This analysis takes account of the availability and effectiveness of the mitigating actions that could realistically be taken to avoid or reduce the impact or occurrence of the underlying risks. The board considers the likely effectiveness of such actions through regular monitoring and

review of risk management and internal control systems. Further details are set out in the Viability Statement on pages 99 and 100. In addition, note 25 to the accounts includes the group's objectives, policies and processes for managing its capital; its financial risk management objectives; details of its financial instruments and hedging activities; and its exposures to credit, liquidity and foreign exchange risk.

After making enquiries, including those detailed above, the directors have a reasonable expectation that the company and the group have adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the annual report and accounts.

2.  Revenue

The effect of the performance regimes was a net profit of £182m (2021: net profit of £329m) which led to an increase in revenue of the respective amount. The performance regime provides a basis for compensation to train operators for the impact of lateness and cancellations on their income. It also provides incentives for Network Rail and train operators to continuously improve performance where it makes economic sense to do so. This is achieved by Network Rail and train operators making bonus payments / paying financial compensation where performance is better than / worse than the benchmark.

The group has assessed its revenue recognition in accordance with IFRS 15 and has deemed that it derives the vast majority of its revenue over-time. Revenue recognised at a point in time is not material in the financial year and therefore is not disclosed separately.

Grant income, franchised network access, freight revenue and property rental income, recognised in line with the accounting policies, were recognised upon fulfilment of the contractual performance obligations, by providing track access or access to rental property, in line with the terms of the existing customer contracts. Recognition is over time, and the input method, specifically time lapsed, is used as the basis for revenue recognition. There are no alternative performance obligations identified for individual contracts within the disaggregated revenue streams.

There are no recognised contract assets, as defined by IFRS 15, that relate to recognised revenue disaggregated in the above table.

3.  Net operating costs

4.  Profit from operations

Total profit from operations is stated after charging/(crediting):

The 2021 Cost of inventories recognised as an expense has been restated due to refined analysis.  For financial years ended 31 March 2022 and 2021 no fees were payable to the company's auditors in respect of non-audit related services. In addition to the audit fee information given in the table the group pays £0.2m for the audit of subsidiaries that are not performed by the group auditor.

5.  Tax

The tax charge is made up as follows:

The tax charge for the year can be reconciled to the profit per the income statement as follows:

Under IAS 12 deferred tax assets can only be recognised where it is probable that taxable profits will be available against which the deferred tax asset can be utilised. As in 2021, it remains improbable that Network Rail will produce a level of taxable profits that will allow for recognition of a deferred tax asset relating to the trading losses carried forward. Network Rail uses all its profits to fund capital expenditure. Following the Budget in March 2021, Network Rail will be able to claim the "super allowance" deduction on certain capital expenditure.  Management's current assessment is that it is likely that these capital allowances will mean there is no significant taxable income for the year to 31 March 2023. In that year then, capital allowances will cover the taxable profit and mean that there is no expected need for use of losses. Beyond the current funding regime, there is no certainty over the funding mechanism of Network Rail and hence the use of any losses.

The Group did not utilise any ACT asset in the financial year (2021: utilised surplus of ACT asset of £36.9m).

Deferred tax at 31 March 2022 is calculated at a rate of 25 per cent (2021: 19 per cent) based on the tax rate expected to prevail based on legislative enactments at the point temporary differences resolve.  The change in tax rate from 19% to 25% was a result of the Finance Act 2021. The Finance Act 2021 was not substantively enacted at 31 March 2021 and only became substantively enacted during the year ended 31 March 2022. The amount at which temporary differences crystallise is sensitive to the decisions on future tax laws to be taken by Parliament.

UK corporation tax is calculated at 19 per cent (2021: 19 per cent). From the statutes of the Finance Act 2021 the corporation tax rate will increase to 25% with effect from 1 April 2023.

6.  Property, plant and equipment - the rail network

Given the economic and physical interdependency of the assets comprising the rail network, the company has concluded that the rail network is considered as a single class of asset. The rail network is carried at its fair value.

As there is no active market in railway infrastructure assets, the company has derived the fair value of the rail network using an income approach. Under this approach the cash flows that a network licence holder expects to generate from the rail network are assessed using a market rate of return. This valuation is carried out twice a year and revaluation gains and losses are reflected in other comprehensive income.

The independent rail regulator, the Office of Rail and Road (ORR), stated (in the 2018 periodic review final determination: Supplementary document - financial framework) that a private network licence holder of the railway network would have its revenue requirement determined using the building block model of regulation. Under this model the network licence holder's annual income (received in the form of the network grant and track access charges) would comprise:

a) The regulator's assessment of the efficient costs of operating and maintaining the network

b) An allowance for Regulatory Asset Base (RAB) amortisation - qualifying capital expenditure is added to the RAB as incurred and recovered by the company through future amortisation allowances (in order to spread the cost to customers and stakeholders of investment in the rail network over many years).

c) An allowed return on the RAB - calculated by applying the rate of return permitted by the ORR (based on its assessment of the market's cost of capital) to the RAB balance.

In the determination for Control Period 6 (2019-2024), published on 31 October 2018, ORR explained that from 1 April 2019 the RAB ceased to be a building block in the determination of the company's revenue requirement, but that the previous method of revenue determination would be restored if the rail network asset were to be transferred to a private owner. IFRS 13 Fair Value Measurement requires management to assess fair value from the perspective of a theoretical market participant, rather than on the basis of the value-in use. Accordingly, the amendments made to the regulatory framework for Control Period 6, which reflect the proximity of Network Rail to the public sector and which would not apply to a market participant, are not relevant to the valuation.

Future cash flows under (a) are assumed to be equivalent over time to the network licence holder's actual costs of operation and maintenance, on the basis that the Regulator aims to set targets which are ambitious but achievable. These therefore have no net impact on forecast future cash flows, or the valuations. The allowed return (c) is based on a cost of capital which would be offset in a discounted future cash flows model (see Discount rate below). The economic rights inherent in ownership of the regulated rail network asset are therefore vested primarily in the value of the RAB, which will be recovered through future regulated income as the RAB is amortised (b).

This means that it is possible for the RAB itself to be used as the starting point for a discounted cash flow valuation. The RAB fluctuates in valuation; increasing in value principally as a result of allowances for capital expenditure and inflation indexation, whilst reducing for amortisation. The adjustments may give rise to upwards or downwards revaluations. Further changes are subject to:

a) Adjustment for any difference between regulatory rate of return and the market cost of capital that a third party investor would use to assess the value of the network (the rate of return and market cost of capital are currently assessed as fully aligned); and

b) Adjustment for forecast future under or out performance against the regulatory determination over the remainder of the current control period. No adjustment is made in respect of future control periods on the expectation of the Regulator setting, over the long term, ambitious but achievable determination. See forecast performance variation below.

When valuing the network, management is required to consider the value a knowledgeable willing party would place on the network in an arm's length transaction. On the grounds that third party investors are known to value the assets of regulated companies by reference to the RAB, and that the cash flows associated with the regulatory framework are considered sufficiently stable and robust to form the basis of a third party valuation, management has used the RAB as the starting point for its valuation.

Revaluations

The valuation includes a £1,844m upward movement in the value of the railway. There are 2 key drivers for the valuation, being the difference between:

•           The impact of indexation inflation (£3.7bn increase in the valuation)

•           The rate at which assets are amortised in the RAB and assets are depreciated under IAS 16 (£1.8bn decrease in the valuation.)

Indexation inflation was based on the November CPI, of 5.1%.

Grant income has been agreed across the five-year funding settlement and is drawn down to augment the other sources of revenue in meeting the in-year operations, maintenance and renewals expenses. Operations and maintenance expenditure passes directly through the Income Statement. Expenditure on renewals is instead treated as an addition to PPE since replacing elements of the network is within the scope of IAS 16; however, because the network is carried on a fair value basis with reference to the Regulatory Asset Base, and the Regulator allows for the amortisation of renewals in-year, any such PPE additions are also expensed in year. This expense is taken through Other Comprehensive Income as part of the revaluation of PPE in line with IAS 16 requirements. In line with this, the renewals related element of the network grant is (like operations and maintenance) credited to the Income Statement in the year of the relevant additions and revaluation; no expense remains to be recognised following the revaluation entry since the additions-related asset element has been eliminated through that revaluation. Until the revaluation reserve in relation to the railway network asset is fully utilised, this difference in in-year income and expense will result in the difference between in-year capitalised renewals and the depreciation charge (which is also subject to the same revaluation effect since it is out of scope for the RAB) representing an impact on profit or loss.  In 2021-22 the net effect of this was of a £1.8bn credit (2020-21 year end: £1.9bn credit) to the Income Statement.

Third party funding

Additions to the railway network funded by capital grant, rather than via the RAB funding mechanism, are included in the valuation at cost. The carrying value of property, plant and equipment is calculated after netting off associated grant funding received or receivable.

Disposals

The disposals of £27m were as the result of property sales in the usual course of business. In line with Regulatory Accounting Guidelines the net proceeds of sales are deducted from the RAB, reducing the valuation of the Railway Network Valuation. The valuation of the disposals is assessed as being equal to the reduction in the valuation of the Railway Network relating to property sales.

Depreciation

The depreciation charge for any year is calculated using the average carrying value for the year and the estimated remaining weighted average useful economic life of the rail network. The remaining weighted average useful economic life of the rail network was calculated using the engineering assessment of serviceable economic lives of the major categories that comprise the rail network. The estimated remaining weighted average useful economic life of the network is currently 40 years (2021: 40 years).

Discount rate

The discount rate used in the income approach is the pre-tax rate of return set by the ORR. The ORR performs a periodic review every five years, which leads to the setting of the appropriate rate for the five-year period. The ORR's method encompasses advice from consultants, comparisons to similar infrastructure assets and discussions with Network Rail. Management believes this cost of capital reflects the assumptions that a market participant would make in arriving at a discount rate.

Should the ORR amend the permitted rate of return in future quinquennial reviews, the regulator would raise or lower the permitted charges to customers so as to achieve the new rate of return. In other words, the cash flows would change but the RAB would not.

The ORR confirmed that a conventionally funded market participant would receive an allowed return equal to the full market cost of capital. This has been reiterated in their final determination for CP6. Management expects that if the rail network asset were to be transferred to a private owner during CP6, ORR would determine the private owner's revenue requirement for CP6 using the pre-tax (CPI) WACC of 4.15% set out in their final determination for this Control Period. Management expects that the rate of return set by the regulator in subsequent quinquennial reviews will be consistent with the market discount rates for infrastructure assets at the quinquennial review date. The full market cost of capital determined by the ORR, on an annual basis, is 3.8% (2021: 3.8%) for the current control period.

Accordingly, the valuation includes a reassessment of this rate to determine whether it continues to reflect market conditions. This assessment is by reference to movements in observable market data, including the risk-free cost of borrowing, and changes in the weighted average cost of capital of listed utilities with similar gearing ratios. The following table shows the effect of changes in the market discount rate on the carrying value of the rail network and on the depreciation charge. The analysis only considers the effects of movements in the market discount rate until the end of Control Period 6 (2024), and not in perpetuity. The effect of changes in the market discount rate apply equally to increases and to decreases in discount rates.

7. Trade and other payables

Deferred income includes £831m (31 March 2021: £962m) relating to cumulative timing differences between government grants received and expenditure being incurred which gives rise to the recognition of income under grant agreements. The remainder of the balance relates principally to IFRS 15 items referred to in that standard as 'contract liabilities.

£23m of the property deferred income balance at the beginning of the year was recognised as revenue in the current year.

The average credit period taken for trade purchases is 30 days (2021: 26 days).

Before accepting new suppliers, and upon letting significant contracts, the group evaluates suppliers' creditworthiness using external credit scoring systems and other relevant data.

The directors consider that the carrying value of trade and other payables approximates to their fair value. All balances are ordinarily non-interest bearing and denominated in sterling.

The Other accruals balances contains a degree of estimation uncertainty regarding the amounts to be paid. The majority of the balance relates to COWD which is disclosed as a key source of estimation uncertainty.

As part of the acquisition of Railtrack PLC, Network Rail received a grant of £300m from the Strategic Rail Authority to fund the purchase. In line with Network Rail's accounting policy this revenue is deferred and amortised over the average remaining life of the railway network (as this represents the substantial part of the assets purchased), currently 40 years, on a straight-line basis. The balance on the grant after amortisation at 31 March 2022 is £105m (2021: £113m).

8.  Notes to the statement of cash flows

Cash and cash equivalents

Cash and cash equivalents (which are represented as a single class of assets on the face of the balance sheet) comprise cash at bank and commercial paper, all of which are on call with the exception of short-term deposits. There were £558m (excluding offsetting clearing accounts) of short-term deposits with the government banking scheme ("GBS") held as at 31 March 2022 (2021: £576m).

9.  Borrowings

* As at 31 March 2022, a collateral facility of £250m (2021: £260m) was included within this balance.

** Included in repayment of borrowings in cash flow statement.