There are timing mismatches in the way that inflation impacts water company earnings. In a rising inflation environment, opex and debt costs are impacted before the benefit flows through to revenue. With >50% debt index-linked, this has a material impact on UU. We cut our FY23EPS by c.90% (Figure 1). Ofwat’s PR24 draft methodology is expected in July. It is not clear whether a view on allowed returns will be given, but we note that the PR19 draft methodology presented a view on the cost of equity. We use the CMA’s ruling in the PR19 appeals as the framework for setting an allowed return for PR24. Allowed cost of debt is likely to fall, with older embedded debt rolling off, and newer debt indexed. Reading across from Ofgem’s NGET AIP, which shows a declining cost of debt across the RIIO-2, we assume a 35bp cut in the allowed cost of debt vs. the CMA’s position, pointing to 1.83% CPIH real. Our cost of equity assumption incorporates the CMA’s 25bp aiming up assumption, and uses the 10-year index-linked gilt as a proxy for the risk-free rate. This points to a cost of equity of 5.09% CPIH real, higher than the CMA’s 4.73%, and Ofwat’s PR19 position of 4.19%. Assuming 60% notional gearing and an 8bp retail margin deduction, we assume an allowed return of 3.05% CPIH real, below the CMA’s 3.12%, but above Ofwat’s PR19 position of 2.92%. This is lower than the 3.18% assumed in our previous estimates, and is a contributory factor to our valuation implying a 20% premium to FY23E RCV vs. 26% previously. Driven by inflation, our FY23E RCV is also c.2.6% higher than in our previous estimates. Our target price moves to 1,285p, of which pensions account for 121p. A 10bp reduction in the return would trim this by c.35p.