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How to profit from Australia’s current severe regional drought

Drought crops

Most Australians live in capital cities, so many readers may not be aware that 98% of New South Wales and almost two thirds of Queensland is either in drought or is drought affected, as reported by News media.

This is already having a major impact on businesses such as Nufarm Limited (ASX: NUF) which was heavily sold off after its market update recently.

The CEO of Nufarm, Greg Hunt, said “We’re facing a perfect storm here in the Australian market, with the dry conditions leading to a poor winter crop, an over supply of products and increased competition across our sector. The whole agricultural supply chain is feeling the impact of this year’s extremely dry conditions.”

These comments were echoed by David McKeon, the CEO of Grain Growers, who said “What a season like this demonstrates is that the impact of drought isn’t just felt at the farm gate, but right through every rural community and right throughout supply chains. It impacts everything from the number of children at local schools to government funding decisions on health services once communities start to lose numbers.”

Finally, Tony Mahar, the CEO National Farmers’ Federation, said “Farmers have sown winter crops that are not up out of ground or, if they are, are not taking off. Droughts are regular and people know they are coming, but you don’t know how bad they are going to be. How bad is it at the moment? It is bad and we don’t know how much worse it is going to get.”

Sounds bad, right?

We don’t yet know which agricultural businesses are going to affected the most. Could it be Australian Agricultural Company Ltd (ASX: AAC)? Select Harvests Limited (ASX: SHV)? Costa Group Holdings Ltd (ASX: CGC)? Or perhaps Graincorp Ltd (ASX: GNC)? We may soon find out in reporting season.

This could turn out to be like insurance companies with a natural disaster. The initial insurance payout is a big hit to the company. But then in future years it can raise prices at a rate much faster than inflation.

How to profit in the near future

There is one company on the ASX called Duxton Water Ltd (ASX: D2O) which owns water entitlements and leases them out to agricultural businesses. It says its objective is to generate annual income through capitalising on the increasing demand for scarce water resources.

Water becomes much more valuable in a drought. Duxton Water’s net asset value (NAV) per share has risen from around $1.05 at September 2016 to $1.27 at the end of June 2018, which also doesn’t include paying 4.7 cents of dividends.

According to Duxton, the Murray Darling Basin had one of the driest January to June periods on record and the driest since 1986. The drier conditions resulted in increased irrigation requirements in a number of regions.

Many irrigators ran short or overused their available allocations, meaning they had to balance their water accounts by 30 June, which saw prices rise.

The 2019 water season is beginning with lower storage volumes and drier forecast conditions, leading to lower water availability.

I hope for all stakeholders involved that it does rain a bit more, no-one wishes suffering on farmers, communities or animals. I can understand some people not wishing to profit from the situation, I respect that line of thinking.

However, I think Duxton Water could be the best way to invest to get exposure to this current trend that may only get worse in the future as demand for food continues to rise.

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Motley Fool contributor Tristan Harrison owns shares of COSTA GRP FPO and DUXTON FPO. The Motley Fool Australia owns shares of and has recommended COSTA GRP FPO. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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