Water is the staff of life – and no more so for ASX listed stocks that depend on water rights to grow their crops or else trade them for gain without tilling a single sod.

What side should investors be on: the suppliers or the users?

As with every aspect of water rights, nothing is straightforward. The simple backdrop is that the Murray Darling Basin (MDB) – the main region for which rights are applicable – had its driest three years on record, with the value of temporary entitlements at one stage soaring from around $300 a megalitre to $1000ML.

Then is started to rain ... and rain some more. But don’t expect the sodden conditions to quell the water – and concomitant climate change debate – in the mid to long term.

During the Big Dry, the water rights price hike prompted criticism of a new breed of ‘water barons’ who allegedly stockpile rights and sell then to needy irrigators at inflated prices.

Foreign ownership is also a vexed issue, bearing in mind that buyers of water rights don’t need Foreign Investment Review Board Approval. Canada’s Public Sector Pension Investment Board has emerged as one of the biggest owners, having recently taken over the Chris Corrigan led, water rights-heavy Webster Limited for $850m.

Along with accusations of lack of transparency on data such as trading volumes, the ‘water baron’ accusations prompted the federal government to request the Australian Competition and Consumer Commission inquiry.

The probe, overseen by interim inspector general for the MDB Mick Keelty, is underway with an interim report is due to be hands of Josh Frydenberg by the end of May. Don’t expect a swift quick response given the Treasurer has more pressing matters, such as keeping the country afloat in a broader sense.

Duxton Water (D2O)

As the only pure-play water rights exposure on the ASX, Duxton has been at the centre of the ‘water baron’ allegations, but the fund hasn’t gone to water yet.

Rather, it’s deployed the full-strength water cannons in defence of its wheeling and dealing business model, which it describes as “flexible water supply solutions to our Australian farming partners.”

The fund notes that of January 31, 66 per cent of its entitlement over 83,388 megalitres had been leased out to worthy producers such as Mallee spud farmers.

And all of its rights are available to support its “irrigation partners” (the farmers).

The fund says its rights only account for one per cent of the available water in the Southern Murray Darling Basin.

In Duxton’s view, the increase in the value of permanent rights mainly reflects long-term drivers, rather than drought.

“Over ten years irrigators have improved per-megalitre returns through more efficient use and conversion to higher-value commodities,” the company says.

In the March quarter the value of Duxton’s net assets per share reduced to $1.91 from $2 on December 31 2019.

During the quarter, the company says, the value of MDB allocations across two key classes slid by an average 37per cent or 43 per cent, to $400-450ML and $475-490ML.

“Whilst we have seen a retracement in permanent entitlement values over the last couple of months, the value uplift over the last 36 months reflects long term drivers rather than the recent drought conditions,” the company chimes.

At last glance Duxton shares traded at $1.30, a 32 per cent discount to net asset value.

Select Harvests (SHV)

A leading almond grower, Select owns a decent wad of rights and has an active trading desk to manage its water requirements, which accounted for 12 per cent of total costs last year.

“Historically the management of water was focused on simply managing consumption,” Select Harvests CEO Paul Thompson says. “Today it is far more complex (involving) trading significant amounts of water at significant cost, in relatively small and opaque markets.”

Thompson says it’s not the price of the rights (or attached temporary entitlements) per se, but the ability to apply the water to the best use: the company will happily pay $1000ML for rights if that improves the corresponding value of the crop by $2000.

The downside for orchardists is that their trees are permanent and need to be watered whatever the market conditions. Croppers such as cotton and rice growers can pick or choose when to plant and indeed the high water prices mean many have opted for a long holiday instead.

Having successful plucked most of its current crop, Select should enjoy decent pricing and lower water costs in the 2020-2021 financial year. The only negative is almost perfect growing conditions in previously drought stricken California, the world’s biggest almond region.

Vitalharvest (VTH)

The rural landlord cites $40 million of water rights to support the activities of its sole tenant Costa Group – the country’s biggest fruit and veggie grower - across four berry and citrus properties.

Managed by Go Farm, Vitalharvest was hived off from Costa in August 2018. The idea was that as a pure agriproperty play, the trust would offer both a growing income stream and capital growth for investors.

It hasn’t panned out that way, with the variable component of the rent hit by Costa’s problems with drought, fruit fly, undersized fruit and crumbly raspberry (it sounds tasty but it isn’t).

Having floated at $1, Vitalharvest units are now worth around 70c. But as of December 2019 balance date, the units had a net asset value of 95c, including 21.5c for the water rights (based on acquisition cost).

While the recent rains might diminish the value of the rights, they’re more broadly positive for Costa and thus Vitalharvest.

Rural Funds Management (RFF)

As with Vitalharvest, the property trust’s 118,000 megalitres of water rights support its tenants who operate in sectors including cattle, vineyards and almond and macadamia orchards.

Valued at $208m, the rights account for 22 per cent of the company’s net asset valuation.

Rural Funds chief David Bryant expects water values to plateau from now, with foreign owners struggling to get a decent return on equity by renting out the temporary entitlements.

The fund itself has been trading high security rights on the open market “and that has been a very lucrative investment.”

Rural Fund owns 38 properties over three climate zones, with an average weighted lease terms of 11.5 years.

Rural Fund shares were pounded last year after US short seller Bonitas Research accused the company of fabricating rental income and overstating net assets.

In February the NSW Supreme Court backed Rural Funds in a damages action bought against Bonitas, which is based in the US and beyond the court’s purview.

Meanwhile, Rural Funds on April 20 affirmed 2019-20 guidance of funds from operations of 13.5 cents per unit and a distribution of 10.85 cents per unit.

Tim Boreham edits The New Criterion

tim@independentresearch.com.au