OEL 0.00% 0.9¢ otto energy limited

OEL Intrinsic Value Simulation Model

  1. 8,494 Posts.
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    It's been a while since I done a thorough Residual Earnings Model (REM)

    What I've done is combine the REM by using a Monte Carlo Simulation (again 5,000) iterations to do the earnings estimate for FY'21 and FY'22.

    There is a few elements to discuss for it to make sense.

    1. REM is based on the concept of earning in excess of the company's cost of capital. If a company had $100K in cash (from selling equity) and the company says it can earn you at least 10%, then if it earned $10K it delivered on its promise. By default its cost of capital is 10% (after all that is what it promised to pay). It it delivered $15K it also delivered on its promise but this time it has delivered $5K of residual earnings. I like companies that can deliver RE.

    2. Book value is important (a lot of talk about dividends etc). In the above example if the company has $100K of cash as its only asset (and no debt .i.e. all equity) then the book value of the company is $100K. If it earned $10K and didn't pay a dividend then it has $110K in cash and its book value is $110K. If it earned $15K, it has residual earnings of $5K. In concept it could pay that out to equity holders as a dividend.

    3. Now the following year though the company must earn $11K to meet is cost of equity capital requirement.

    So Book Value builds as the company achieves earnings. The Intrinsic Value that we as shareholders care about is the value of the equity in the company. Neither should be confused with the Market Value of the equity which is what the share trades at. Book Value is reported on the Balance Sheet. So we know the Book Value as of June 30. The IV that the model calculate is the present book value + the discounted value of future residual earnings + some Continuing Value post the forecast earnings period and also discounted back to present value

    The key input variables are the BV off the balance sheet, estimated earnings for FY'21 (using the monte carlo simulation of net income model with 0% tax) and estimated earnings for FY'22 (using the same net income model but changing the production variable to 850,000/50,000 mean/stdev to come up with earnings). These inputs are randomly iterated 5,000 times over the normal distributions to come up with the residual earnings. The residual earnings take into account an 18% cost of capital (because we have a risky company ... the company's WACC is above 16% as confirmed by JJ at last years AGM). Now clearly there is more value in the company than 2 years of forward earnings. So I created a Continuing Value (CV) to capture that. Now you'll see that there is a negative 10% growth rate in RE. This is deliberate ... if the company does not invest (and that new risk) in finding replacement oil the company must shrink. I'm thinking that is a likely corporate decline rate anyway.

    The number which the simulation comes up with is $128.623,011, which is the intrinsic value at Jun 30, 2020
    Converting that AUD and to per share the result is AUD$0.0325

    And the model
    ... hopefully explained above. The model does not discount inept mgmt ... but you could allow for that by make the Required Rate of Return even higher. Happy to answer questions.

    https://hotcopper.com.au/data/attachments/2310/2310531-94843525afd642c1d7caa2682932da25.jpg
 
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