What Are The Drivers Of Otto Energy Limited’s (ASX:OEL) Risks?

If you are a shareholder in Otto Energy Limited’s (ASX:OEL), or are thinking about investing in the company, knowing how it contributes to the risk and reward profile of your portfolio is important. There are two types of risks that affect the market value of a listed company such as OEL. The first risk to think about is company-specific, which can be diversified away by investing in other companies in order to lower your exposure to one particular stock. The second type is market risk, one that you cannot diversify away, since it arises from macroeconomic factors which directly affects all the stocks in the market.

Not all stocks are expose to the same level of market risk. A popular measure of market risk for a stock is its beta, and the market as a whole represents a beta value of one. A stock with a beta greater than one is considered more sensitive to market-wide shocks compared to a stock that trades below the value of one.

Check out our latest analysis for Otto Energy

An interpretation of OEL’s beta

Otto Energy’s five-year beta of 1.95 means that the company’s value will swing up by more than the market during prosperous times, but also drop down by more in times of downturns. This level of volatility indicates bigger risk for investors who passively invest in the stock market index. According to this value of beta, OEL can help magnify your portfolio return, especially if it is predominantly made up of low-beta stocks. If the market is going up, a higher exposure to the upside from a high-beta stock can push up your portfolio return.

ASX:OEL Income Statement Mar 31st 18
ASX:OEL Income Statement Mar 31st 18

Could OEL’s size and industry cause it to be more volatile?

A market capitalisation of AU$90.32M puts OEL in the category of small-cap stocks, which tends to possess higher beta than larger companies. Furthermore, the company operates in the oil and gas industry, which has been found to have high sensitivity to market-wide shocks. So, investors should expect a larger beta for smaller companies operating in a cyclical industry in contrast with lower beta for larger firms in a more defensive industry. This is consistent with OEL’s individual beta value we discussed above. Next, we will examine the fundamental factors which can cause cyclicality in the stock.

How OEL’s assets could affect its beta

During times of economic downturn, low demand may cause companies to readjust production of their goods and services. It is more difficult for companies to lower their cost, if the majority of these costs are generated by fixed assets. Therefore, this is a type of risk which is associated with higher beta. I examine OEL’s ratio of fixed assets to total assets to see whether the company is highly exposed to the risk of this type of constraint. With a fixed-assets-to-total-assets ratio of greater than 30%, OEL appears to be a company that invests a large amount of capital in assets that are hard to scale down on short-notice. As a result, this aspect of OEL indicates a higher beta than a similar size company with a lower portion of fixed assets on their balance sheet. Similarly, OEL’s beta value conveys the same message.

What this means for you:

You may reap the gains of OEL’s returns in times of an economic boom. Though the business does have higher fixed cost than what is considered safe, during times of growth, consumer demand may be high enough to not warrant immediate concerns. However, during a downturn, a more defensive stock can cushion the impact of this risk. In order to fully understand whether OEL is a good investment for you, we also need to consider important company-specific fundamentals such as Otto Energy’s financial health and performance track record. I highly recommend you to complete your research by taking a look at the following:

  1. Financial Health: Is OEL’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
  2. Past Track Record: Has OEL been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of OEL’s historicals for more clarity.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.