We recently published a list of 8 Most Undervalued Small-Cap Stocks To Buy According To Analysts. In this article, we are going to take a look at where Seadrill Ltd. (NYSE:SDRL) stands against the other most undervalued small-cap stocks to buy according to analysts.
Is a Multi-Year Small-Cap Cycle Ahead?
The landscape for small and mid-cap companies is becoming increasingly exciting in light of the Fed’s recent rate cuts, which could unlock significant investment opportunities. While the Russell 2000 index has lagged behind larger averages, analysts are optimistic about the growth potential of these stocks as market conditions improve.
Many small and mid-cap companies are well-positioned to capitalize on the favorable economic environment, with innovative strategies and strong fundamentals that can drive demand and market share. As interest rates stabilize and investor confidence grows, these companies are likely to attract renewed attention from investors seeking high-growth opportunities.
With the current environment ripe for exploration, there has never been a better time for investors to consider small and mid-cap stocks. Such was the sentiment of Curtis Nagel, senior US SMid cap internet analyst at BofA Securities, who spoke on this market scenario on CNBC earlier. We covered his opinion in another one of our articles, 7 Best Small Company Stocks To Invest In. Here’s an excerpt from it:
“…he believes this could spell big opportunities for SMID-cap stocks across various sectors, including home furnishings and subscription services.
Nagel specifically pointed out Restoration Hardware, noting that it is a household name that often flies under the radar… Nagel’s overall thesis focuses on updating price targets for companies with high sensitivity to interest rates and strong prospects for revenue and earnings growth in a soft landing scenario. ACV Auctions was highlighted as an intriguing opportunity. Nagel described it as a digital marketplace for wholesale vehicles where dealerships trade cars. He noted that this market has not been fully digitized yet, placing the company at the forefront of this transition. Although the wholesale vehicle market has faced challenges, down about 25% relative to historic averages, Nagel theorized that as interest rates improve and car affordability increases, the company could see a market rebound. He views this stock as potentially overlooked but having significant upside.”
In an interview on CNBC on September 30, Nancy Prial, Co-CEO & Senior Portfolio Manager at Essex Investment Management, expressed that she expects small-cap stocks to grow, driven by rate cuts and stock-picking opportunities.
Prial noted that small caps have been outperforming in the third quarter, largely driven by expectations of rate cuts, with a 50 basis point reduction being more significant than previously anticipated. She expressed optimism that small caps have substantial room to grow, emphasizing that this could mark the beginning of a multi-year cycle for these stocks. Currently, small-cap stocks are underrepresented in the market, comprising just under 5% of the total equity market, which is at record lows. This low ownership level presents an attractive opportunity for investors.
She pointed out that small-cap stocks remain significantly undervalued compared to their larger counterparts. Prial argued that for small caps to gain traction, several conditions must be met: the continuation of rate cuts, confidence in navigating a soft landing rather than a recession and expanding relative earnings growth. She noted that relative earnings growth for small caps is starting to improve and is expected to surpass that of large caps by the end of the year.
When asked about overall market estimates, Prial acknowledged that while the S&P 500 is projected to see earnings growth of 13% in the fourth quarter and 15% in 2025, she believes small caps could exceed these figures. Despite a slight slowdown in economic growth, she maintained that small-cap stocks could achieve earnings growth rates between 15% and 20% next year. She cautioned, however, that overall indices might not reflect this growth as estimates often start high before being revised downward.
Prial also discussed her investment picks related to infrastructure and near-shoring, specifically mentioning Clean Harbors. While acknowledging its strong performance in Q3, she clarified that they do not expect new legislation from Washington to drive further gains. Instead, she believes companies like this will benefit from existing bills that are now being implemented. Additionally, she highlighted Arcosa as a “picks and shovels” play within the sector, emphasizing its role in supporting the build-out of artificial intelligence infrastructure and digitalization efforts across various industries.
Her insights reflect a bullish outlook on small-cap stocks amid changing economic conditions and anticipated monetary policy shifts. By focusing on strategic stock selection and recognizing the potential for earnings growth within this sector, investors may find compelling opportunities as they navigate the evolving market landscape.
Methodology
We used stock screeners to look for companies trading between $1 billion and $10 billion, that’s our definition of small-cap stocks. We then found 25 stocks with a forward price-to-earnings ratio under 15, and an upside potential of over 20%. We then selected the 8 stocks that were the most popular among elite hedge funds and that analysts were bullish on. The stocks are ranked in ascending order of their analysts’ upside potential.
Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
Drilling rig silhouetted against a setting sun in an offshore location.
Seadrill Ltd. (NYSE:SDRL)
Forward Price-to-Earnings Ratio: 9.98
Average Upside Potential: 47.57%
Number of Hedge Fund Holders: 41
Seadrill Ltd. (NYSE:SDRL) is a global offshore drilling contractor that provides drilling services to the oil and gas industry. It owns and operates a fleet of drilling rigs, including semi-submersibles and drillships, which are used to explore and develop oil and gas fields in deepwater and harsh environments.
It has also been returning value to shareholders through buybacks as part of a $200 million program. Despite industry challenges, Seadrill Ltd. (NYSE:SDRL) has a potential FCF of $900 million, representing one-third of its enterprise value. Day rates have rebounded from lows, and it has restructured its debt and refined its fleet strategy.
The company’s recent acquisition of Aquadrill and successful jack-up sales have strengthened its position. Despite such moves, revenue fell 9.42% in the second quarter of 2024. While the company is not under financial pressure, it is strategically managing its fleet by reactivating idle rigs only when profitable contracts are secured.
On September 12, the company’s CEO expressed interest in acquiring “distressed assets” or companies with “distressed balance sheets.” It’s also interested in adding to its fleet of drilling rigs through acquisitions or partnerships. In a recent transaction, it completed the sale of 3 jack-up rigs to Gulf Drilling International for $338 million.
Later on September 17, Seadrill Ltd. (NYSE:SDRL) and Oil States formed a strategic partnership to enhance offshore Managed Pressure Drilling (MPD) operations. Oil States’ MPD Integrated Riser Joint (IRJ) system will be used on Seadrill Ltd.’s (NYSE:SDRL) West Polaris rig.
It’s a well-positioned offshore drilling contractor with a strong balance sheet and a focus on value creation. It has demonstrated resilience and a strategic approach to its business, making it a top stock to buy.
Patient Capital Management stated the following regarding Seadrill Limited (NYSE:SDRL) in its fourth quarter 2023 investor letter:
“We purchased a new energy name in the quarter, buying shares in Seadrill Limited (NYSE:SDRL). Seadrill is the fourth largest pure play deepwater drilling specialist. The company emerged from bankruptcy in February 2022 with a net cash position. The company is set to benefit from limited supply and increasing demand in the deepwater drilling rig market. Nearly half of all deepwater drilling rigs in the world were scrapped during the last decade. In addition, player consolidation puts the industry in a more rational position than we have seen historically. As land-based oil production growth comes under pressure, offshore production is receiving renewed interest. With a highly specialized rig base, the company is benefiting from increasing prices which are leading to strong FCF yields given the limited need for capital expenditures (CAPEX). The company has committed to returning 50% of FCF to shareholders via dividends and buybacks. Since September 2023, the company has repurchased 8% of shares outstanding. As old contracts roll-over and new contracts are signed at the higher day rates, operating profit and FCF are expected to expand dramatically. Seadrill could either consolidate the space or be acquired.”
Overall SDRL ranks 3rd on our list of most undervalued small-cap stocks to buy according to analysts. While we acknowledge the growth potential of SDRL as an investment, our conviction lies in the belief that AI stocks hold great promise for delivering high returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than SDRL but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article is originally published at Insider Monkey.
