Insider trading can provide a peak into sentiment within a company, and oftentimes it's not a pretty picture. Given the rise of stock options and large stock grants, there's more selling from insiders than outside investors want to see.
But sometimes insider buying can be a hugely bullish sign for investors, and Seadrill's (NYSE:SDRL) founder and major shareholder John Fredriksen just showed how much he thinks of his biggest holding. Fredriksen bought 2 million shares in Seadrill earlier this week to increase his stake to 115.1 million shares and also holds a total return swap agreement with exposure to 3.9 million shares and another 2 million shares worth of call options.
If Fredriksen is buying the business he knows so well, maybe we should reconsider whether the stock's sell-off is way overdone.
Why Seadrill stock has crashed
To understand why Fredriksen is buying shares of Seadrill we need to look at where the stock and the offshore drilling market have been so far this year. The stock has struggled for most of this year as the offshore drilling market saw demand fall but fell off a cliff after earnings were reported on August 27.
What's interesting is that earnings weren't all that bad. Revenue was down slightly to $1.2 billion and operating profit fell just 6% from a year ago to $476 million. But two catalysts have investors extremely worried.
U.S. sanctions on Russia have put a $4.25 billion deal with Russia's OAO Rosneft in question, although Seadrill is technically based in Bermuda so the long-term impact is unknown. A Seadrill board member who was a close advisor to Fredriksen also resigned, shocking some investors. So, why is Fredriksen buying in this environment?
Why Fredriksen is so bullish on Seadrill
Being bullish on Seadrill may be hard right now, but when we take a step back and look at the business there's a lot to like. The offshore drilling market is splitting into four broad segments: shallow water and ultra-deepwater, and then old rigs and new rigs. Seadrill is well positioned in this market dynamic.
Ultra-deepwater rigs command high dayrates and long-term contracts give stability for rig owners. Seadrill has exposure to both shallow and deepwater markets, but ultra-deepwater accounts for the majority of revenue so this is a strong strategic position for the company.
More importantly, newer rigs offer performance and safety features that an aging fleet can't and therefore find work more easily than older rigs. This is the latest bifurcation in the market with new rigs having strong utilization rates and older rigs (particularly 30+ years) having a hard time finding work and in many cases being scrapped by rig owners. Seadrill has the youngest fleet in the industry so this plays in its favor in a big way and is why Seadrill is profitable in a highly competitive time for the industry.
Short-term, rig demand is down because oil and gas companies have reduced capital expenditure budgets. Multi-billion dollar bets are tough to make when returns are falling and oil prices aren't rising. But long-term, more than half of the new oil reserves found last year were in ultra-deepwater and more than three quarters were offshore. This plays into rig owners' hands if they can get through the rough patch in the industry right now.
High risk, but a huge opportunity
While Seadrill is well positioned in the offshore drilling market, the stock doesn't come without risk and that's the reason the market is selling off. There's uncertainty with the Rosneft deal, and it's unknown exactly why one of John Fredriksen's key advisors left. There's also $12.3 billion in debt hanging over the company's operations that's a worry, especially when management is spending billions each year on the dividend.
But no one knows Seadrill's business better than John Fredriksen and if he's buying millions of dollars in shares now I think the risk is likely overestimated by the market. That presents a buying opportunity for investors, and with a dividend yield of over 14% and a forward P/E ratio of just over 8, this is a stock has high potential written all over it -- if you can handle the risk.
Travis Hoium manages an account that owns shares of Seadrill. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. 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.