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A Precision Investment Strike

By John Persinos on April 12, 2013

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The unmanned aerial vehicle (UAV) is revolutionizing the projection of power around the world. Despite Pentagon belt-tightening, certain programs beloved of military strategists will emerge largely unscathed—and UAV procurement is one of them.

Although often portrayed by his opponents as soft on defense, President Obama has shown a hearty willingness to deploy “hunter-killer” drones in combat theaters overseas and his administration continually proposes big hikes in UAV spending.

Meanwhile, a “drone caucus” has emerged in the halls of Congress that fiercely protects UAV funding and touts these futuristic aircraft as a way to help save money on defense, protect the lives of US soldiers, better patrol America’s borders, and assist law enforcement agencies in surveillance.

All of these trends make AeroVironment (NASDAQ: AVAV), the leading manufacturer of UAVs, a good bet now on the boom in pilotless drones.

This California-based company boasts a pipeline stuffed with innovative products that the military brass covets, but the stock is now attractively valued because of a dip in the previous quarter’s sales. This setback has more to do with Washington’s budgetary legerdemain than with long-term demand.

Case in point: On April 10, AeroVironment announced that the US Army has released $13.8 million in incremental funding to pay for additional units of the company’s RQ-11B Raven UAV. The Pentagon has awarded the company a total of $65.5 million to produce UAVs this year for the Army and the money is now getting shaken loose.

The Raven is a 4.5-pound UAV that’s carried in a soldier’s backpack and launched by throwing into the air. The device wirelessly sends day and night real-time video imagery back to a ground controller for battlefield reconnaissance.

UAVs have become a ubiquitous feature on the 21st century battlefield, since combat operations were launched in Iraq and Afghanistan in 2001. By that year, the US armed forces had started to deploy a wide variety of UAVs, with the Air Force in the forefront.

The Predator drone, made by the private company General Atomics, has become synonymous with UAVs in the popular imagination. However, AeroVironment offers the broadest array of UAV products than any of its competitors, especially ultra-sophisticated drones predicated on nanotechnology.

The company’s UAVs provide a range of military and civilian functions and feature such evocative names as Raven, Wasp, Puma and Switchblade. The company also makes systems for cleaner, more efficient transportation and energy production.

AeroVironment commands 30.82 percent of the world’s unit production of UAVs, giving it the biggest market share by far of any UAV manufacturer. By contrast, the maker of the storied Predator drone—General Atomics—only holds a 7.24 percent share.

Dynamic Growth


UAVs are the most dynamic growth sector of the aerospace industry. According to a new study from Teal Group, an aerospace consultancy based in Fairfax, Virginia, the worldwide UAV market will nearly double over the next decade—from $6.6 billion in research, development, test and evaluation (RDT&E) and procurement expenditures in 2103, to about $11.4 billion in 2022 (see chart, below).



Source: Teal Group

The biggest catalyst for this global growth is enormous demand for UAVs by the US military, stemming from operations in Iraq and Afghanistan, as well as the trend towards information warfare and net-centric systems.

UAVs are a crucial component in the emergence of intelligence, surveillance, and reconnaissance (ISR). They’ve also expanded beyond ISR and into combat missions, with the advent of the Hellfire missile-firing UAVs that regularly make the news.

While the Clinton administration in the 1990s preferred the use of Tomahawk cruise missiles to extend the global reach of military force, the George W. Bush and Obama administrations have decisively shifted in favor of hunter-killer UAVs.

According to Teal Group’s study, the US will account for 62 percent of all RDT&E spending on UAV technology over the next decade, and about 55 percent of the procurement. However, the study also expects the Asia-Pacific region to represent a growing segment of UAV demand, as countries there become increasingly affluent and militarily assertive.

Teal Group also predicts that a significant civilian UAV market will emerge, as increasing numbers of federal organizations such as the Coast Guard, Border Patrol and even the Forestry Service require airborne surveillance and monitoring systems. This forecast assumes, however, that FAA standards for airspace access will be formalized and less restrictive, which is not a foregone conclusion.

These trends present AeroVironment with enormous growth prospects, but the company’s stock sports a trailing 12-month price-to-earnings (P/E) ratio of only 14.3, which compares favorably to the P/E of 16.2 for its peers in the aerospace and defense sector.

The culprit for the low valuation is the company’s most recent earnings report, which disappointed investors. In March, AeroVironment reported that revenue for the third quarter of its fiscal 2013 was $47.1 million, down $24.9 million from third quarter fiscal 2012 revenue of $72 million.

Third-quarter earnings were $3.9 million, a decrease of $1.8 million from earnings in the same period a year ago. Earnings per share (EPS) for the third quarter were $0.17, a decrease of $0.09 from EPS of $0.26 in the same year-ago quarter.

Analysts’ negative sentiment is forgetting that defense procurement is convoluted and often generates short-lived postponements. As was evident during the fiscal cliff and sequestration slugfests in Congress, military budgets must endure protracted bureaucratic gauntlets but they rarely get drastically cut.

AeroVironment’s revenue shortfalls in the third quarter represent delays in order timing—not lost orders. Accordingly, the company has recalibrated its expectations for the remainder of 2013 and full-year 2014 and expects demand for its UAVs to significantly increase in future months.

Now’s the time for investors to strike, while this major UAV player flies under the radar at bargain levels.

What did you think of this article? Please post your comments below.


John Persinos is managing director of Personal Finance and its parent website, Investing Daily.

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