A Small-Cap Play on Amazon’s Sky-High Ambitions

How’s this for gee-whiz gadgetry right out of science fiction, or perhaps James Bond: Amazon (NSDQ: AMZN) this week was awarded a U.S. patent for a shipping label with a built-in parachute.

This innovative device allows drones to deliver a package without having to land — the package safely descends to the ground via parachute, making the delivery process faster, cheaper and more efficient.

The shipping label looks just like any other label until it’s triggered into action. The cords, breakaway cover and parachute all lie dormant, waiting for sensors to indicate that the drone is hovering over its destination.

GPS navigates the package to the right destination, shock absorbers protect against a potentially rough landing, and a harness keeps the entire apparatus together. Amazon has been working to perfect the technology since the patent was first submitted in 2015.

It’s like something I used to marvel at as a kid, when reading Popular Mechanics. What’s the best play on this “disruptive” technology? It’s not necessarily Amazon itself. I provide the answer below, but first let’s turn to Linda McDonough, chief investment strategist of Profit Catalyst Alert, for context on Amazon’s technology breakthroughs:

“It’s no secret why Amazon’s stock has increased almost 500 times since its IPO. Bezos’ relentless drive for constant innovation allows the company to create new markets and therefore new demand. Amazon has birthed new products and services before anyone else. And in a world where competition is so ruthless, this has allowed the e-commerce juggernaut to quickly gain scale…

Certainly, investors can jump on board Amazon’s stock to ride Bezos’ innovation train. But with Amazon’s $15 billion of cash on hand and an annual operating budget of $136 billion, the Holy Grail for investors is to find those small customers that have been chosen to help Amazon reach its goals and to buy those stocks…

As always, the trick is to find high-quality companies that can survive if a big customer like Amazon turns tail but will rocket if it gains a fraction of its spending budget. It’s worth the digging to find companies that can leverage the genius of Amazon.”

Well, as my colleague Linda suggests, I’ve done the digging. Read on.

Why is this man laughing?

Jeff Bezos, the founder, CEO, president and chairman of Amazon, prides himself on being a “disruptor.”

His company has disrupted the way books are sold, published, and consumed, the way market share is captured, and the way customers around the world shop for physical goods. Bezos’ affect on the development of global e-commerce can’t be understated. He laughs at the status quo.

Bezos drop-kicked a highly paid job as a Wall Street analyst in 1994, after seeing projections that online commerce would grow for the rest of that decade at the remarkable annualized rate of 2,300%.

Bezos formed a business plan to create an online commerce store with the ambitious goal “to sell everything, to everybody.” Launched in 1995, Amazon has become the world’s largest online retailer, as well as a major global provider of web-based infrastructure and cloud computing services. Amazon’s market cap currently stands at $475.4 billion.

Amazon’s air force…

Now, Amazon is launching its own air force of unmanned aerial vehicles.

With Linda McDonough’s advice in mind about small-cap secondary plays, let’s take a look at AeroVironment (NSDQ: AVAV), the world’s largest designer and manufacturer of drones.

With a market valuation of $714 million, AeroVironment makes a broad spectrum of drones for both commercial and military applications. The Pentagon, worldwide militaries, and growing numbers of federal, state and local policing organizations are adopting AVAV’s drones for intelligence, surveillance, and reconnaissance. As Amazon’s foray into aviation shows, drones also are increasingly used in the commercial sector.

Amazon recently launched a test program of its drone delivery program, making Bezos’ oft-stated dream of home delivery by drone closer to reality. Bezos first shared his drone-delivery vision with the public during a now famous television interview in 2013 with Charlie Rose on 60 Minutes. The entrepreneur’s surprise announcement caused Rose’s jaw to drop.

Today, the idea isn’t so fanciful. Amazon operates a drone research and development facility near the town of Cambridge, U.K. Amazon also has been testing its drones in the U.S., Canada, and the Netherlands, as well as at several undisclosed locations.

Quantum leap in home delivery…

Bezos’ implementation of what the company calls “Amazon Prime Air” is a quantum leap for the company and e-commerce as a whole. It’s also a huge opportunity for drone-maker AeroVironment, which would be in line for major contracts once Amazon transitions from the experimental stage to actual drone procurement.

Amazon’s drones are designed to carry parcels weighing up to five pounds and to land them on a customer’s doorstep or drop them by parachute, even if the buyer isn’t home. To be sure, comprehensive drone delivery is liable to regulatory oversight, but the FAA and its foreign counterparts are starting to implement drone-friendly flight rules, thanks to intense lobbying from the drone industry and powerful people like Bezos.

Amazon’s drones are built to travel at speeds of 60 miles per hour or more, at altitudes of between 200 and 400 feet, well beneath the general aviation threshold. After initial skepticism, the FAA is becoming convinced that passenger aircraft and drones can safely coexist in the skies.

Drone delivery would save Amazon considerable money by reducing its fleet of trucks and airplanes; it would also revolutionize retailing and prompt its rivals to get into the drone game. Wal-Mart (NYSE: WMT) already is starting to test its own version of drone home delivery.

On the battlefield, too…

California-based AeroVironment boasts diversification, with a pipeline stuffed with well-engineered products that the military brass covets. Notably, the U.S. Army widely uses the company’s RQ-11B Raven, a 4.5-pound drone that’s carried in a soldier’s backpack and launched by throwing into the air (see picture).

The device wirelessly sends day and night real-time video imagery back to a ground controller for battlefield reconnaissance. The company also makes systems for cleaner, more efficient transportation and energy production.

AeroVironment won early fame as an aerospace innovator when it built NASA’s Gossamer Albatross, a human-powered aircraft that in June 1979 flew 23 miles across the English Channel. Founded in 1971, the company now commands the biggest market share by far of any drone manufacturer, making it one of the most promising small-cap technology stars of 2017 and beyond.

AVAV shares are up nearly 16% year to date; they’ve risen more than 19% over the past three months, as it becomes clearer that President Trump’s tough anti-terrorism stance will result in boosted procurement for drones.

The average analyst expectation is that AVAV’s year-over-year earnings growth will soar by a whopping 347.8% in the current quarter and by 68.6% in the next quarter.

The investment takeaway: As the drone industry stands on the cusp of explosive growth, now’s an opportune time to grab shares of AeroVironment, while it’s still a small-cap stock with room for significant upward trajectory. Amazon’s accelerating boost to overall drone demand is icing on the cake.

Another exciting possibility for investors is AeroVironment’s suitability as a takeover target, with possible suitors including Amazon or major aerospace/defense contractors such as Lockheed Martin (NYSE: LMT) or Boeing (NYSE: BA).

Lockheed Martin last week launched its experimental Vector Hawk, a small military drone for the U.S. Navy, from the ocean surface of the Narragansett Bay in Rhode Island. As a boy, I spent many pleasant summer afternoons sailing on Narragansett Bay; I never dreamed that those blue skies would one day be dotted with unmanned flying machines. As drones increasingly pervade all aspects of our everyday lives, AeroVironment is a stock to watch.

Got any comments? Parachute me an email: mailbag@investingdaily.com — John Persinos

Rapid change, rapid profits…

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