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AeroVironment (AVAV): A Small Military Drone Stock

In a previous article, we talked about how drones fall into two different categories; defense-related drones and consumer/commercial drones. One of these components provides exposure to the defense industry while the other component is a new high growth “sector” that has taken off recently with drones being used commonly now for filming and if Amazon has its way, for home delivery as well. While we’re more excited about the growth potential of consumer/commercial drones, we can’t discount the potential for growth in defense drones, especially the smaller ones. Just yesterday, ABC News stated that the Pentagon is planning to increase its use of drones by about 50 percent over the next several years. Aside from the usual “large defense company” suspects like Lockheed Martin, are there any companies that give us pure-play exposure to military drones? One company worth taking a look at is AeroVironment, Inc. (NASDAQ:AVAV).

Click for company website

AeroVironment (AVAV) was founded in 1971 by serial innovator Dr. Paul MacCready, the creator of the world’s first human-powered airplane. AVAV has established numerous world records over the years and has 7  of its breakthrough vehicles in the Smithsonian Institution. The Company developed the first hand-launched small drone for military reconnaissance in 1987 and since then has become the largest supplier of small drones to the U.S. military. By July 2011, AVAV had provided 85% of all the unmanned aircraft in the United States Department of Defense inventory. In addition to drones, AVAV also offers electric vehicle charging solutions which only constituted 15% of 2015 sales, a proportion that has been consistently declining over time. 45% of AVAV’s sales in 2015 were to the U.S. Army while an additional 35% of sales were from other agencies of the U.S. government.

While large drones like the Predator (General Atomics) and the Sentinel (Lockheed Martin) have been in use for a long time now, smaller hand-launched drones are becoming more a part of tactical warfare, especially scouting. AVAV specializes in these types of small drones, ones that can be launched by one or two persons without the need for an airstrip. The Company’s drones are very small, with offerings such as the 2.85-pound Wasp™ AE, 13-pound Puma™ AE or the 4.8-pound Raven® which can fly for up to 90 minutes. The miniaturization of drones is a key factor driving the growth in the civilian drone space, a target market which AVAV is also looking to address. Revenues over time for AVAV have been showing consistent growth, yet fell 26% between 2012 and 2013 due to decreased sales of their drones and decreased service revenues which were related to retrofitting existing drones:

AVAV_Revenues

While growth in revenues may be recovering, profitability is on a downward trend for AVAV with margins declining over time. This is partially a result of their heavy R&D spending which constituted 18% of revenue ($46.5 million) for fiscal 2015. Still, with all the planned growth for drones, investing in AVAV is a no brainer right? Not necessarily. The stock has not performed well, even in the face of the serious growth opportunity that drones present. If you would have bought AVAV at the time of their IPO in 2007, you’d be up just over +10% today:

AVAV_Stock_Performance

Had you invested in a far less risky S&P tracker fund, your investment would be up +47% over the same time frame. However past performance is no indicator of future results. Small drones are what have been driving the growth in the commercial/consumer sector and AVAV is one way to play this. Teal Group’s 2014 market study estimates that UAV spending will nearly double over the next decade from current worldwide UAV expenditures of $6.4 –  $11.5 billion annually, to almost $91 billion in the next ten years. This massive growth should benefit companies like AVAV who are building the small drones that will drive this growth both in military and civil applications.

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