Earlier this year, the Department of Defense unveiled their Unmanned Systems Integrated Roadmap, laying out their plans for the future of a changing military. As budgetary challenges and changing threats are forcing the U.S. Defense Department to search for new advancements, the need for new, adaptable, and cost effective measures are driving many companies to look to unmanned systems, most commonly known as drones, to fit the military's changing needs. With unmanned aerial systems having already been budgeted $21.6 billion through 2018, and a total unmanned systems budget of $23.8 billion, this market does not include the possibilities of further investment from the $46.5 billion this year alone under the National Intelligence budget, from which the CIA and the NSA draw their funding.
Combining the rise in global crisis points from Afghanistan to Ukraine and the Chinese-Japanese border -- and the increased international cooperation in responding to these threats -- experts believe that this market for unmanned systems will double over the next 10 years to $89 billion globally. One company has already established itself as a leader in the UAV market and looks to make amazing strides going forward.
AreoVironment - The Biggest Small Company in Drones
AeroVironment (NASDAQ: AVAV) has made huge strides in this market, having already produced 86% of the Department of Defense's unmanned aircrafts. The Unmanned Aerial Systems division, the company's biggest revenue producer, made up 81% of the company's revenue in FY 2014 and produced compound annual growth rates of 23% from 2002 to 2013. With the development, implementation and training of warfighters on such products such as the Raven unmanned drone, a 4.2-pound hand launched reconnaissance drone capable of line-of-sight 10 kilometer vision, and the Switchblade tactical missile system, a backpack transportable UAV missile targeting system, the company has adapted itself to become a the leading provider of small reconnaissance UAVs.
Unlike its high profile cousins, the Predator drone built by General Atomics for offensive capacity and surgical strikes, these systems are designed to be purchased en mass to support frontline forces and provide greater intelligence on the battlefield. This subtle difference means that while AeroVironment may not win contracts for long range offensive capabilities, any situation that require lives placed directly in harms way will provide new opportunities for the company to grow.
Having recently ended FY 2014, the company posted revenues of $251.7 million, a 5% increase over the $240.2 million from 2013, with an increase in the UAS (unmanned aerial systems) division of $14.5 million. FY 2014 Q4 earnings beat Wall St. consensus estimates by 36%, with the company earning $73.5 million over the expected $69.6 million. However, it is still significantly below the company's high of $325 million in FY 2012, and still has yet to return to its FY 2011 revenues of $292 million. With a PEG ratio of 9.54 and a P/E ratio of 53.38, these numbers may suggest a company overvalued and looking at subtle growth.
While these are reasons for investors to begin wondering if this is the company for their portfolio, the potential this company has outweighs the negatives it currently shows. First, the company's market cap is only $724 million, making it an industry underdog compared to larger competitors like Boeing (NYSE:BA) or Northrop Grumman (NYSE:NOC). However, this is a company that has provided 86% of unmanned drones to the Department of Defense and continues to receive more and more orders like the $37 million in new Switchblade orders in 2013, making it an underdog with well-established product lines and the ability to continuously win repeat business with its current products.
Second, unlike many of its larger competitors, the company's research and development is all done in-house as opposed to through acquisitions, meaning that the company can reinvest its earnings into the business and does not have to worry about reducing its cash position or diluting its equity by offering new shares to finance acquisitions. Finally, the company has already started to sell its current product lines to civilian companies, such as BP in Alaska, allowing the company the ability to offset government cutbacks and use that revenue to continue its military R&D. Combined with a $65.9 million backlog, the company upped its FY 2015 earnings expectations to between $250 and $270 million and target operating revenues between 34% and 37%.
Unlike many of its bigger competitors in the aerospace and defense segment, AeroVironment provides the best pure play for capitalizing on the UAV market. While competitors in the unmanned system market like Textron (NYSE:TXT) and Boeing are also growing their unmanned systems divisions, they still comprise significantly less as a percentage of total revenue, subjecting their financials to the fluctuations of their other divisions. With its primary revenues derived and research and development devoted to unmanned systems, AeroVironment seems to be the best pure play for capitalizing on the growth of the unmanned systems trend. This may not be a "get rich quick" stock, but it has the potential to be a long-term winner.
Unmanned systems look to be the major growth sector for defense contractors, and for investors looking to maximize their investment in a changing defense environment. The emergence of increased unconventional threats to global security, combined with reductions in defense spending, will make the emergence of unmanned systems a new staple of military operations over the next 30 years. AeroVironment seems to be developing the most innovative products and providing great growth opportunities for investors. While there still may be some short-term pain when investing in this industry, the long-term growth potential could be tremendous.
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