By Michael Vodicka
The U.S. military has been the largest investor in drones since the industry got its start 15 years ago.
While U.S. military drone spending will continue growing, a recent regulatory breakthrough from the Federal Aviation Association (FAA) sets the stage for commercial drone sales to eclipse military spending and become one of the fastest growing industries in the world in the next five years.
A Regulatory Breakthrough Sets The Stage For Massive Commercial Drone Demand
The commercial drone industry scored a big win in late August. That was the day the Federal Aviation Association opened up the skies to commercial drones.
The FAA ruling allows for small commercial drones to operate during daylight and below 400 feet.
That alone is a regulatory breakthrough for the commercial drone industry. But the FAA also recently loosened its restriction on commercial drone pilots.
Before, a commercial drone pilot needed an actual pilot license. Now, commercial drone pilots will only be required to pass a test that costs $150.
These key regulatory adjustments clear the path for the most powerful S&P 500 companies to invest billions of dollars into their commercial drone programs.
In fact, it's already happening.
Amazon (NASDAQ:AMZN) is testing Amazon Prime Air, its system to use drones to fulfill local deliveries in Canada, the UK and the Netherlands. Now that the FAA has opened up the U.S. skies to commercial drones, Amazon hopes to fully launch Prime Air in the United States in 2017 or 2018.
The cost savings of Amazon's drone program are astronomical. According to Deutsche Bank, this is how the cost of using drones to deliver a shoebox-sized package compares to more traditional methods:
- Premium ground like UPS or FedEx: $6 to $6.50
- Mid-tier carriers like OnTrac: $4 to $5
- USPS for last mile alone: about $2
- Robots/drones: Less than $0.05 per mile of delivery
These cost savings are the reason commercial drones are expected to be one of the fastest growing industries in the world in the next five years.
A recent report from consulting firm PriceWaterhouseCoopers predicts that the global market for commercial applications will grow to $127 billion by 2020 from just $2 billion today.
Not only is the military drone market growing slower than the commercial drone market, these companies are so large that even mega growth in their drone divisions isn't enough to have a material impact on earnings.
A better way to invest in drones is with my favorite 'pick and shovel' company operating on the commercial side of the drone industry.
The reason I like Ambarella is because it's a pick and shovel play on the drone industry, selling components to the companies that build drones as opposed to actually building them in-house.
That makes the company a broad play on the drone industry, and a direct play on the FAA's recent regulatory breakthroughs.
Ambarella has already had an incredible run. Shares are up 943% in the last five years. Take a look at the chart below.
However, this is the best time to invest in the past two years.
Ambarella recently fell 50% from its all-time high. More importantly, its forward P/E ratio of 24 is a 45% discount from its all-time high in 2015.
Looking forward, Ambarella is on a clear upward trajectory. Analysts are projecting 40% earnings growth to $2.16 per share next year.
Risks To Consider: Expectations for the commercial drone industry is running high. That shows up in the high valuation of many of the early industry leaders. Stocks with higher valuation can take a beating if they fall short of lofty short-term expectations.
Ambarella is a global leader supplying HD video chips to the commercial drone industry. Although Ambarella is far from a value stock, its forward P/E ratio of 24 is more than a 45% discount to its all-time high. I am expecting shares to beat the S&P 500 in the next three to five years. In the short run, look to buy under $70.
This article was originally posted on StreetAuthority.com.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.