Commercial Drone Adoption Taking Flight

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Includes: AMBA, AMZN, PAOTF, SNE, UAVS
by: ClearBridge Investments

Summary

The accelerating use of drones is part of a larger trend toward automation that includes advanced robotics and self-driving cars.

We believe the first business applications for drones will occur in logistics and automation in factory and warehouse settings.

Given the growing market, UAVs are drawing increasing interest from investors, and venture capital firms continue to pour funding into drone-related startups.

By Grace Su

Drones will top the wish lists of many children and hobbyists this holiday season. As technology continues to improve and costs come down, however, the much greater potential for drones should be realized in commercial applications. We expect drones will gain widespread business adoption in the next three to five years.

The accelerating use of drones is part of a larger trend toward automation that includes advanced robotics and self-driving cars. Also known as unmanned aerial vehicles ((UAVs), drones are evolving from models aimed at consumers to more sophisticated uses.

Consumer drones are typically priced under $1,000 with limited battery life, standard image resolution and basic software for flight control. China is currently the largest end market for consumer drones, though popularity is strong globally. Industry leader DJI disclosed that it sold over a million drones just in the last year.

The next step up is the "pro-sumer" market that is being driven by the growing use of video in social media and other applications. Here, photographers, videographers and other visually-driven professionals like real estate agents are purchasing drones in the $1,000 to $3,000 range that feature higher definition cameras with faster speeds, longer battery life and better image stabilization.

Beyond $3,000 lies the commercial market. Amazon.com (NASDAQ:AMZN) has drawn attention for its test deliveries using drones, and we believe the first business applications for drones will occur in logistics and automation in factory and warehouse settings, as well as for video capture.

Additionally, some companies in Japan already employ drones for crop spraying, and the technology is well-suited for other agricultural uses, such as taking images of crops and monitoring progression through the growing season. Drones could also be deployed for surveillance, industrial inspection, scientific measurement and research as well as marine applications. These areas are why we think the commercial market for drones could be orders of magnitude greater than today. Estimates by Macquarie Research peg the addressable market growing by over 50% annually to $60 billion by 2020, from under $10 billion for 2016.

The main headwinds to widespread UAV adoption are regulatory. As usage increases, governments will have to define safety and privacy standards. Rules have yet to be written on how far and how high can drones can fly, and different regulations will be applied at the local, country and even international levels.

Investor Interest Picking Up

Given the large and growing market, UAVs are drawing increasing interest from investors, and venture capital firms continue to pour funding into drone-related startups. Technological disruption is one of the themes guiding our research efforts, and we have identified several companies whose outlook is directly tied to the growing adoption of drones.

Sony (NYSE:SNE) is the largest producer of image sensors in the world. These sensors go into the cameras that are mounted on drones and represent one of the main growth drivers for the company.

Ambarella (NASDAQ:AMBA) makes image processing semiconductors that provide high resolution image capture with low power consumption. The Silicon Valley company got its start as a component supplier for GoPro (NASDAQ:GPRO) cameras and currently supplies image processors to many of the top Chinese drone manufacturers.

Parrot (OTCPK:PAOTF) (EPA:PARRO) is the No. 2 maker of consumer drones. The French firm has been conducting R&D for over 10 years and in addition to its consumer business, has developed industry-specific commercial applications for mapping, agriculture and inspection.

Drone makers are now moving beyond basic hardware manufacturing into software and applications that help make use of the data captured by drones. We believe that companies that own the entire ecosystem (hardware plus software) will be the real winners as this market takes off.

Disclosure: I am/we are long AMZN, SNE, AMBA, PARRO.

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.

Additional disclosure: All opinions and data included in this commentary are as of December 8, 2016 and are subject to change. The opinions and views expressed herein are of Grace Su and may differ from other analysts, or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments nor its information providers are responsible for any damages or losses arising from any use of this information.

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