Original Recommendation

AeroVironment

AeroVironment (AVAV)

our opinion

hold

current price

$77.37

target price

$96.00

market cap

$1.8B

div yield

0.00%

  • AeroVironment represents over 86 percent of the U.S. Department of Defense's drone inventory.
  • Revenue for the first nine months of fiscal 2018 grew 30% year-over-year.
  • A joint venture with SoftBank could result in a massive windfall for the company.

trade details

The cost and casualties of war can be tremendous. The United States along with much of the world has realized that “Boots on the Ground” is not the best option. The future of warfare is unmanned systems – specifically drones.

In 2018 the U.S. government allocated only $6.97 billion for unmanned aircraft. In 2019, that number jumped to $9.39 billion. This budget includes funding for the procurement of 3,447 new air, ground, and sea drones.

That’s roughly a 3X year-over-year increase in unmanned aircraft demand from the United States. There’s clearly a growing demand for military-grade drones and, according to research firm William Blair, the U.S. is expected to grow its drone investments by 15% annually over the next five years.

The company likely to benefit the most from this increased demand isn’t Raytheon, Northrop Grumman or Lockheed Martin. It’s a lesser-known company called AeroVironment.

Company History
AeroVironment was founded by Paul MacCready in 1977. They were the pioneers in building solar airplanes, and quickly became the leader in building drones as early as the 1980’s.

The company wasn’t always a pure play on drones. In 2018, the company sold off its efficient energy systems (EES) division. The charging station technology used for electric vehicles was sold to Germany’s Webasto for $35 million. This has allowed the company to focus solely on developing its drone technology.

Their drone technology is nothing short of incredible. We recommend that you take a look at their Wikipedia Page to learn more about their unmanned aircraft projects.

What We Love
The company is now focused solely on manufacturing drones. AeroVironment represents over 86 percent of the U.S. Department of Defense’s drone inventory. They’re also revolutionizing the way drones are used in non-military applications.

On January 3, 2018, AeroVironment announced a joint venture with SoftBank where it will “design and develop solar-powered high-altitude unmanned aircraft and ground control stations”. In layman’s terms, AeroVironment is building a stratospheric airplane that is powered entirely by solar power.

Why is this important? The join venture is attempting to use these drones to deliver 5G internet connectivity to the entire world. The size of this market is massive if they succeed. It would completely revolutionize the way our devices connect to the Internet.

While AeroVironment only retained a 5% share of the joint venture, they stand to benefit from the manufacturing of these drones. The windfall would be massive. In the third quarter, AeroVironment announced the joint venture was valued at $100 million, but through the joint venture the company received a $65 million contract to demonstrate the High-Altitude Pseudo-Satellite, or HAPS. If successful, more contracts from the joint venture will be awarded to AeroVironment.

While the aforementioned project is still very speculative, shareholders can always rely on their consistent, growing drone business. In early 2018, funded backlog was $123.5 million compared to $78.0 million as of April 30, 2017. Their backlog will continue to expand in coming years as drones for commercial and military purposes continues to grow.

Lastly, AeroVironment is a perfect takeover candidate. Consistent growth, best-in-class technology and engineering talent, and a clean balance sheet. We expect one of the larger defense companies to scoop up AeroVironment in the coming years.

The Concerns
AeroVironment is unlikely to have explosive revenue or earnings growth in the near future. Many companies that we recommend are doubling revenue, tripling net income, and in the early stages of experiencing dramatic multi-year growth. AeroVironment is likely to grow at a stable 15 to 20 percent per year – for many years to come. This likely means slow, consistent gains for our portfolio.

After selling off its Efficient Energy Systems (EES) segment, the company’s revenue will likely be reduced by approximately $5 million annually. This is fully reflected in the company’s annual estimate of $290 million top line revenue. It’s worth mentioning but hardly a concern.

Financial Health
AeroVironment has beat earnings estimates seven out of the last eight quarters. We expect another earnings beat again when the company reports on March 7th. The company is also reaping the rewards of The Tax Relief and Jobs Act of 2017, which has effectively reduced their tax rate and boosted their EPS.

Revenue for the first nine months of fiscal 2018 was $181.5 million, an increase of 30% from the first nine months’ fiscal 2017 revenue of $139.5 million. This is exceptional growth for a mature company (they’ve been in business for 40+ years). Gross profit for the first nine months of fiscal 2018 was $63.2 million, an increase of 46% from the first nine months’ fiscal 2017 gross profit of $43.5 million.

The company has absolutely no debt on its books.

Trade Recommendation
We recommend taking a half position between $75 and $80. For example, if you are comfortable holding 200 shares in your portfolio, buy 100 shares between our current price range. If shares pull back below $75 we will instruct you when to buy the remaining 100 shares.

We recommend adding a protective stop of $64/share.