It’s Time To Buy This Out-Of-Favor Stock

We are a nation of drivers. The U.S. Bureau of Transportation says that the United States is home to nearly 272.5 million cars, almost a million buses and more than 12 million trucks.

As drivers and investors, our attention is turning to the future of self-driving cars and on the progress and setbacks that autonomous driving research encounters. But the drive to create a fully autonomous car — and all the investor attention that these efforts enthuse — should not detract us from the progress achieved in other areas of transportation technology.

One such area concerns unmanned aerial vehicles (UAVs) — also known as drones. While drones as a group are not autonomous in the full sense of the word, these helicopters or planes have no human pilots and are controlled by onboard computers or by a pilot on the ground via remote control.

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The idea is not new: as far back as World War I, Elmer Ambrose Sperry, the inventor of the gyroscope, was hired by the Navy and tasked to develop air torpedoes — unmanned biplanes designed to fly over an enemy position. The first drones, too, were used by the military for target practice. 

drone photoAs is often the case, this military technology (and it’s the military applications of drones that prevail in the UAV market) has resulted in the development of civilian drones and their numerous civilian applications. (The global positioning system (GPS) is another example of a military project that went civilian – much to the benefit of us all.)

We all know adults and even children fly drones for fun. And we’ve heard that large online retailers such as Amazon (Nasdaq: AMZN) are working on using the technology for package delivery. But there is even more to this. Today, drones can be found and used almost everywhere — from wheat fields to police departments to oil, gas and geological surveying to engineering to disaster management to telecommunications. 

The UAV market, which used to be all about the military, has been changing fast.

The global commercial drone market was valued at $5.8 billion, with an estimated 274.6 thousand units sold, in 2018, up sharply in just four years (from $450 million in 2014) and is expected to continue its outsized growth for the next few years.
Fortunately for us, a leading drone company is in a position to benefit from these changes: AeroVironment (Nasdaq: AVAV). 

The Case For AVAV
AeroVironment designs, develops, produces, supports and operates a portfolio of drone-related products and services for government agencies and businesses.

Just like the market for drones is still primarily military-focused, the majority of AVAV business is military, and most of its revenue is generated by the U.S. Department of Defense. 

However, AVAV is not all about DoD — almost half of the company’s total revenue is generated by foreign, commercial and consumer customers. Of course, a big part of the foreign government demand is also military, but the good news here is that AVAV isn’t overly dependent on Department of Defense business. Moreover, as demand from businesses and consumers grow, so will AVAV’s revenue and profits.

Also, consider this: creating and operating truly unmanned systems is impossible without advances in robotics — which is also AVAV’s strength. The company, in fact, is uniquely positioned as a technology provider at the intersection of several existing and up-and-coming technologies — drones, robotics, sensors, software, and connectivity.

The innovations developed by AVAV over the years include the world’s first effective human-powered and manned solar-powered airplanes; the first modern passenger electric car, the EV1 prototype for General Motors; Global Observer, the world’s first liquid hydrogen-fueled unmanned aircraft system, the Nano Hummingbird, the world’s first flapping-wing drone, and more. 

With more than 200 U.S. patents issued and a few dozen patent applications pending, AVAV is likely to remain a leader in unmanned technology.

Inside The Numbers
You would not think that this profitable company is one of the leaders in a growing market, though, by looking at AVAV price chart: year-to-date, its share price is down 25% versus the 14% rally in the S&P 500.

AVAV chart

Tame guidance is mostly to blame here. But I think the numbers don’t justify a NEARLY 40-point underperformance. At current levels, the stock presents a low risk/high reward opportunity.

Let’s look at the recent growth numbers first. For fiscal 2019, a year ended April 30 and reported on June 25, AVAV delivered $314.3 million in revenue, 17% more than a year ago. A stronger gross margin (up from 39% in 2018 to 40% in 2019) and higher revenue have resulted in higher income from continuing operations, too – to $33.8 million in fiscal 2019, an 11% increase from the previous year.

AVAV’s fiscal 2020 forecast didn’t point to strong growth — hence the share-price weakness. But the numbers aren’t bad, either: For fiscal 2020, the company said it expects earnings per share of between $1.35 and $1.55 on revenue of $350 million to $370 million. 

Action To Take
The market, which expected stronger guidance, has overreacted, creating an opportunity for long-term investors. However, because the persistent share-price weakness over the past year could indicate some sort of deep-seated problem, I would be cautiously bullish on this stock. Keep a close eye on the company, on the industry developments, and on AVAV’s ability to grow its non-military business.

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