Drones Caused a Big Buzz at CES 2015: Is AeroVironment a Top Play?

by Ryan Fitzwater, Director of Research, The Oxford Club

Editorial Note: Drones are a hot-button issue for many people. But as Ryan explains below, this tech is on the verge of becoming a multibillion-dollar-a-year consumer industry. Our Chief Income Strategist, Marc Lichtenfeld, has been following this situation closely, as well as a slew of other innovations that could keep you profiting for decades. Click here to view his findings.

Every January since 1967, in the middle of the Nevada desert, enthusiastic technology junkies have gathered to marvel over what the future might hold.

This annual Vegas-based tech spectacle is called the International Consumer Electronics Show, better known as CES.

In the not-so-distant past, wonders such as the plasma television, Blu-ray Discs, webcams, and ground-breaking smartphones  captivated audiences. Today, those technologies are a part of everyone’s daily shuffle. They grab headlines only if a company discontinues the product or goes belly-up.

Of course, not all technologies promoted at CES live up to the momentary hype. Do you remember the nearly brick-sized “Microsoft watch” that Bill Gates debuted at CES 2003? (When I asked my colleagues that question, I got a room full of blank stares.)

Smartwatches are starting to take off now, but that relic from Microsoft’s (Nasdaq: MSFT) past still lays dead in the tech graveyard.

Which brings us to what took center stage at this year’s show...

The Drones Have Taken Over

Those who walked the floors of CES last week had to contend with the constant buzz of unmanned aerial vehicles, also known as drones.

For most, the word “drone” still brings images of military spying and destruction to mind. But the industry is eager to break through those perceptions by highlighting drones’ commercial and consumer uses.

Here are some commercial applications for drones that would save money and lives:

  • Dangerous Jobs: Forest fire surveillance, search and rescue missions, scientific research (ex. volcanos, tornadoes, hurricanes), gauging the potential damage of natural disasters for insurance companies.
  • Surveying Jobs: Power lines, rail roads, highways and oil pipelines. Mapping. Archaeological and geological surveys.
  • Agriculture Jobs: Crop fumigation to apply pesticides, fertilizers and water. Inspecting fields for soil problems and crop rotation.
  • Cinema and Television Production: Aerial camera shots, sports coverage (think winter sports like snowboarding and ski jumping).
  • For Consumers: Wedding photos, action selfies (think surfers, mountain climbers, snowboarders etc.), inspecting gutters and delivery services (both Google (Nasdaq: GOOG) and Amazon (Nasdaq: AMZN) have projects in the works).

As you can see, there are numerous non-military functions for drones. And this year’s CES helped bring that notion to the forefront.

One of the most talked-about drones at the show was Squadrone System’s Hexo+ auto-follow drone. Easily programmable from your smartphone, it autonomously tracks users and takes videos. (That sounds creepy but, again, think of the applications for film crews and athletes compiling highlight reels.) Added features include built-in cameras provided by GoPro (Nasdaq: GPRO).

Those inclined can pre-order the Hexo+ for a hefty price tag of $1,400.

Positioned for Growth

Based on this year’s CES, it’s clear commercial demand for drones is growing. The Consumer Electronics Association (CEA) predicts that consumer drone sales will reach $130 million in 2015, a 50% increase over last year’s sales. By 2018, the CEA projects sales of $1 billion.

But there is one big obstacle for this industry: The Federal Aviation Administration (FAA). They have yet to relax their policies and regulations toward commercial drone use. Right now, drone pilots are extremely limited in where they can fly and under what conditions and altitude. A permanent solution is still in the works.

But some 15 companies have already been granted approval by the FAA for commercial use in the U.S. AeroVironment (Nasdaq: AVAV) is one of those companies and is the focus of today’s Stock Grader.

Ready for Takeoff?

Based out of Monrovia, California, AeroVironment is an unmanned aircraft systems provider.

The company has made its “bread and butter” serving organizations in the U.S. Department of Defense. This includes the U.S. Army, Air Force, Marine Corps and Special Operations Command. Its most popular unmanned aircraft are its Raven, Wasp and Puma models.

AeroVironment is the top provider of drones to the Pentagon. The company has also begun providing drones to commercial and consumer customers. And with worries over declining military demand on the horizon, it is looking to grow these civilian segments.

Looking for New Customers

Qube is one of AeroVironment’s latest drone innovations. The drone system is designed specifically for law enforcement, fire fighters and first responders. The idea is to get humans out of harm’s way.

The company is also positioning its military recon drones for commercial applications. These applications are the same ones I mentioned above, covering everything from search and rescue to agriculture.

The question is: Will AeroVironment be able to break into the commercial sector as its military revenue slows down?

As you can see in the chart, AeroVironment’s stock performance has lagged its peers over the last 12 months. It really took a hit in November when it reported an earnings-per-share (EPS) loss of $0.13. That was its second quarter of earnings losses in a row.

Over the long term, the company appears well-positioned for the coming commercial and consumer drone transformation. But for now, the earnings upside in the short term looks bleak.

For the entire 2015 fiscal year, earnings are expected to remain flat. But in 2016 and 2017, they are projected to come in at $0.49 and $0.80 respectively.

So growth is projected down the road for both AeroVironment and the domestic drone market. But these earnings estimates and projections include a lot of unknowns.

Obtaining and retaining military contracts, fluctuations in government spending, changes in commercial and consumer demand, and FAA regulatory issues make our crystal ball super cloudy.

For now, let’s ditch the projections and see how AeroVironment performs on our Investment U Fundamental Factor Test. This will ground us in the present and allow us to look at the company from an objective fundamental perspective.

Earnings-per-Share (EPS) Growth: I already mentioned that AeroVironment’s earnings were negative in the last quarter. No year-over-year growth here.

Price-to-Earnings (P/E): Even with AeroVironment’s recent price drops, its P/E ratio of 39.09 is well above the industry average of 23.10. Very overpriced on an earnings basis.

Debt-to-Equity : A very positive note here: The company has no debt so its debt-to-equity ratio is 0.00%. The industry is averaging 66.77%. The boasts well for AeroVironment as it transitions from military to commercial sales.

Free Cash Flow per Share Growth : In the last quarter, AeroVironment saw negative free cash flow growth. It will continue to struggle in this area if sales stay stagnant or drop.

Profit Margins : The company’s profit margins over the last 12 months are 5.16%, slightly below the industry average of 5.33%. But close only works in horseshoes and hand grenades.

Return on Equity : Unfortunately AeroVironment closed out the last metric with another bad mark. Its ROE of 3.93% is well below the industry average of 22.09%.

While CES 2015 highlighted the potential growth in demand for commercial and consumer drones, that demand is not here yet. And while AeroVironment has plenty of wiggle room when it comes to its debt load, it is currently overpriced and is underperforming on other major metrics. Failing on five out of six fundamental metrics has earned it a sell rating.

*Why did we look at these specific metrics? Find out more here.

Fundamental Factor Test Score

F: Sell (One key metric or less)

Please note that our fundamental factor checklist is just the first step in performing your own due diligence. There are many other factors you should consider before investing. That’s why The Oxford Club offers over a dozen newsletters and trading advisories all aimed at helping investors grow and maintain their wealth. For more details, click here.

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