The UAV Industry's Winners and Losers in the 2015 Defense Department Budget

Some drones are hot, some are not... find out which caught the eye of the DoD.

May 18, 2014 at 5:35PM

The Shadow 200 is one of the few UAVs that received an increase in procurement funding in the DOD's 2015 budget. Photo: Wiki Commons

Unmanned Aerial Vehicles, or UAVs, have emerged as the largest growth industry in the global aerospace industry, with worldwide expenditures projected to reach $89 billion by 2025. However, with the commercial use of drones awaiting Federal Aviation Administration regulations, and considering that export licenses are difficult to obtain, U.S. companies remain dependent on government contracts to fuel their contributions to the UAV industry's growth. The budget cuts imposed on the Department of Defense by the Bipartisan Budget Control Act of 2013 are making those government contracts harder to come by. DOD procurement expenditures for UAVs have decreased from $3.9 billion in 2013 to a requested $2.4 billion for 2015. The decrease in funding will hit some companies harder than others.

The road ahead
The grim reality of DOD funding for unmanned systems was spelled out in the December 2013 report "Unmanned Systems Integrated Roadmap FY2013-2038". Despite the rosy forecast for the global UAV industry and the prominence of U.S. companies in the market -- the privately held General Atomics currently holds 20.4% of the drone market, followed by Northrop Grumman's (NYSE:NOC) 18.9% -- the Defense Department was blunt in its report that it would not be a major player in the UAV industry's growth. The report states: "[A] comparison of DoD funding plans versus industry predictions indicates DoD will not be the bulk user within that market."

DOD expenditures on UAV acquisition will continue their downward spiral into the foreseeable future. Instead, the DOD plans to maximize the effectiveness of its current inventory of UAVs through maintenance and modifications. The shifting mission and focus of the department also has affected UAV procurement practices. As ground combat operations in Iraq and Afghanistan grind to a halt, the DOD has an increased need for UAVs capable of operating in inaccessible areas for intelligence, surveillance, and reconnaissance missions. The shifting DOD priorities are evident in Secretary of Defense Chuck Hagel's 2015 budget request. Some companies continue to feast on government contracts with products in line with projected national security needs, while others get a taste of famine.

What's hot and what's not
Unmanned systems are not limited to the air; however, UAVs receive the bulk of research and development and procurement contracts from the U.S. Government. General Atomics' MQ-1 Predator and MQ-9 Reaper have long been the military's iconic drones and the center of the controversy surrounding President Obama's drone policy. The UAVs are designed for hunter-killer operations and combine intelligence, surveillance, and reconnaissance capabilities with missile payloads capable of striking targets.

General Atomics' Predators and Reapers, however, are losing their status. DOD contracts for MQ-9 Reaper procurement fell from $979 million in 2013 to $411 million for 2015. Predator procurement was reduced from $28 million in 2013 to $5 million for 2015. AeroVironment's (NASDAQ:AVAV) RQ-11 Raven, a portable UAV capable of reconnaissance, surveillance, and target identification, were also a favorite for combat operations in Iraq and Afghanistan. The Raven, however, took an enormous hit in 2015. Procurement contracts for the compact drone dropped from $30 million in 2013 to $13 million for 2015.

Despite the dramatic decrease in overall funding for UAVs, funding for some unmanned aerial systems increased. High-altitude, long-endurance drones designed specifically for intelligence, surveillance, and reconnaissance missions continued to reap the rewards of research and development and procurement contracts. Northrop Grumman's RQ-4 Global Hawk, capable of surveying 40,000 square miles a day, saw a reduction in procurement funding from the U.S. Air Force -- funding dropped from $136 million in 2013 to $76 million for 2015. However, research and development funding increased from $240 million in 2013 to $244 million for 2015 -- an indication that the Global Hawk is being prepped for future procurement contracts.

The RQ-7 Shadow, produced by the AAI Corporation, a subsidiary of Textron (NYSE:TXT), saw the largest increase in procurement funding in 2015. The Shadow has emerged as the favored tactical UAV of the U.S. Army; it has a range of 68 miles and a flight time of nine hours. Procurement for the Shadow skyrocketed from $73 million in 2013 to $128 million for 2015. Insitu, a Boeing (NYSE:BA) subsidiary, also, produced a winning product. Procurement for Insitu's RQ-21 Blackjack, a small, lightweight, tactical UAV capable of launching from land or sea, saw a dramatic increase -- from $14 million in 2013 to $71 million for 2015.

Government contractors will take a hit in 2015 with the mandated reduction in Defense Department spending. In the UAV industry, however, those cuts will not be felt equally.

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Abigail W. Adams has no position in any stocks mentioned. The Motley Fool recommends AeroVironment. The Motley Fool owns shares of AeroVironment, Northrop Grumman, and Textron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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