Is It Time to Buy AeroVironment Stock?

This expensive stock could look even pricier if it doesn't deliver on earnings in two weeks.

Aug 22, 2014 at 10:37AM

Unmanned aerial vehicle maker (and producer of Posicharge fast-charging systems for electric cars) AeroVironment (NASDAQ:AVAV) is scheduled to report fiscal Q1 2015 earnings after the market close on Monday, August 25 . With less than a week to go before earnings, investors are wondering: Is it better to buy AeroVironment stock ahead of earnings, or wait for the news to arrive before deciding?

As for me, I choose door number two.

AeroVironment's Raven small spy drone. Fly! Be free! Photo: Wikimedia Commons.

What came before
If it feels to you like AeroVironment just finished reporting earnings, and that earnings coming 'round again in just two weeks seems a little too quick -- don't worry. You're not wrong. In fact, AeroVironment just finished reporting earnings for Q4 of last fiscal year in July . (This isn't unusual. The past several years saw similarly quick turnarounds). And if this month's report is anything like last month's, investors could wind up very pleased indeed.

AeroVironment's Q4 report featured 36% revenue growth, a significant uptick in a year when full-year earnings grew only 5%. Q4 2013 losses were transformed into a profit, and for the full fiscal year, AeroVironment grew earnings by 32% -- with a nice gain in free cash flow to boot.

Where's AeroVironment at today?
Today, this leaves the stock trading for 53 times "GAAP" earnings and 33 times free cash flow. Relative to the average P/E of other niche defense companies within the aerospace/defense products and services industry (19.5), these numbers seem high.

Granted, AeroVironment does appear to have stronger growth prospects than its peers. According to analysts polled by S&P Capital IQ, AeroVironment is likely to grow earnings at about 14% annually over the next five years. The aerospace/defense products and services industry as a whole is expected to produce less than 12%  annualized earnings growth over the same time period, according to Yahoo! Finance.

But are AeroVironment's mere two percentage points-worth of excess growth worth paying a P/E ratio 270% higher than the average in its industry? That almost seems a rhetorical question...

What comes next?
The real kick in the gut for AeroVironment investors, of course, is the risk that as overvalued as the stock looks today, it could soon look even more overpriced -- perhaps as soon as this upcoming earnings report. Here's why:

When last we heard from management, AeroVironment was warning that fiscal 2015 (that's the year we're in now) sales are likely to run between $250 million and $270 million. If accurate, this prediction suggests a best-case scenario of revenues growing only 7% this year, and a worst-case scenario of revenues actually slipping below last year's performance ($252 million).

Management expects  its "core business" to be gross-profitable off this level of revenues, but with the caveat that "investments in tactical missile systems, commercial UAS, and [the company's experimental "Global Observer" high-altitude, long-endurance hydrogen-fueled spyplane] will increase operating expenses." The net result "may" be that profitability in the core business of selling drones and charging station will be "largely offset" by R&D costs in areas of hoped-for future growth.

Or in other words: After a strong performance in fiscal 2014, AeroVironment's profits could be slim-to-none this coming year. Given this risk, I think prudent investors should avoid buying the stock -- at least until after earnings come out, and we've got a clearer picture of when AeroVironment's long-term profitability.

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Like these drones, is AeroVironment stock "grounded" for the duration? Photo: Wikimedia Commons.


Rich Smith has no position in any stocks mentioned. The Motley Fool recommends AeroVironment. The Motley Fool owns shares of AeroVironment. 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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