When it comes to hot stocks and hot technologies, AeroVironment (NASDAQ:AVAV) shares seem to have it all. Up 18% through midyear, and rising again sharply after the drone maker released fourth-quarter earnings in July, AeroVironment stock has been one of the market's better performers, beating the S&P 500 by better than 2-to-1 so far in 2014. And news that the company has teamed up with petroleum powerhouse BP (NYSE:BP) in the first FAA-approved commercial drone operation over U.S. soil has investors expecting big things out of AeroVironment going forward.
But if you ask me, investors are underestimating the risks. Just this week, the FAA warned that widespread approval of commercial drone use in the U.S. remains "years away." And there are even bigger reasons to stay away from AeroVironment stock at its current head-spinning valuation of 53 times trailing earnings.
Here are three of these reasons.
AeroVironment missed the boat on rechargeable batteries
One of the early pioneers in the field of fast-charging battery systems, AeroVironment has signed up partners ranging from Fiat to Ford to Nissan to help hawk its PosiCharge battery chargers.
"Electric" has been a growing market in the past few years -- both in electric cars and the charging stations that charge them. But much of the growth is coming not from companies that AeroVironment has partnered with, but rather the single highest-profile company that it has not inked a deal with -- Tesla Motors (NASDAQ:TSLA).
Tesla sold 22,450 electric Model S sedans in 2013, enough to make it the best-selling large luxury car -- let alone large luxury electric car -- in America last year. But Tesla doesn't use AeroVironment equipment.
Meanwhile, there are early signs that demand for plug-in hybrid vehicles may have begun to stall. Through the first six months of 2013, according to website Cleantechnica.com, overall sales of plug-in hybrid electrics were less than half of total 2013 sales. If this is a plateau for the industry (ex-Tesla), AeroVironment may have placed a bet on a growing market just as it begins to shrink.
AeroVironment's UAVs aren't suited for an air war
Of course, the bigger part of AeroVironment's business isn't electric car chargers, but unmanned aerial vehicles such as the Raven, Switchblade, and Puma. Here, too, however, AeroVironment may be caught wrong-footed.
AeroVironment's business benefited mightily from troops' desire to have "eyes in the sky" while on patrol in Iraq and Afghanistan. But U.S. troop strength in Afghanistan is down from a high of 100,000 after the surge to about 32,000 troops today -- and this number is set to shrink to around 10,000 by the end of 2015.
U.S. combat troops withdrew from Iraq in 2011. True, the threat from the Islamic State of Iraq and Greater Syria has forced President Barack Obama to return 300 U.S. special forces troops to the theater. But that's a far cry from the more than 170,000 U.S. combat troops who were operating in Iraq in 2007.
Meanwhile, the limited airstrikes by fighter jets and drones that Obama has authorized against ISIS insurgents in Iraq probably won't involve use AeroVironment drones, which are by and large unarmed aircraft. Add to this the fact that, as was revealed on AeroVironment's earnings conference call last month, the U.S. Army has "pretty much reached its acquisition objective," and prospects for the sale of large numbers of unarmed, AeroVironment-built UAVs for use in the Middle East in the near future seem less than bright.
Global Observer is a money pit
Final point: A lot of investors see a lot of potential in AeroVironment's Global Observer high-altitude, long-endurance drone. Earlier this year, defense giant Lockheed Martin (NYSE:LMT) signed a memorandum of understanding to assist AeroVironment in finding "international opportunities" for Global Observer. That task may prove tougher than it sounds, however.
In an article blasting the Global Observer as a "gigantic hydrogen-powered drone" that "no one wants," Wired magazine pointed out that AeroVironment has already sunk nearly $28 million into developing the drone. But, according to Wired, Global Observer is really only a "technology demonstration," and "no service or defense agency has advocated for it to be a program" that the Pentagon might actually pay to purchase.
Meanwhile, AeroVironment is still on the hook for the bills. In the company's latest earnings call with analysts, AeroVironment CEO Tim Conver warned that costs associated with Global Observer development, along with other expenses, "will increase operating expenses [and] may largely offset operating profit from our core business" in the current fiscal year.
In AeroVironment we have a very sexy stock with popular technology -- both of which factors are reflected in a very high stock price. The company, though, is not doing a great job of capitalizing on consumer interest in electric cars (and that interest may already be waning). Its market for small spy drones for infantry support is likewise drying up as the U.S. withdraws "boots on the ground" from Iraq and Afghanistan. And its only large drone project is something that "no one wants."
To me, these seem like three good reasons to be cautious about AeroVironment's high stock price.
Rich Smith has no position in any stocks mentioned. The Motley Fool recommends AeroVironment and Tesla Motors. The Motley Fool owns shares of AeroVironment, Lockheed Martin, and Tesla Motors. 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.