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This Drone Maker Is Playing the Long Game

By Travis Hoium - Sep 18, 2015 at 10:04AM

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Drone stocks aren't going to double overnight, but this company could pay off big for long-term investors.

The military has long been a big believer in drones. Image source: AeroVironment. 

It's only a matter of time before drones begin playing a bigger role in the economy. Remote-control drones are already popular in the military -- and as toys -- and they're working their way into commercial applications, which could affect everything from agriculture to security.

And though GoPro and Amazon have gotten a lot of headlines for their drone efforts, they're not the ones leading the charge. A small company by the name of AeroVironment (AVAV 3.48%) is developing solutions that may become indispensable to thousands of businesses around the country.

The powerful drones you didn't see coming
We've all seen the quad-copter drones with attached cameras that have become popular with flying enthusiasts. Dozens of companies are making such devices, which are easy to operate and fairly inexpensive to buy. But for investors, that's not where the real opportunity lies.

The real value is taking that kind of aircraft to another level and adding commercial capabilities. Topographical mapping, surveillance, storm monitoring, and agricultural imaging are just a few of the functions commercial companies are testing. AeroVironment makes everything from small hand-launched drones to quad copters that can fill those needs.

Duke Energy recently announced that it is using AeroVironment's drones to inspect transmission lines, assess damage after storms, and fly over solar fields to see if repairs are needed. This can replace timely and dangerous work normally done in the field.  

This is just scratching the surface of commercial drone applications, and with the FAA still determining long-term regulations and companies just starting to test out how drones could benefit them, the market is just now starting to open up.

That said, drones are already a big business for AeroVironment. The company's unmanned aircraft systems business had $40.2 million in sales last quarter and generated a 34% gross margin. Commercial applications are just starting to hit the income statement, so you can expect big upside from those numbers in the future.  

Global Observer. Image source: Aerovironment.

Miles above the Earth
Drones that can be held in someone's hand are important, but the larger opportunity for AeroVironment may be in its high-altitude, long-endurance, or HALE, drone dubbed the Global Observer. This is an aircraft that can fly 12 miles above the Earth's surface, scanning a 600-mile diameter, and fly for up to a week at a time (maybe more using solar energy).

If the Global Observer is successful, the sheer magnitude of it could be enormous. A medium-altitude drone costs about 100 times more than a small drone and a Global Observer system can be another 10 times that amount. Just a few countries getting behind Global Observer could add hundreds of millions in revenue for AeroVironment.  

But this is a high-risk program as well. The U.S. government essentially abandoned Global Observer before the program was done. AeroVironment's management saw enough potential to buy the program from the Department of Defense, and has continued development. Now it can potentially build an aircraft it can sell to the U.S., foreign governments, and commercial companies for a variety of purposes. The thinking is that a deployable aircraft with that kind of range would be great as a communications relay, or for performing surveillance, tracking storms, and other missions.  

If management's bet on Global Observer is right, it could change the company's future dramatically.

This is the drone stock to watch
As the drone revolution begins, it's important to understand the difference between drones as a hobby and drones as a business. AeroVironment is providing practical applications to the military, law enforcement, first responders, and businesses, which should provide a sustainable lead in this booming market.

If you take the long view and understand that investments in R&D today should lead to massive sales growth in the future, I think this is the drone stock you should be watching.

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