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Hey! Who's Flying This Thing?

By Rich Smith - Updated Apr 5, 2017 at 9:24PM

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The military shows its love for unmanned aerial vehicles.

When a Fool writes about a stock he or she owns, there's an inherent conflict of interest. Actually, two conflicts. You should be most aware of the risk that, despite the best intentions, the writer may view the company through proverbial rose-colored glasses. But there's another conflict more pertinent to today's column: We can't write and buy stock at the same time. So commands the Fool's disclosure policy.

Why this is important
For the past few days, I've been eyeing the stock of unmanned aerial vehicle (UAV) maker AeroVironment (Nasdaq: AVAV) with a certain amount of greed. I already own shares of the company, but more might be better.

You see, since the new year dawned, AeroVironment (AV) has received two bits of good news:

  1. Permission from the Air Force to begin building its "Wasp" UAVs as fast as humanly possible.
  2. An Associated Press report detailing the extent of the military's interest in deploying UAVs.

More on this news in a moment. For now, just understand that both announcements were "good news," yet the stock has followed the market down nearly 4% since Dec. 31.

Fools love to buy stocks whose share prices drop on no news. But a stock that drops on good news? That's manna from heaven, baby. Problem is, I can't take advantage of the price decline and clue you in about it. So today, I'm taking one for the team. I'm making sure you get the memo, and postponing my own purchases for the 10 days required by the above-mentioned disclosure policy.

Bird's eye view
So here's the deal. According to The Associated Press, the U.S. military can't get enough of UAVs. Between January and October of last year, the Air Force more than doubled its use of UAVs. Use was up so much that the Air Force had to pull an extra 120 pilots out of their planes and assign them to joystick duty, flying UAVs remotely. And throughout the military, UAVs saw more than half a million flight-hours in 2007.

Nice. But how do I invest in it?
There are several ways to play the military's increasing reliance on UAVs. Pretty much everybody who is anybody in the defense sphere now makes the things. Privately held General Atomics manufactures the best-known UAV, the Predator. But publicly traded companies haven't been shy about grabbing their pieces of pie.

  • Northrop Grumman (NYSE: NOC) makes both the huge Global Hawk and the Fire Scout mini-helicopter.
  • Lockheed Martin (NYSE: LMT) likewise has big (Polecat) and small (Desert Hawk) UAVs. 
  • Boeing (NYSE: BA) has its tiny ScanEagle.
  • Textron (NYSE: TXT) bought its way into the game with its purchase of United Industrial and its Shadow.
  • Even Honeywell (NYSE: HON) is getting in on the act, with a "micro air vehicle" that looks less like an airplane and more like a flying coffee can.
  • L-3 (NYSE: LLL) is developing the software that will help network the various UAVs that everybody else is so busy building.

But from my vantage, no one has ridden this wave quite as well as little Nasdaq newcomer AeroVironment. According to the AP report, a huge chunk of the 500,000 UAV-hours clocked last year belonged to AV. Its Raven UAV (a cousin to the Wasp) flew some 150,000 of those hours, a number that the Pentagon expects to double in 2008.

Now, maybe you're thinking all these projections will come to naught if the wars in Iraq and Afghanistan wind down. And you're right to think that -- the future is always uncertain, and that "risk" of peace breaking out has to factor into your analysis.

But according to one U.S. Army spokesman quoted in the AP piece, "Even as the surge ends, I suspect the deployment of the unmanned systems will not go down, particularly for larger systems." That's a sentiment echoed by the Air Force spokesman, who said, "The demand far exceeds all of the Defense Department's ability to provide (these) assets ... and as we buy and field more systems, you will see it continue to go up."

Foolish takeaway
So let's recap, shall we? Demand for UAVs is surging, and the military wants more of the things even if peace prevails. All of the companies named above should benefit, "particularly" big-UAV builders like Northrop, Lockheed, and, I'm guessing from this picture, Boeing. But the Air Force authorizing AeroVironment to begin "full-rate production" of its tiny UAVs suggests they will be in demand as well. And in the face of all this good news, AV's share price has dropped nearly 4%.

As a result, the shares now trade for around 20 times trailing earnings, despite analyst predictions that AV will grow its profits north of 21% per year over the next five years. It doesn't make much sense to me, but one thing is clear: Just as soon as the Fool's disclosure period expires, I'm going to pick myself up some more shares.

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Stocks Mentioned

AeroVironment, Inc. Stock Quote
AeroVironment, Inc.
AVAV
$82.80 (0.53%) $0.44
The Boeing Company Stock Quote
The Boeing Company
BA
$141.53 (5.64%) $7.56
Honeywell International Inc. Stock Quote
Honeywell International Inc.
HON
$180.02 (3.12%) $5.45
Lockheed Martin Corporation Stock Quote
Lockheed Martin Corporation
LMT
$419.04 (2.05%) $8.42
Textron Inc. Stock Quote
Textron Inc.
TXT
$60.62 (4.10%) $2.39
L3 Technologies, Inc. Stock Quote
L3 Technologies, Inc.
LLL
Northrop Grumman Corporation Stock Quote
Northrop Grumman Corporation
NOC
$463.70 (1.64%) $7.46

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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