This article is the first in our Company Spotlight series. I selected AeroVironment Inc. (AVAV) as the initial candidate. AeroVironment is a U.S. company that was founded in 1971 and is currently headquartered in Arlington, VA. The company is classified in the “Industrials” sector, “Aerospace and Defense” (A&D) industry. It operates through two business segments: “Unmanned Aircraft Systems” and “Medium Unmanned Aircraft Systems”. Its primary customers are the U.S. and foreign military services.

I contacted the Investor Relations department to inquire how much of their revenue was related to UAS and related technologies. Their response: “All of it!”. As such, AeroVironment is one of two U.S.-based companies that I consider to be “pure drone plays”, and thus holds the highest weighting on the DRONES Index. As far as I can tell, AeroVironment was the first Drone-Dedicated company to be publicly listed on the U.S. stock exchange. It first listed on the NASDAQ in February 2007, beating the other pure drone play by a matter of months.

Here is how I categorize AeroVironment in my Drone Industry Taxonomy.

Drone Industry Taxonomy: AeroVironment Inc.
Drone Industry Taxonomy: AeroVironment Inc.

As of the most recent Annual Report (2021), AeroVironment has five major product lines:

– Small/Medium UAS (SUAS/MUAS)

– Tactical Missile Systems (TMS)

– Unmanned Ground Vehicles (UGV)

– High-Altitude Pseudo-Satellite (HAPS)

– Advanced AI

The first two products are clearly designed for and marketed to military customers and have been the company’s mainstays for decades. If you follow the military, you may be familiar with some of their flagship products: the RQ-11 Raven, RQ-12 Wasp, RQ-20 Puma, and the Switchblade loitering munition.

AeroVironment is attempting a pivot to law enforcement and commercial customers, but they have not yet gained significant traction here. The products are ruggedized for harsh environments, hardened against cybersecurity threats, optimized for day/night surveillance, and priced out of many small organizations’ reach.

The remaining three product lines are still in the development phase, and the addressable market is not yet clear to shareholders.

AeroVironment appears to be keen to break out of its typecast mold as small UAS (Group 1) specialists by segueing into Groups 2-3 UAS and unmanned ground vehicles (UGV). It also acquired rival company Arcturus in 2021 to add Vertical Takeoff and Landing (VTOL) capabilities to the portfolio. These all appear to support military operations.

AeroVironment took its business to the interplanetary scale when it contributed to NASA’s Ingenuity aircraft. This marks the first aerodynamically-powered craft to fly on another planet. So, they got that going for them, which is nice.

Small UAS sales historically account for ~60% of the company’s revenue, with over 70% of contracts being fixed-price. Fixed-price contracts often provide a reliable profit to the vendor and are typically most appropriate for non-development items. This is a primary mode of operations for a Products-based company: selling mass quantities of off-the-shelf equipment.

I had the pleasure of touring AeroVironment’s Simi Valley production facility in 2016. Like most sUAS manufacturers, it was a large warehouse with rows of tables full of components at various stages of completion—an assembly line. It was an impressive sight, and I’m afraid I have no photos to share here.

AVAV is a member of the DRONES Growth Portfolio. Let’s take a look at some of its vital signs compared to other members of the Aerospace & Defense (A&D) industry.

Let us start with a look at some of its fundamentals. The following graphic was derived from AeroVironment’s 2022 Income Statement.

AVAV 2022 Income Statement. Generated by Paladin Automation LLC.

AeroVironment Inc. posted a net loss of around $4M on its 2022 annual report. This tax year appears to have burned some of the company’s cash reserve to pay its operating expenses, particularly Research and Development (R&D).

For stock price performance, I will use the SPDR Aerospace & Defense ETF (XAR) to represent the industry.

  • P/E Ratio: N/A   (A&D Average: 31.02)
  • EPS: -$0.02    (A&D Average: $9.61)
  • P/S Ratio: 4.60
  • PEG Ratio: N/A
  • Price/Book Ratio: 3.46
  • Return on Equity: -0.08%
  • Analyst Recommendations: 2.4 (Weak Buy)
  • Analyst Price Targets: $91.33 (+8.7%)
AVAV Price vs Revenue
AVAV Price vs Revenue

As I write this in June 2022, it is hard to look at any company as a good investment. After all, we have been in a bear market for several months, and economists warn us daily of an upcoming recession. Nonetheless, let us take a look at AeroVironment’s history and future potential.

AeroVironment is, without a doubt, a major Defense contractor. Like its colleagues, revenue ebbs and flows with government spending. The good news for Defense contractors is that the government spends piles of money regardless of which part of the economic cycle the country is in. The bad news is that the funds’ destination varies with geopolitical realities and government leaders’ personalities.

War is hell, but it tends to be profitable for our Defense contractors. I took the liberty of researching the U.S. Department of Defense (DoD) small UAS (sUAS) budget for the last 15 years, adding total figures (Procurement and RDT&E funding) across all services. “Procurement” is the budget appropriation for purchasing new equipment, to include custom sUAS. “Research, Development, Test, and Evaluation” (RDT&E) is the budget appropriation for developing new technology. I made no attempt to include the Operations and Maintenance (O&M) budgets, as these do not clearly define specific aircraft types. This was a time-consuming process that I quickly turned into an automated process.

First, let us chart the Total Revenue against the DoD sUAS budget.

We can almost see a pattern here, but there are two phenomena that skew the numbers. First, AeroVironment’s reported Fiscal Year is May-April, while the DoD uses October-September; this means that the DoD’s FY21 is about 6 months out of phase with AeroVironment’s FY21. Second, government funding for a certain fiscal year can actually be obligated to the vendor one or two years in the future—FY20 funding may not reach AeroVironment until FY22!

For the sake of comparison, let me present an alternate view, in which I shift the DoD budget 12 months to the right to compensate for the skewing.

This presents a clearer pattern that is completely explainable: the DoD sUAS budget shows a steady increase through 2009, at the height of both the Iraq and Afghanistan wars. This was a period of significant investment into warfighting equipment, particularly unmanned aircraft. 2010-2014 saw a precipitous drop in sUAS funding while the country was in a period of relative peace. The military went through a downsizing period, and the demand for military equipment diminished. Military demand then steadily increased from 2016 through present as the U.S. postured itself for a future conflict.

The DoD funding charts do not depict the roughly $47 billion emergency aid to Ukraine, a portion of which purchased AeroVironment products such as the Switchblade. Similarly, AeroVironment’s revenue from these aid packages will not be depicted until they release their FY22 Annual Report later this summer.

Is AVAV a buy right now? It is certainly selling at a discount: it sits about 20% below its 2021 highs. The company has a solid record of positive earnings, but its most recent reported year shows a minor loss (potentially due in part to mergers and acquisitions (M&A)). 

The DoD sUAS budget has been slowly declining since 2019. It is not clear what fraction of the overall sUAS budget is intended for AeroVironment, but I believe that it is indicative of diminishing demand for small tactical-level UAS across the services. Foreign militaries may have different priorities than our own. The war in Ukraine will certainly show some revenue increases, as we will see reflected on the FY22 Annual Report.

While the FY21 Annual Report alludes to law enforcement and commercial users, I personally do not see any of the company’s current projects having a clear and compelling use case that would attract these sorts of customers. If anything, AeroVironment’s products are too exquisite for such mundane uses. If they are currently working on commercial-grade products, they must be doing so in stealth mode.

With their cash on hand ($181 million), I would not be surprised to see AeroVironment continue to acquire small private UAS manufacturers to further develop their commercial portfolio. Small private companies dominate the commercial UAS vendor base, and they are getting hit hard by supply shortages and rising interest rates. There are inevitably a few vendors near bankruptcy who are unable to secure a loan and would be willing to sell to a company such as AeroVironment for a steep discount. Were this to occur, I would expect an initial 10-20% drop in AVAV share price, but the long-term revenue should eventually overcome this dip.

If you choose to add AVAV to your own portfolio, be prepared to play the long game.

UPDATE (29 June 2022): Since the date this article was published, AeroVironment released its 2022 Annual Report and Q4 Quarterly Report. Unsurprisingly, it reported revenue and earnings that did not quite meet analyst and shareholder expectations, though it did have higher-than-expected revenue from Services (presumably its depot-level and field support activities for fielded systems). Share price has fallen nearly 15%, putting it deeper in the value basket.

As a medium- to long-term investment (greater than one year), there are three signals I would look for prior to pulling the trigger.

1. News of widespread sales to European countries, especially its Switchblade loitering munition.

2. Pivot to commercial UAS, very likely to come via merger & acquisition (M&A).

3. Pivot to Drone Logistics, targeting the fixed-wing long-range, less-than-truckload (LTL) niche: the industry is lacking some density in the ability to mass-produce UAVs capable of 10-20 pounds carriage over a distance greater than 5 miles, and AeroVironment is one of only a small handful of companies with an R&D shop and manufacturing line capable of producing thousands of units per year. Bonus points if the UAV price point puts it in the “attritable/expendable” category for single-use applications in military environments.

As always, please conduct your own research and consult a Financial Advisor for any potential investments. The author does not currently hold shares of AVAV.



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