Unmanned aerial vehicles (UAVs) — better known as drones — have revolutionized the art of war with their often-lethal mix of remote control, stealth and surveillance/strike capability. Now, new laws and valuable commercial applications could spark a similar revolution in the civilian world, giving defense contractors a lift in these leaner times.
Lockheed Martin’s (NYSE:LMT) acquisition this month of UAV company Chandler/May is an early salvo in what could become a “drone war” among defense contractors seeking new revenue streams to offset hefty Pentagon budget cuts. Since Chandler/May was a key UAV subcontractor to Textron (NYSE:TXT) subsidiary AAI, the deal could kick off a shopping spree among defense/aerospace companies jockeying for position in the drone market.
Northrop Grumman (NYSE:NOC), Boeing (NYSE:BA) and privately held General Atomics are all major players in this market, too. If they can leverage their huge investments in military UAVs into civilian markets, it could ease the pain of shrinking defense budgets and beef up the bottom line for shareholders.
How big of a bonanza can these so-called dual use technologies be when they cross over into the civilian world? You’re using dual-use technology right now to read this article: The Internet that also powers Cyber Monday sales was the brainchild of the Defense Department’s Advanced Research Projects Agency. And the GPS functionality in your mobile phone started out as a satellite navigation system for the U.S. military.
The commercial market potential of drones could be the next such blockbuster. The Federal Aviation Administration (FAA) believes 30,000 drones could be over U.S. skies by 2020. UAVs will be the most dynamic growth sector of the world aerospace market this decade — with $89 billion spent over that time, according to a forecast by Teal Group.
Because UAVs can go where no human can (or wants to) go, they’re ideal for applications like border control, law-enforcement surveillance or infrared heat detection for firefighters. Many federal, state and local public-safety agencies already have obtained waivers from the FAA to operate drones in U.S. civil airspace.
These drones come in all sizes. Some local law-enforcement agencies currently are using Draganfly Innovations’ X6, AeroVironment’s (NASDAQ:AVAV) Qube and Vanguard Industries’ Shadowhawk, which are between three- and seven-feet long. Raytheon’s (NYSE:RTN) nine-foot long Cobra is being used for military research, while NASA and U.S. Customs & Border Protection are using General Atomics’ Predator B, which is 35-feet long and has the wingspan of a commercial jet.
UAVs offer a compelling value proposition in mapping, remote monitoring of oil fields and industrial sites or for agricultural and weather applications. Outside the U.S., paparazzi are using small drones to photograph celebrities — and gossip site TMZ has already filed for a drone permit to do the same thing here.
The FAA’s $64.4 billion funding bill passed earlier this year requires the agency to fully integrate UAVs into the nation’s airspace by September 2015. Although privacy concerns have delayed the FAA’s first step — selecting test sites — the law has powerful friends on Capitol Hill, and the agency still is under the gun to meet the deadline.
Bottom Line: The coming drone wars create two opportunities for investors. First, despite gloom and doom forecasts for small-cap defense/aerospace stocks facing the fiscal cliff, I think AeroVironment could be a bargain buy for investors now.
AVAV shares slumped about 10% since it reported a wider-than-expected loss and slower drone sales in September. But AeroVironment’s forecast for the full fiscal year ending in April beat expectations. I like AVAV in 2013. It doesn’t hurt that the company also develops electric vehicle charging stations — it has deployed 10,000 of them in North America so far.
Second, I think drone commercialization presents an attractive revenue stream for mega-cap defense/aerospace contractors. Fiscal cliff or no, defense cuts are a fact of life for companies like LMT, NOC, RTN, TXT and BA. Developing new growth will be at least as important as cost-cutting as these companies strive to deliver shareholder value in a down defense market.
And keep an eye out for more acquisitions like Lockheed Martin’s Chandler/May deal as commercial drones begin to take off in a big way.
While the FAA still has to iron out safety and national security issues before vast flocks of drones start zipping around your rooftop, investors in the right UAV stocks stand to gain big when the drone market soars.
As of this writing, Susan J. Aluise didn’t own any securities mentioned here.