Drones Will Be a Lucrative Play … Eventually

by Susan J. Aluise | May 21, 2013 9:13 am

Unmanned aerial vehicles — more commonly known as “drones” — have revolutionized modern warfare with their unmatched ability to conduct surveillance and attack targets remotely. But drones aren’t just for military use: That same technology is now being leveraged for commercial and public safety applications — and placing more drones in the sky is sure to put more cash into the pockets of manufacturers and their shareholders.

But as President Barack Obama prepares to justify his administration’s expanded military use of drones in a major policy address this Thursday[1], growing controversy over the technology could delay commercial deployment of UAVs in the U.S.

First, the good news: Teal Group, a defense and aerospace analysis firm, estimates annual UAV spending will double to $11.4 billion over the next decade[2], meaning the UAV market will total nearly $89 billion in that time frame — and the forecast even takes into account deep defense cuts of as much as $1 trillion over that period.

Several aerospace/defense firms stand to gain from broad deployment of UAVs for commercial use. Among them, major U.S. defense contractors like Textron (TXT[3]) subsidiary AAI, Northrop Grumman (NOC[4]), Raytheon (RTN[5]), Boeing (BA[6]) and privately held General Atomics are all major players in the drone space.

Perhaps the closest thing to a pure play is AeroVironment (AVAV[7]), which has sold a number of drones to local law enforcement agencies.

Drones in the U.S. obviously will play a far different role than the “killer robots” that routinely roam the skies in Afghanistan, Pakistan and other conflict zones. UAVs currently are being used to conduct surveillance for law enforcement agencies, though common applications extend to the public safety arena,where firefighters can view hot zones within fires by using drones outfitted with infrared cameras.

Commercial use of UAVs got a shot in the arm last year when the Drone Act was tucked into the Federal Aviation Administration’s $64.4 billion funding bill. The act gives the agency until 2015 to fully integrate commercial drones into U.S. airspace. FAA so far has licensed more than 300 commercial drones; the agency expects that number to balloon to 30,000 by 2020. UAVs can be used for everything from mapping to remote monitoring of oil fields, industrial sites, utilities and weather to photographing celebrities.

But here’s the bad news: Those high-potential applications also have raised the ire of privacy advocates like the American Civil Liberties Union and the Electronic Privacy Information Center. Safety also is an issue, since the drones will be sharing the national air space with aircraft.

The House Judiciary Committee last Friday held a hearing on whether — and what kind — of regulations are needed before flocks of drones take flight. In addition to Congress, 30 states currently are considering drone-related laws[8], according to Huffington Post. Balancing these competing interests has been tough for the FAA, which missed a Dec. 31 deadline to select six drone test sites as stipulated in last year’s law.

The bottom line is that commercial use of UAVs eventually will turn into big business for the companies that manufacture them and their shareholders, but privacy, safety and other PR issues will create strong headwinds in the near-term. Large U.S. defense contractors are now looking overseas for UAV customers as a means of diversifying their revenue streams[9], and smaller, more focused companies also have valuable non-drone products that can beef up the bottom line near-term.

With that in mind, there are two plays I like at the moment for investors who want to get in on the ground floor and ride out the turbulence.

AVAV looks attractive because it has a strong charging-network solution for electric vehicles that is sparking growth opportunities. Also, Lockheed Martin‘s (LMT[10]) acquisition of drone-maker Chandler/May last November boosts its position in the market. Strengthening drone sales have given the defense contractor a bounce in recent months — the stock is now trading near 52-week highs.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.

Endnotes:
  1. in a major policy address this Thursday: http://thehill.com/blogs/blog-briefing-room/news/300629-obama-to-address-drone-policy-gitmo-in-thursday-speech
  2. annual UAV spending will double to $11.4 billion over the next decade: http://www.tealgroup.com/index.php/about-teal-group-corporation/press-releases/66-teal-group-predicts-worldwide-uav-market-will-total-89-billion-in-its-2012-uav-market-profile-and-forecast
  3. TXT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TXT
  4. NOC: http://studio-5.financialcontent.com/investplace/quote?Symbol=NOC
  5. RTN: http://studio-5.financialcontent.com/investplace/quote?Symbol=RTN
  6. BA: http://studio-5.financialcontent.com/investplace/quote?Symbol=BA
  7. AVAV: http://studio-5.financialcontent.com/investplace/quote?Symbol=AVAV
  8. 30 states currently are considering drone-related laws: http://www.huffingtonpost.com/2013/05/17/congress-drone-regulations_n_3294098.html
  9. now looking overseas for UAV customers as a means of diversifying their revenue streams: http://www.policymic.com/articles/42351/drones-made-in-america-sold-to-militaries-everywhere
  10. LMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=LMT

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