Defense Stock Has a Tactical Advantage

11/15/2011 11:09 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

As technology continues to overtake human soldiers on the battlefield, this stock is best positioned for major profit, writes senior editor Igor Greenwald.

We’re living in contentious times. The United States is hunting enemies who would do it violent harm across hostile terrain all over the globe. Those enemies are seeking a cost-effective means to counter-attack a militarily superior civilization.

The power of social networks to fill the streets with crowds demanding change has unsettled every autocratic government...and many democratic ones. Europe is facing massive demonstrations and riots as austerity bites. Stateside, the streets and campuses are up for grabs as Occupy protesters defy orders to disband.

This can only mean one thing. Or rather, in short order, thousands of things—mostly airborne and increasingly self-directed, guarding, spying, pacifying, and inevitably terrorizing. 

The drones are coming in numbers now, to Afghanistan and to America. They could soon make fancier military hardware filled with troops a luxury no military can afford. They’re likely to patrol the skies above our cities and the streets below. They will help people see what authorities don’t wish known and allow police to eavesdrop without warrants.

And they will be cheap, for the information and the control they provide. People are expensive. Intelligence is expensive. Fuel is expensive. But energy storage is a rapidly improving field, and computing power has never been cheaper.

A distributed, networked drone force will be hard to kill and hard to defend against. It could also prove better practically and optically at dispersing peaceful protests than a phalanx of baton-swinging cops. Gas from above, spray from above, taze from above. Or snap a picture and send a summons to the address on the matching driver’s license, plausibly.

Lots of countries are now pursuing drone technology. But the proven lead in the field, honed above Afghan battlefields and Pakistani villages, belongs to the US.

And one of the best portfolios of tactical airborne snoops and killers belongs to Aerovironment (AVAV), the California firm founded 40 years ago by a beloved aeronautical pioneer and mastermind of the Gossamer Albatross human-powered flight.

The company has come a long way from those innocent days—it's now the leading supplier of small drones to the Pentagon. It doesn’t make the Predator or the Reaper, but its Ravens spy on Somali militants.

The Switchblade, a highly portable explosive drone launched from a tube and guided to its target by an operator via a camera feed, has been successfully tested in Afghanistan, where it will be soon be deployed.

Aerovironment created a lot of buzz earlier this year with its Nano Hummingbird mini-drone. Last month, it launched the Qube surveillance drone for the law enforcement market.

The drone business has been growing by 30% annually, but that may not be sustainable as the industry matures. This year, Aerovironment is aiming for growth of 10% to 15%.

Its business is lumpy, and heavily dependent on the Defense Department. Exports account for just 7% of revenue, leaving plenty of room for improvement. The company is conservatively managed by a CEO who’s been at the helm for 20 years. Aerovironment has no debt, and its $188 million in cash accounts for more than a quarter of the $700 million market cap. Backing out the cash, the price/earnings ratio is 18 for the fiscal year ending in April.

The stock is up 18% since I mentioned it three months ago, but down 6% from October’s high, consolidating along its rising 20-day moving average.

Aerovironment’s toys aren’t cheap, and neither is the stock. But relative to anything with a pilot’s canopy or the cost of boots on the ground, its wares are a bargain. And the Pentagon is going to need all the good deals it can get in the years ahead.

Aerovironment also has a promising sideline in the infrastructure for the charging of electric vehicles. But, for better or worse, the drones are its future, and ours.

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