Drones are the future of warfare.
Demand for unmanned aerial vehicles (UAVs) is projected to remain on the ascent as governments seek to reduce both the human and monetary costs of armed conflict. The U.S. Department of Defense alone requested $9.39 billion for unmanned systems in its fiscal 2019 budget proposal, according to the Center for the Study of the Drone at Bard College. That’s up from $7.5 billion in 2018.
Companies that meet this growing need stand to profit handsomely in coming years. For investors looking to share in those profits, here are two of the best drone stocks available today.
The pure play
AeroVironment (NASDAQ:AVAV) is a leading producer of military drones. It specializes in small UAVs that can be used for video surveillance and other tactical purposes.
After the recent sale of some non-core businesses, AeroVironment is now essentially a pure play on the growth of the military drone market. Yet while it’s a leader in its field, the company’s $1.8 billion market capitalization places it squarely in small-cap territory, leaving plenty of upside potential for investors.
Moreover, while AeroVironment expects its revenue to rise as much as 14% to $310 million in fiscal 2019, the company’s sales represent just a small fraction of a massive and rapidly growing military drone market. And with the U.S. military projected to increase its drone investments by about 15% annually over the next five years, according to research firm William Blair, AeroVironment should continue to grow at impressive rates for at least the next half-decade.
Better still, AeroVironment has a fortress-like balance sheet, with $290 million in cash and investments against zero long-term debt. That gives it the ammunition it needs to invest aggressively in research and development, which should help it keep its UAVs at the vanguard of drone technology.
Best of all, recent market pessimism has contributed to a sharp pullback in AeroVironment’s stock price. With its shares down about 35% from their 52-week high, it now trades for about 36 times earnings. That’s an attractive price for a drone leader that’s projected to grow its profits by 30% annually over the next five years. But this opportunity to purchase AeroVironment’s stock at a discount may not last long, so you may want to consider buying some shares soon.
The game changer
Those willing to take on more risk for potentially more reward may also be intrigued by Kratos Defense & Security (NASDAQ:KTOS).
Unlike AeroVironment, Kratos is not a drone pure play. Its government solutions segment — which offers products and services in areas such as satellite communications and electronics — generates most of the company’s revenue and profits. It’s a solid but relatively moderate-growth business. Kratos’ drone business, however, could be a game-changer with the potential for exponential growth in the coming years.
Target drones — which are used by military forces for target practice — currently comprise the core of Kratos’ drone sales. But the company has been developing a new kind of jet-powered combat drone that could potentially help to revolutionize modern aerial warfare.
Kratos — and many defense experts — envision a future in which high-performance unmanned jet fighters augment the U.S. military’s fleet of pilot-flown aircraft. Think drone “wingmen,” tasked to help protect our F-22 and F-35 fighters. While this may seem like something out of a science fiction movie, Kratos’ recent contract wins suggest that the U.S. military is already moving in this direction.
Excitement surrounding Kratos’ forthcoming combat drones has driven its stock price higher in recent months. Some analysts even speculate that Kratos could be an acquisition target for a larger defense company. Takeover chatter alone isn’t a great reason to invest in Kratos — as a deal may not occur — but it is another sign that the company’s drone business is gaining speed.
Wall Street seems to agree. Analysts at Goldman Sachs recently upgraded Kratos’ stock to buy and issued a $20 price target — 30% higher than it was trading today — due to their belief that the company’s drone revenue growth will soon accelerate. Goldman even predicts that Kratos’ drone business could grow 10 times larger by 2025.
Still, sustained profitability has so far eluded Kratos. This — combined with the fact that its stock currently trades for about 45 times Wall Street’s forward earnings estimates for 2019 — makes it relatively higher-risk than the typical defense company, which tends to be highly profitable and trade at a lower P/E multiple.
However, Kratos did report better-than-expected net income and free cash flow in its most recent quarter. And if the company’s new drone programs can deliver on their immense potential, Kratos’ current $1.6 billion market cap may significantly understate its long-term profit potential. This makes its stock an intriguing play on the growth of the drone market in the years ahead.
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