How to cash in on drones

Facebook's interest in drone maker Titan Aerospace shows that unmanned aircraft are more than just hot air.

By InvestorPlace Mar 11, 2014 10:30AM

This undated image released by Titan Aerospace shows the company's Solara 50 aircraft. © AP Photo/Titan AerospaceBy Susan J. Aluise

What do Mark Zuckerberg, Defense Secretary Chuck Hagel and a U.K. Domino's (DPZ) franchise owner have in common? Innovative ideas for using unmanned aerial vehicles (UAVs), commonly known as drones.

With myriad new commercial and military applications, drones might be one of the coolest, highest-potential tech markets around for investors. The next big thing is here: drone stocks.

Zuckerberg's Facebook (FB) raised the ante in the commercial drone war this week with news of a deal to buy UAV manufacturer Titan Aerospace for $60 million. Titan's solar-powered UAVs -- which can stay airborne for five years at an altitude of 65,000 feet -- potentially could enable FB to cost-effectively extend the reach of the Internet and mobile services to underserved rural regions around the globe.

Facebook's move into drones clearly illustrates the game-changing potential of the technology. But other examples abound, showing how some tech stocks are moving toward becoming drone stocks:

  • Leaner Pentagon spending has had an impact on the Defense Department's drone plans. Instead of keeping the iconic U-2 spy plane for high-altitude reconnaissance, the Air Force instead is looking to retire the fleet, replacing it with Northrop Grumman's (NOC) upgraded Global Hawk drones.
  • Amazon (AMZN) founder Jeff Bezos rocked the UAV world last December with his announcement that the e-commerce giant was testing package delivery via drone. The "Prime Air" concept, Bezos told CBS' "60 Minutes," would dispatch small drones known as "octocopters" to deliver small packages to customers within 30 minutes.
  • A Domino's franchise in the UK tested drone delivery of pizzas last summer. But don't expect to see the so-called "DomiCopter" to show up in U.S. skies anytime soon.
  • Last May, Google's (GOOG) venture capital unit invested $10.7 million in Airware, a company that builds development platforms -- autopilots -- for UAVs. It's not Google's first foray into the drone sector, either: Back in 2010, the tech giant reportedly tested a battery-powered surveillance drone manufactured by Germany's Microdrones GmbH.
  • In China, drones will soon be an important part of the government's "War on Smog." The government reportedly will deploy UAVs with flexible parasails that are capable of spraying chemicals that freeze atmospheric pollutants and cause them to fall to the ground. The drones can reportedly carry more than 1,500 pounds of the chemicals.

The biggest near-term headwind for commercial drones taking to the air en masse is the Federal Aviation Administration (FAA), which is in charge of U.S. airspace. The FAA needs to make sure that thousands of drones flitting about without flight plans would not pose a hazard for aircraft.

And make no mistake, the FAA takes its job seriously: It recently grounded Wisconsin brewery Lakemaid's beer-delivery-by-drone plans after the company posted a YouTube video of a delivery to ice fishermen.

Still, it's only a matter of time before drone applications like this become commonplace. The FAA is under the gun to integrate drones into U.S. airspace by September 2015, but only released its initial roadmap last November. The next big step is expected later this year, when the agency says it will publish rules and requirements for drones weighing less than 55 pounds.

Despite delays, regulatory challenges and privacy dilemmas, widespread commercial deployment of drones is in our future. So what is the best way for investors to play this lucrative new market of drone stocks?

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) subsidiary AAI, Northrop Grumman, Raytheon (RTN), Boeing (BA) and privately held General Atomics are all major players in the drone space.

Perhaps the closest thing to pure play drone stocks is AeroVironment (AVAV), which has sold a number of drones to local law enforcement agencies. AVAV stock spiked more than 20 percent on Wednesday after it reported earnings and revenue well ahead of expectations. For the quarter ended in January, AVAV stock posted an EPS of 49 cents, blowing away Wall Street's 19-cent expectations. The company reported revenue of $69.2 million -- 47 percent higher than the year earlier and well above the consensus $63.9 million.

Last month, AVAV inked a deal with Lockheed Martin (LMT) to jointly pursue UAV opportunities. It has worked with government agencies on the Global Observer, a hybrid-electric, stratospheric reconnaissance and communication drone. It also provides commercial and public safety UAV solutions. Additionally, the company also develops electric vehicle charging stations.

With a market cap of $817 million, AeroVironment's valuation is rich: It has a price-to-earnings-growth ratio of 6.71 and trades at nearly 66 times forward earnings. But for the risk-tolerant growth investor looking for the next big thing, I like AVAV stock in 2014.

More from InvestorPlace

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



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