AeroVironment Inc. (Nasdaq: AVAV) Is the Future of the Defense Industry

If you don't know about AeroVironment Inc. (NASDAQ: AVAV), it's a name you need to follow.

My fascination with the founder of AeroVironment, which designs, develops, produces, and supports aircraft and energy systems, started when I was 12 years old. History was made that year when a man-powered aircraft flew across the English Channel for the first time.

I remember the flight clearly. The 70-lb aircraft made the 26-mile journey in 2 hours and 49 minutes.

The idea that a man could pedal a bicycle fast enough to fly across the channel seemed crazy to me at the time. But it was made possible because of groundbreaking designs by Dr. Paul MacCready.

MacCready made the first human-powered aircraft in 1977, the Gossamer Condor. Two years later came the Gossamer Albatross, the first fully human-powered aircraft to cross the English Channel. MacCready won the prestigious Kremer prize, which honors pioneers in human-powered flight, for each design.

His innovative creations led TIME magazine to call him one of the "greatest minds of the 20th century."

MacCready started AeroVironment in 1971. His imagination and persistence helped the company become a leader in creating UAVs (Unmanned Aerial Vehicles). Now AeroVironment has grown into the largest provider of UAVs to the U.S. military.

UAVs will play an incredibly important role in our country's future. The art of war is evolving, and these devices have become the next key tool in the U.S. arsenal.

With its great niche in the defense industry, AeroVironment Inc. is a "Buy." (**)

Providing for the Future of Defense

When I think of UAVs, I think of the hunter-killer models the United States uses in its "War on Terror."

However, those are typically large, expensive, unmanned planes with missiles attached to them, which can fly three to five days without refueling. But in fact the U.S. military has purchased thousands upon thousands of small handheld UAVs, with the smallest designs weighing less than five pounds each.

These drones are revolutionizing the real-time gathering of battlefield information. The smaller breed of UAVs use a localized Wi-Fi type communications package instead of broadcasting their information to military satellites. This gives field troops direct access to intelligence, without it having to be relayed back from the United States.

The new UAVs also allow American soldiers to scout enemy territory without having to risk their lives.

AeroVironment provides 85% of the UAVs used in Iraq and Afghanistan, according to the U.S. Department of Defense.

The company is behind the popular Raven B drone, the most commonly used in the U.S. military, according to Bloomberg News. It weighs just a couple of pounds and looks like a small airplane. It's tossed in the air and allows a ground control unit to see infrared video from where it travels.

AeroVironment's next highly-anticipated product is a UAV called Switchblade, developed with help from the U.S. Air Force. It is carried conveniently in a tube, and can be transformed during its flight into a weapon if an enemy is spotted. The U.S. Army recently put in a $6 million order for Switchblade.

The U.S. government will wind down defense spending over the next few years, but UAVs are one of the few growth areas in the Pentagon's military budget. AeroVironment will benefit from this spending, especially because it has an established relationship as the major UAV supplier for the military.

AeroVironment also will boost profits by branching out beyond the military. As technology gets cheaper, private sector demand for UAVs is growing. Police organizations, for example, have put these tools to use by employing them to look for escaped prisoners or lost civilians.

AeroVironment's second-quarter earnings for fiscal 2012 blew away the results of the same quarter last year. Profit soared to $6.6 million, or 30 cents a share, from $262,000, or one cent a share. Revenue was up 26% to $80.4 million.

Analysts surveyed by Thompson Reuters predict income of 45 cents a share on revenue of $89 million for the third quarter.

AeroVironment currently has a market cap of about $670 million, with an enterprise value of $500 million once net debt and cash are taken into consideration.

The company has no debt, and $177 million in net cash. This gives the stock a cash value of $8.15 per share. The stock is up 17% this year.

I love to find a company that has 30% of its market cap in cash, with a large niche market and a history of performing well.

Action to Take: Buy AeroVironment Inc. (Nasdaq: AVAV) (**).

When we go to pick up this stock, you are going to want to be methodical and use small limit orders to build your position. Normally I suggest that you buy at market or you should enter limit orders at specific discounts to the current market price.

This time, I think you should use patience.

A patient investor should put in good-til-cancelled limit orders for share-price dips of about 2% and expect to get a fill over time.

(**) Special Note of Disclosure: Jack Barnes has no interest in AeroVironment Inc. (Nasdaq: AVAV).

About the Writer: Columnist Jack Barnes started his career at Franklin Templeton in 1997. He started out in the company's fund-information department - just as the Asian contagion infected the Asian tiger countries.

Barnes launched his own shop, RIA, in 2003, just as the second Gulf War was breaking out. In early 2006, after logging a one-year return of nearly 83%, Forbes named Barnes the top stock picker in its "Armchair Investors Who Beat the Pros" competition. His two audited hedge funds generated double-digit returns in 2008.

Barnes retired to the beach in the summer of 2009, and continues to write from there. He's now the author of the popular blog, "Confessions of a Macro Contrarian," and his "Buy, Sell or Hold" column appears in Money Morning on Mondays. In his BSH column last week, Barnes analyzed Automatic Data Processing Inc. (Nasdaq: ADP).

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