AEROVIRONMENT INC AVAV S
September 12, 2018 - 5:40pm EST by
ladera838
2018 2019
Price: 108.00 EPS 0.95 0.99
Shares Out. (in M): 24 P/E 114 108
Market Cap (in $M): 2,600 P/FCF 0 0
Net Debt (in $M): -326 EBIT 0 0
TEV ($): 2,274 TEV/EBIT 0 0
Borrow Cost: General Collateral

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Description

AeroVironment traded up recently to a nonsensical valuation prior to and immediately following its latest earnings report on September 5, likely due to a combination of superficial market commentary (for example, Motley Fool, provided below and Zack's, which has had similar comments) and perhaps some algo trading (that focuses on parsing press releases without any context).

 

I believe that the stock will decline for these very reasons after the next earnings call in December, when the current “good” news inverts to “bad” news.

 

Business:

AVAV designs, develops, produces, supports and operates a technologically‑advanced portfolio of products and services for government agencies and businesses. AVAV supplies unmanned aircraft systems (UAS – i.e. drones) and related services primarily to organizations within the U.S. Department of Defense and to international allied governments, and tactical missile systems and related services to organizations within the U.S. Government. AVAV derives the majority of its revenue from these business areas and believes that the markets for these solutions have significant growth potential. 

 

From what I can tell, AVAV is not a particularly strong competitor in the UAS field – per the 10-K:  We believe that a number of established domestic and international defense contractors have developed or are developing small UAS that continue to compete, or will compete, directly with our products. Some of these contractors have significantly greater financial and other resources than we possess. Our current principal small UAS competitors include Elbit Systems Ltd., L3 Technologies, Inc., and Lockheed Martin Corporation. We do not view large UAS such as Northrop Grumman Corporation’s Global Hawk, General Atomics, Inc.’s Predator and its derivatives, The Boeing Company’s ScanEagle and Textron Inc.’s Shadow as direct competitors to our small UAS because they perform different missions, do not typically deliver their information directly to front‑line ground forces and are not hand‑launched and controlled. However, we cannot be certain that these platforms will not become direct competitors in the future. Potential competition from consumer-focused drone manufacturers could emerge as their capabilities increase and their prices remain low relative to existing defense solutions, which could result in some level of military consideration even if such drones do not meet traditional military performance or security specifications.

 

Financials:

 

 

Year Ended April 30,

2019E

2018

2017

2016

2015

2014

(In thousands, except per share data)

           

Revenue

300,000

271,052

228,940

233,738

220,951

208,810

NI from continuing operations

23,300

22,576

16,633

15,393

11,682

25,659

             

EPS from continuing operations:

           

Basic

0.99

0.97

0.72

0.67

0.51

1.14

Diluted

 

0.95

0.72

0.67

0.50

1.10

Shares outstanding (basic):

23,575

23,471

23,059

22,936

22,869

22,354

Shares outstanding (diluted):

24,010

23,814

23,308

23,153

23,146

22,719

             

2019E are AVAV management estimates, reiterated in the 1Q19 press release, and excluding EPS of $0.26 from a one-time litigation settlement.

 

     
 

1 year

5 year

Revenue CAGR thru FY19

11%

8%

EPS CAGR thru FY19

2%

-3%

       

 

 

Valuation:

AVAV currently has a P/E of over 100x.  Capex exceeded depreciation in each of the last three years, so free cash flow multiples are also high.  As of 7/28/18, the company had net cash and investments of $326 million, implying a current enterprise value of $2.25 billion for a defense drone company with $300 million in revenue and $25 million in net income, and the growth profile outlined above.

 

Why?

 

Some of the excitement was generated by the “good” performance in the fiscal first quarter ended 7/28/18.

 

The market was excited by the first quarter earnings press release, which says:

Revenue for the first quarter of fiscal 2019 was $78.0 million, an increase of 127% from first quarter fiscal 2018 revenue of $34.4 million. The increase in revenue was due to an increase in product sales of $36.5 million and an increase in service revenue of $7.1 million. 

Gross margin for the first quarter of fiscal 2019 was $32.6 million, an increase of 275% from first quarter fiscal 2018 gross margin of $8.7 million. The increase in gross margin was primarily due to an increase in product margin of $22.7 million and an increase in service margin of $1.2 million. As a percentage of revenue, gross margin increased to 42% from 25%. The increase in gross margin percentage was primarily due to an increase in sales volume and an increase in the proportion of product sales to total revenue. 

Income from continuing operations for the first quarter of fiscal 2019 was $14.2 million, an increase from first quarter fiscal 2018 loss from continuing operations of $8.1 million. The increase in income from continuing operations was primarily a result of an increase in gross margin of $23.9 million, partially offset by an increase in research and development (“R&D”) expense of $0.9 million and an increase in selling, general and administrative (“SG&A”) expense of $0.7million. 

AND ….

Earnings per diluted share from continuing operations attributable to AeroVironment for the first quarter of fiscal 2019 was $0.85 compared to a loss per share from continuing operations attributable to AeroVironment for the first quarter fiscal 2018 of $0.19. 

What’s not to like?

 

In an example of market commentary on AVAV stock, Motley Fool said on 9/6/18:

 

https://www.fool.com/investing/2018/09/06/why-aerovironment-stock-just-popped-17.aspx

 

 From the above article:

Expected to report $0.29 per share in profits for the first quarter of its new fiscal year, AeroVironment instead said it earned $0.85 per share. Sales for the quarter reached $78 million, which was also more than Wall Street had been expecting.

So what

AeroVironment had a tough time of things last year as its stock was dogged by short reports questioning its ability to grow its business and calling its valuation "nonsensical and distorted." The best way to respond to such short reports, however, is by proving the critics wrong -- and AV did that in spades last quarter.

Q1 sales surged 127% year over year, and gross profit margins earned on those sales came close to doubling, up from 25% a year ago to 42% in fiscal Q1 2019, pulling AeroVironment up from an operating loss a year ago to an operating profit this year. On top of all that, proceeds from a beneficial litigation settlement added $0.26 per share to AeroVironment's bottom line, resulting in the aforementioned $0.85-per-share profit.

Now what

Expect more good things from AeroVironment as the year progresses. Backlog at the company (which will transform into revenues as the year progresses) more than doubled to $157 million by the end of the quarter, lending AeroVironment management confidence to make the following prediction:

By the end of fiscal 2019, AV expects to have earned between $1.10 and $1.40 per share on sales of from $290 million to $310 million.

Assuming this is how things work out, at the midpoint of those estimates, the company is on track to grow earnings 49% on sales growth of only 11%. No wonder AV's shareholders are thrilled. 

 

However, the reality is that management did not change FY19 annual revenue or EPS guidance. The company had announced earlier in the year that revenue would flatten across quarters in FY19 compared to previous years, and it lived up to that outlook in the first quarter.

 

The implications for the rest of the fiscal year are:

 

EPS

FY18

FY19

 

Q1

-0.19

0.59

excl 0.26 from litigation settlement

Q2

1.14          total Q2-Q4

0.25-0.55 total Q2-Q4

 

Q3

 

Q4

 
       

Total EPS estimated by management

0.95

0.84-1.14

excl 0.26 from litigation settlement

       

Revenue

FY18

FY19

 

Q1

            34.3 

            78.0 

 

Q2

236.8       total Q2-Q4

212-232 total Q2-Q4

 

Q3

 

Q4

 
       

Total Revenue estimated by management

271.1

290-310

 

 

 

 

Over the next three quarters combined, AVAV expects to report total EPS of $0.25-0.55, compared to $1.14 in the last three quarters of FY18 combined.  Revenues will be down slightly.

 

AVAV management explicitly confirmed this in response to a question in the 1Q19 earnings call:

 

Brian Ruttenbur

Okay. So you’ve made $0.85 in the first quarter but you only anticipate making another $0.35 to $0.60 whatever, you’ve made half – over half – I haven’t done the math or have it on top of my head, I apologize. You’ve made half here in the first quarter and you anticipate the second quarter being also very strong. Is that correct at least on the revenue side but not as much on the margin side? Is that correct?

Wahid Nawabi(CEO)

That is correct, Brian. So this is Wahid. You bring up a really good point which is absolutely as you heard from my remarks, we expect the second, third, and fourth quarters in terms of revenue to be roughly equal up to that of our first quarter. However, the profit margin on the second quarter and the remaining of the year has a significantly different picture than the first quarter, and it’s driven primarily by the following factors.

First, the mix of our revenue for the remainder of the year is quite different. We have lower margin product sales as well as a higher percentage of services contracts than product contracts that we anticipate to shift throughout the remainder of the year. Second, we also expect to increase our OpEx investments. Q1 was lower as we mentioned that to you guys last quarter.

And then third, our effective tax rate would also be higher for the remainder of the year. We benefitted from that on the first quarter, and that would not be the case in the remaining three quarters. So the combination of those three factors equates to a lower EPS for the remainder of the year, and we therefore reconfirmed our guidance of $1.10 and $1.40 for the full year.

Meanwhile analysts have started to figured out what the future holds, and have begun to cut future quarterly earnings estimates.  Price targets are well below the current stock price.

 

https://www.dailypolitical.com/2018/09/09/analysts-set-expectations-for-aerovironment-inc-s-q2-2019-earnings-avav.html

 

Previous VIC Write-up

AeroVironment was written up as a long report on VIC in May 2013 at a price of $19.98.  A contrast of valuation metrics between then and now is illuminating:

 

 

2013

Current

EV/LTM Revenue

0.91x 

7.55x 

P/E

14x 

109x 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

 

The stock should trade lower after the next earnings call (December 2018) when earnings begin to decline on a comparable quarter basis, or in anticipation of that call.

    sort by    

    Description

    AeroVironment traded up recently to a nonsensical valuation prior to and immediately following its latest earnings report on September 5, likely due to a combination of superficial market commentary (for example, Motley Fool, provided below and Zack's, which has had similar comments) and perhaps some algo trading (that focuses on parsing press releases without any context).

     

    I believe that the stock will decline for these very reasons after the next earnings call in December, when the current “good” news inverts to “bad” news.

     

    Business:

    AVAV designs, develops, produces, supports and operates a technologically‑advanced portfolio of products and services for government agencies and businesses. AVAV supplies unmanned aircraft systems (UAS – i.e. drones) and related services primarily to organizations within the U.S. Department of Defense and to international allied governments, and tactical missile systems and related services to organizations within the U.S. Government. AVAV derives the majority of its revenue from these business areas and believes that the markets for these solutions have significant growth potential. 

     

    From what I can tell, AVAV is not a particularly strong competitor in the UAS field – per the 10-K:  We believe that a number of established domestic and international defense contractors have developed or are developing small UAS that continue to compete, or will compete, directly with our products. Some of these contractors have significantly greater financial and other resources than we possess. Our current principal small UAS competitors include Elbit Systems Ltd., L3 Technologies, Inc., and Lockheed Martin Corporation. We do not view large UAS such as Northrop Grumman Corporation’s Global Hawk, General Atomics, Inc.’s Predator and its derivatives, The Boeing Company’s ScanEagle and Textron Inc.’s Shadow as direct competitors to our small UAS because they perform different missions, do not typically deliver their information directly to front‑line ground forces and are not hand‑launched and controlled. However, we cannot be certain that these platforms will not become direct competitors in the future. Potential competition from consumer-focused drone manufacturers could emerge as their capabilities increase and their prices remain low relative to existing defense solutions, which could result in some level of military consideration even if such drones do not meet traditional military performance or security specifications.

     

    Financials:

     

     

    Year Ended April 30,

    2019E

    2018

    2017

    2016

    2015

    2014

    (In thousands, except per share data)

               

    Revenue

    300,000

    271,052

    228,940

    233,738

    220,951

    208,810

    NI from continuing operations

    23,300

    22,576

    16,633

    15,393

    11,682

    25,659

                 

    EPS from continuing operations:

               

    Basic

    0.99

    0.97

    0.72

    0.67

    0.51

    1.14

    Diluted

     

    0.95

    0.72

    0.67

    0.50

    1.10

    Shares outstanding (basic):

    23,575

    23,471

    23,059

    22,936

    22,869

    22,354

    Shares outstanding (diluted):

    24,010

    23,814

    23,308

    23,153

    23,146

    22,719

                 

    2019E are AVAV management estimates, reiterated in the 1Q19 press release, and excluding EPS of $0.26 from a one-time litigation settlement.

     

         
     

    1 year

    5 year

    Revenue CAGR thru FY19

    11%

    8%

    EPS CAGR thru FY19

    2%

    -3%

           

     

     

    Valuation:

    AVAV currently has a P/E of over 100x.  Capex exceeded depreciation in each of the last three years, so free cash flow multiples are also high.  As of 7/28/18, the company had net cash and investments of $326 million, implying a current enterprise value of $2.25 billion for a defense drone company with $300 million in revenue and $25 million in net income, and the growth profile outlined above.

     

    Why?

     

    Some of the excitement was generated by the “good” performance in the fiscal first quarter ended 7/28/18.

     

    The market was excited by the first quarter earnings press release, which says:

    Revenue for the first quarter of fiscal 2019 was $78.0 million, an increase of 127% from first quarter fiscal 2018 revenue of $34.4 million. The increase in revenue was due to an increase in product sales of $36.5 million and an increase in service revenue of $7.1 million. 

    Gross margin for the first quarter of fiscal 2019 was $32.6 million, an increase of 275% from first quarter fiscal 2018 gross margin of $8.7 million. The increase in gross margin was primarily due to an increase in product margin of $22.7 million and an increase in service margin of $1.2 million. As a percentage of revenue, gross margin increased to 42% from 25%. The increase in gross margin percentage was primarily due to an increase in sales volume and an increase in the proportion of product sales to total revenue. 

    Income from continuing operations for the first quarter of fiscal 2019 was $14.2 million, an increase from first quarter fiscal 2018 loss from continuing operations of $8.1 million. The increase in income from continuing operations was primarily a result of an increase in gross margin of $23.9 million, partially offset by an increase in research and development (“R&D”) expense of $0.9 million and an increase in selling, general and administrative (“SG&A”) expense of $0.7million. 

    AND ….

    Earnings per diluted share from continuing operations attributable to AeroVironment for the first quarter of fiscal 2019 was $0.85 compared to a loss per share from continuing operations attributable to AeroVironment for the first quarter fiscal 2018 of $0.19. 

    What’s not to like?

     

    In an example of market commentary on AVAV stock, Motley Fool said on 9/6/18:

     

    https://www.fool.com/investing/2018/09/06/why-aerovironment-stock-just-popped-17.aspx

     

     From the above article:

    Expected to report $0.29 per share in profits for the first quarter of its new fiscal year, AeroVironment instead said it earned $0.85 per share. Sales for the quarter reached $78 million, which was also more than Wall Street had been expecting.

    So what

    AeroVironment had a tough time of things last year as its stock was dogged by short reports questioning its ability to grow its business and calling its valuation "nonsensical and distorted." The best way to respond to such short reports, however, is by proving the critics wrong -- and AV did that in spades last quarter.

    Q1 sales surged 127% year over year, and gross profit margins earned on those sales came close to doubling, up from 25% a year ago to 42% in fiscal Q1 2019, pulling AeroVironment up from an operating loss a year ago to an operating profit this year. On top of all that, proceeds from a beneficial litigation settlement added $0.26 per share to AeroVironment's bottom line, resulting in the aforementioned $0.85-per-share profit.

    Now what

    Expect more good things from AeroVironment as the year progresses. Backlog at the company (which will transform into revenues as the year progresses) more than doubled to $157 million by the end of the quarter, lending AeroVironment management confidence to make the following prediction:

    By the end of fiscal 2019, AV expects to have earned between $1.10 and $1.40 per share on sales of from $290 million to $310 million.

    Assuming this is how things work out, at the midpoint of those estimates, the company is on track to grow earnings 49% on sales growth of only 11%. No wonder AV's shareholders are thrilled. 

     

    However, the reality is that management did not change FY19 annual revenue or EPS guidance. The company had announced earlier in the year that revenue would flatten across quarters in FY19 compared to previous years, and it lived up to that outlook in the first quarter.

     

    The implications for the rest of the fiscal year are:

     

    EPS

    FY18

    FY19

     

    Q1

    -0.19

    0.59

    excl 0.26 from litigation settlement

    Q2

    1.14          total Q2-Q4

    0.25-0.55 total Q2-Q4

     

    Q3

     

    Q4

     
           

    Total EPS estimated by management

    0.95

    0.84-1.14

    excl 0.26 from litigation settlement

           

    Revenue

    FY18

    FY19

     

    Q1

                34.3 

                78.0 

     

    Q2

    236.8       total Q2-Q4

    212-232 total Q2-Q4

     

    Q3

     

    Q4

     
           

    Total Revenue estimated by management

    271.1

    290-310

     

     

     

     

    Over the next three quarters combined, AVAV expects to report total EPS of $0.25-0.55, compared to $1.14 in the last three quarters of FY18 combined.  Revenues will be down slightly.

     

    AVAV management explicitly confirmed this in response to a question in the 1Q19 earnings call:

     

    Brian Ruttenbur

    Okay. So you’ve made $0.85 in the first quarter but you only anticipate making another $0.35 to $0.60 whatever, you’ve made half – over half – I haven’t done the math or have it on top of my head, I apologize. You’ve made half here in the first quarter and you anticipate the second quarter being also very strong. Is that correct at least on the revenue side but not as much on the margin side? Is that correct?

    Wahid Nawabi(CEO)

    That is correct, Brian. So this is Wahid. You bring up a really good point which is absolutely as you heard from my remarks, we expect the second, third, and fourth quarters in terms of revenue to be roughly equal up to that of our first quarter. However, the profit margin on the second quarter and the remaining of the year has a significantly different picture than the first quarter, and it’s driven primarily by the following factors.

    First, the mix of our revenue for the remainder of the year is quite different. We have lower margin product sales as well as a higher percentage of services contracts than product contracts that we anticipate to shift throughout the remainder of the year. Second, we also expect to increase our OpEx investments. Q1 was lower as we mentioned that to you guys last quarter.

    And then third, our effective tax rate would also be higher for the remainder of the year. We benefitted from that on the first quarter, and that would not be the case in the remaining three quarters. So the combination of those three factors equates to a lower EPS for the remainder of the year, and we therefore reconfirmed our guidance of $1.10 and $1.40 for the full year.

    Meanwhile analysts have started to figured out what the future holds, and have begun to cut future quarterly earnings estimates.  Price targets are well below the current stock price.

     

    https://www.dailypolitical.com/2018/09/09/analysts-set-expectations-for-aerovironment-inc-s-q2-2019-earnings-avav.html

     

    Previous VIC Write-up

    AeroVironment was written up as a long report on VIC in May 2013 at a price of $19.98.  A contrast of valuation metrics between then and now is illuminating:

     

     

    2013

    Current

    EV/LTM Revenue

    0.91x 

    7.55x 

    P/E

    14x 

    109x 

     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise do not hold a material investment in the issuer's securities.

    Catalyst

     

    The stock should trade lower after the next earnings call (December 2018) when earnings begin to decline on a comparable quarter basis, or in anticipation of that call.

    Messages


    SubjectGrowth Driver?
    Entry09/12/2018 06:22 PM
    Memberchewy

    Thanks for the writeup. What has been the big driver of sales and why is this expected to slow?  Can you point to AVAV being on one large defense platform or program that is ending?   


    SubjectGuidance
    Entry09/13/2018 12:00 AM
    Memberjelly621

    Hi Ladera,

    Thanks for the interesting idea. Anything in particular you’ve come across that gives you comfort that this isn’t a case of mgmt just completely sandbagging the guide? 


    SubjectCongrats, you found a R2K tech stock where the valuation doesn't make any sense!
    Entry09/13/2018 10:35 AM
    Memberspecialk992

    Next level financial sleuthing.

    In all seriousness I don't think you understand the bull case whatsoever. After four+ years of churning, the stock price started to move up about 2 years ago and while a single lumpy positive quarter maybe caused the move from $88 to $111 the move from $25 to $88 before was seemingly caused by optimism over their Switchblade product addressing the governments LMAMs program. I suggest you do some work around this if you want to be short, AVAV has historically been the sole source provider of small observation drones for the U.S. DoD, but the Switchblade product actually delivers an explosive payload, given the fact that it would not be re-usable- no one wants to re-land a small drone with a missile on it- the TAM is potentially much larger than the TAM for the small observational drones.

    Don't get me wrong, I think this stock is a joke and driven by dumb thematic investing, but you need to understand the bull case if you want to be short a stock. The stock is not where it is because they financially outperformed in one quarter in a lumpy defense business.

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