AeroVironment Inc.

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

AeroVironment is a technology solutions provider primarily engaged in the design, development, production, delivery, and support of technologically advanced, lightweight, hand-launched, and small unmanned aircraft systems (UAS) and unmanned ground vehicles (UGVs) for the U.S. Department of Defense and for other government agencies and industries.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

AeroVironment’s core business is centered around providing advanced tactical, logistical, and security solutions. The company’s products and services primarily cater to government and defense markets, presenting a very different dynamic than what you’d expect from a typical technology stock.

Business Overview:

Revenues Distribution:

AeroVironment primarily operates through three segments:

  • Unmanned Aircraft Systems (UAS): This segment is the most significant revenue driver, accounting for a large portion of their total revenue. It includes the sale of UAS, parts, services, and support related to tactical drones. Within the UAS segment the company provides a wide range of small unmanned aircraft solutions including the Puma, Raven, Wasp, and Shrike families.
  • Tactical Missile Systems (TMS): This segment is focused on tactical missile systems, which include small- and medium-range missile systems with precision guidance and strike capability. The company’s Blackwing product line is a major part of this segment.
  • Medium Unmanned Ground Systems (MUGS): This segment consists of robotic systems, including unmanned ground vehicles for logistics, detection, reconnaissance, and targeting capabilities. The company’s robotic systems help customers deal with all kinds of terrestrial dangers. The products under this category are typically less prominent than the UAS segment, but they are nonetheless an important element of the broader defense strategy.
  • Other: Services: Services are a smaller but crucial component of the overall revenue. They include training, maintenance, and other support services. This segment also supports the company’s other business segments and customers.
  • Revenues by Geography: Though Aerovironment has a presence in international markets, the vast majority of its revenues are generated from U.S. Government related customers.

Industry Trends and Competitive Landscape:

  • Growing UAS Market: The market for unmanned systems continues to grow rapidly because of increased adoption for a broad array of military, commercial, and security applications. The increasing use of unmanned systems in the military space is largely driven by the fact that these systems are effective in intelligence, surveillance, and reconnaissance (ISR), targeting, and security roles.
  • Rising Global Security Concerns: Global conflicts and political instability are increasing defense budgets and bolstering demand for security and defense-related solutions, including UAS and UGVs.
  • Technological Innovation: There is an ongoing need for cutting-edge autonomous capabilities, improved imaging, faster communications, and advanced AI in unmanned systems. This leads to constant development and upgrades of products to meet the increasing demands.
  • Intense competition: The unmanned systems and defense markets are competitive, which can lead to price pressure and an emphasis on product differentiation. With the growing popularity of the market, several large and small players are all fighting for a bigger share.
  • High Entry Barriers: The defense market has many entry barriers such as long sales cycles, specialized technology requirements, and difficult regulatory conditions. This leads to established players enjoying advantages over newcomers.

AeroVironment is unique because of its established relationships with the U.S. and allied government agencies, its long expertise in small, tactical unmanned systems, its focus on the high-end of the tactical market, and its dedication to creating leading technologies that address specific client needs.

Financial Analysis:

  • Growth: AVAV has shown strong revenue growth over the past year with a $10.4 million increase compared to previous year’s same quarter. The company’s focus on innovative products in an expanding market, especially within the defense sector, has translated well into increased business for them.
  • Margins:
    • The company’s gross margin has increased, standing at 31.8% compared to 30.9% from the previous year’s same quarter. This reflects an improvement in the efficiency of operations.
    • However, the company’s adjusted EBITDA margin declined, standing at 17.8% compared to 20.7% last year. This is mostly due to the increases in selling, general and administrative expenses (SG&A), as well as increases in R&D.
    • There was also a drop in the company’s operating margin this quarter, standing at 16.2%, compared to 18.7% in the previous year’s same quarter.
    • The overall margins are being impacted by increased material and labor costs.
  • Operating Expenses: * R&D spending continues to be a major expense, as expected of a technology company. This includes the development of new products, the acquisition of new technologies, and efforts to maintain competitiveness.
  • SG&A expenses increased due to increased headcount and operational capacity needed to fulfil the ever increasing orders.
  • Revenue Mix: The main revenue segment is from UAS and services. TMS and MUGS bring a much smaller proportion to the overall revenues.
  • Cash Flow: The cash flow for the quarter was positive, driven by the increase in orders and revenue.
  • Backlog: The backlog continues to increase, and now stands at $430.5 million, which represents the orders for future deliveries. This provides the company with a revenue base for the coming quarters, and acts as a good indicator of business strength.

The recent earnings report from the first quarter of the financial year 2024 was strong, with increased revenues and positive cash flow, however, the margins declined due to the company’s increased spending on expansion and R&D. Still, the backlog continues to expand, which points to a positive outlook and future earnings.

Balance Sheet Health:

  • Reasonably Healthy: Aerovironment’s balance sheet is reasonably healthy, as they are in a favorable financial position. The company has no debt to speak of, which means that is low risk for bankruptcy. They also have a healthy current ratio of 2.7, meaning they have sufficient short term assets to pay off short term liabilities.
  • Cash and Equivalents: Aerovironment maintains a good amount of cash and cash equivalents. This ensures that they have enough capital to finance their operations and R&D.
  • Inventory: The company does carry some inventory, which they will need to account for. They have been struggling with some supply chain issues, but management seems confident that this issue will be resolved quickly.
  • Goodwill and Intangibles: Goodwill and intangibles make up a significant portion of the total assets, primarily resulting from acquisitions. The value of intangible assets may be difficult to measure, since the company invests a large portion of their capital in innovative tech and research, and not fixed assets.

Moat:

AeroVironment’s moat can be described as narrow, mainly supported by a combination of factors:

  1. Intangible Assets (Proprietary Technologies & Brand Reputation): The company’s long history and expertise in small, tactical unmanned systems give it a competitive edge. They have acquired a certain level of brand loyalty and recognition amongst US government customers. The company’s ability to make highly reliable and effective products, and their ability to innovate also create barriers for potential competitors.
  2. Customer Switching Costs: For government customers and military contracts, switching to other providers can be extremely time-consuming and complex, as it means changing supply chains, equipment, and training protocols. This results in high switching costs and strong client stickiness.
  3. Economies of Scale and Distribution Channels: Over several years AeroVironment has built a large supply chain, manufacturing process, and distribution network which other newer players will struggle to create.

Given these points, AVAV has an economic moat, but not a very wide one, and is given a moat rating of 3 / 5.

Risks to Moat and Business Resilience:

Despite its advantages, AeroVironment faces certain risks:

  • Technological obsolescence: The rapid pace of technological innovation in the tech and military space could make their products obsolete and easily replacable by new upstart competitors if they do not keep innovating.
  • Government Contracts: A substantial portion of the revenues are derived from the US government. This reliance exposes the company to uncertainty arising from budget cuts, cancellations or delays in contracts, or major political shifts.
  • Intense Competition: The market for unmanned systems is becoming increasingly competitive. A failure to innovate or maintain price competitiveness could impact the company.
  • Supply Chain Issues: The company has experienced supply chain issues that could lead to delayed production and decreased margins.

Business Resilience: AeroVironment is well positioned for the short term, as it has a large backlog, recurring revenues from support services, and no debt. However, it must always stay ahead of new entrants and competing technologies to survive in the long run.

Understandability:

AeroVironment’s business is fairly straightforward and easy to understand: create and sell technology and related services, especially to governments and the military. What makes them different, however, is in the fine detail and technical analysis in the specific aspects of the defense industry and the technology space. Due to this complexity, it gets an understandability rating of 4 / 5.

Additional Notes:

AeroVironment, along with other companies in the defense sector, has seen its valuations boosted recently, due to increased demand caused by global instability. Investors have also been increasingly interested in companies that prioritize technology and innovation in order to maintain and grow earnings. However, they need to pay extra attention to the company’s earnings and margins, as this will be a primary focus going forward.

The company is actively working to expand its international footprint, reduce production costs, and create new revenue opportunities. The management is well aware of the long-term requirements to build a strong and sustainable business. The company has a unique proposition, and if it successfully executes its strategy, it can deliver solid returns over the longer term.