AeroVironment Growing But Richly Priced

By Ryan C. Fuhrmann | September 14, 2011 AAA

AeroVironment (Nasdaq:AVAV) reported first quarter results on Wednesday after the market close that continued to demonstrate it is one of the few players growing rapidly in the defense industry. However, earnings growth has been more uneven and the stock trades at rather rich profit multiples.
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First Quarter Recap
Sales jumped 62% to $62 million. Management cited higher sales in both the Unmanned Aircraft Systems (UAS) and Efficient Energy Systems (EES) segments. The UAS unit grew 56.1% and made up the bulk of sales at roughly 84%. EES accounted for the rest and saw sales more than double. EES sells electric energy systems, including infrastructure for plug-in electric vehicles and solar-powered airplanes.

Total sales costs rose nearly 54% to $40.3 million while SG&A expenses increased a more modest 20.5%. R&D costs fell 5% to $7.6 million to account for more than 12% of sales. The end result was positive operating income of $429 million after a $7.3 million loss in last year's first quarter. Net income was also positive at $326 million, or 1 cent per diluted share.

Outlook
The company currently projects full-year sales between $321 million and $336 million and earnings in a range of $1.28 and $1.35 per diluted share. The current sales backlog was $72.7 million as of quarter-end, which was down from $82.9 million as of the end of April, but a $65.5 million contract from Puma systems has provided what management believe is "more visibility into full year revenue than at the same point in previous years."

The Bottom Line
Despite the more erratic quarterly profit trends, AeroVironment has reported positive free cash flow for at least the past three years. Last year, free cash flow came in at $23.3 million, or approximately $1.05 per diluted share.

AeroVironment is favorably positioned as one of the few firms to be growing rapidly in the defense industry. The winding down of major combat operations in the likes of Iraq and Afghanistan and defense spending cutback pressures in the face of overall budget cutbacks are making it hard for larger rivals including Lockheed Martin (NYSE:LMT), Raytheon (NYSE:RTN) and Northrop Grumman (NYSE:NOC) to grow their top lines.

However, these larger firms are still growing profits more consistently than AeroVironment. Additionally, they trade at very low forward P/E multiples in the high single to low double digits. In contrast, AeroVironment trades at a forward P/E of more than 22. The trailing free cash flow multiple is even higher at nearly 29.

Investors confident that AeroVironment's rapid sales growth will eventually translate into equally rapid cash flow growth will be unconcerned about these lofty multiples, but more conservative investors may find the risk-reward tradeoff favors the larger players in the industry. Looking at other opportunities, Elbit Systems Ltd (Nasdaq:ESLT) looks interesting at less than nine times forward earnings. Sales are growing rapidly, as are profits as the firm is focused on intelligence and related defense systems that are seeing less pressure from overall defense spending cutbacks. (For additional reading, take a look at Can Investors Trust The P/E Ratio?)

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