AeroVironment (AVAV): Revenue Growth Does Not Translate Into Corresponding Profit Growth

Introduction

AeroVironment (NASDAQ:AVAV) has benefited significantly from the conflict in Ukraine, which has fuelled demand for several models of its UAVs around the world. Many countries have seen the importance of drones and have dramatically increased orders. For example, it’s Switchblade and Puma, which can work in tandem. It can be assumed that as the conflict in Ukraine turns peaceful, the company’s orders will start to decline, which will pull down its financials as well. Modernisation in many armies will last for several years, but then there is always some kind of decline. From an investment point of view, the company does not look attractive. In normal life, attack drones are not expendable, so as the conflict in Ukraine fades, Backlog is likely to stop growing.

Future prospects and product development

In short, the company designs, develops, manufactures, delivers and supports a portfolio of robotic systems and related services for government agencies and businesses in the U.S. and abroad. The conflict in Ukraine and Switchblade’s success on the battlefield has accelerated the global trend toward greater adoption of barrage munitions. The product line for unmanned ground vehicles, or UGVs, reached record levels of performance. Like the TMS segment, UGV revenue more than doubled YoY, marking the best year for the division since its inception. Expect another year of growth for this business in fiscal 2024. Puma systems have again proven themselves on the battlefield and provide reconnaissance and support for all US-supplied artillery weapon systems. The TMS business product line represents a significant growth opportunity for the company. TMS’s total revenue for the quarter more than doubled YoY, but that’s just the beginning. However, AeroVironment has not been selected by the U.S. Army to continue work on FTUAS Increment 2, future tactical unmanned aircraft systems, also known as FTUAS. However, AVAV has submitted a request to the U.S. Army for further clarification on the reason for the denial. Company is confident that the JUMP 20 UAS is the most versatile and cost-effective solution in the Group 2 and 3 unmanned aircraft system market today, and will focus on meeting current customer needs. In this way, the company is trying to capitalize on the fighting and geopolitical tensions in the world as much as possible. As sad as it may sound, military action is the source of the company’s income.

Financials

Overall recent report was a mixed, where high adjusted profit was created by Goodwill write-offs, which is excluded from the calculation base. Revenue reached a new record high of $186 m$, +40% y/y. The improvement in revenue was due to higher sales of SUAS and TMS. These results reflect continued demand for Switchblade and Puma products. Gross margins declined slightly to 39% from 41% in the prior year. Adjusted EBITDA was $46 m$, +60% YoY, margin improved by 3 ppts to 25%. The main contributor to this increase was the growth in sales volumes, partially offset by higher selling, general and administrative expenses and investment in research and development. The increase was primarily impacted by $156 m$ of non-cash charges as a result of goodwill adjustments due to the revaluation of Medium UAS due to the Arcturus acquisition. In other words, almost 30% of total Goodwill was written off, which increased adjusted earnings but resulted in a GAAP loss of $6.31 per share. If we exclude the impact of the write-downs and one-time items, adjusted EPS is essentially flat YoY. Operating profit is deeply negative due to the aforementioned Goodwill impairment. Work in progress doubled YoY and set another record at $424 m$. This backlog was driven by orders of more than $750 m$ during FY 2023, reflecting strong demand from the Solutions, UAS and SUAS, and Tactical Missile Systems, or TMS, divisions. Cash flows are very weak, even excluding the reported quarter. Quarterly FCF ranges from a small minus to $20 m$, which is very little. The balance sheet is adequate, with zero net debt and Goodwill at 10% of the company’s capitalization.

Valuation

According to the multiples (look at the picture below), the company looks expensive – two or more times more expensive than the industry average. Compared to its peers, it is more expensive than all major defense companies and the only one that does not pay dividends. Yet have better growth rates and comparable profitability. On historical top ranges, the 3-year revenue GAGR is 14% and is expected to grow by 19% in 2023. However, we believe the company’s valuation is overvalued.

Potential risks

At the same time, profitability remains problematic, with revenue growth not translating into EPS growth in return, excluding Goodwill impairment and one-off items. The exclusion from the FTUAS (Future Tactical Unmanned Aerial System) programme is negative. Despite previously being confident in Jump 20 and participating in the competition, emphasising that it was the only company selected for all three phases of FTUAS, and ended up being the only company out of five not selected for the RQ-7B drone replacement competition. Naturally, the reasons for the exclusion are not disclosed, but they are usually fairly serious reasons related to either technical inadequacies or the inability to sufficiently scale the product.

Summary

From an investment point of view, the company does not look attractive to buy. With high multiples and slow growth rates will definitely lead to a decline in the stock. In addition, when the conflict or hostilities end, the company’s backlog will stop growing. The company is a beneficiary of combat operations, and in peacetime combat drones are not in high demand.