Futuristic Drone Stock Could Deliver 14% Profits

When you read this story, you may think I'm writing science fiction instead of a financial article.

Imagine, however, drone helicopters scuttling across the sky, bypassing crowded streets, landing seamlessly and dropping a parcel at your front door. And doing all that in 30 minutes from the time you made your online purchase!

While it may sound like something out of a Jules Verne novel, the Unmanned Autonomous Vehicle (UAV) is, in fact, nearly upon us.

In June, I described how Domino's Pizza (NYSE: DPZ) was looking at the possibility of using drone helicopters for pizza delivery.

On Cyber Monday, Amazon.com (NASDAQ: AMZN) announced it had developed a drone delivery service, called Amazon Prime Air. It aims to get you your package in less than an hour after you make the purchase. The only hitch is your package must weigh less than five pounds.

Amazon Prime Air plans to begin commercial operation as soon as the Federal Aviation Administration (FAA) has determined rules for testing, licensing and operating UAVs. It's expected regulations will be in place in 2015. 

One of the companies best-positioned to benefit is AeroVironment (NASDAQ: AVAV). A leading manufacturer of security-based unmanned aircraft systems (UAS) and electric transportation solutions, the company has a strong position in the existing domestic security and military market. It specializes in creating "flying security cameras" for public safety.

Currently, AVAV's main clients include agencies of the U.S. Department of Defense. The company is working with the Pentagon to develop a "Hummingbird drone." This stealth security device, which looks like an actual hummingbird, will be made to hover and watch a potential threat's every move. It's anticipated the airborne security camera will literally give a bird's-eye view and could eventually be used for surveillance in busy urban domestic settings.

AVAV's current surveillance drone, known as the Qube, fills a similar function. Weighing about five pounds, and costing $50,000, the drone acts as a video surveillance device, helping security teams, like police departments, document and capture crime scenes and events.

The company has already sold its drone security devices to over 20 countries and will likely continue to conquer new territory as the use of UAS security and surveillance increases worldwide.

From a technical perspective, the stock appears to be in the midst of an important bullish turnaround.

AVAV Stock Chart

After hitting a multi-year peak near $36 in July 2011, shares formed a major downtrend, losing more than half their value over the ensuing year and a half. In March 2013, AVAV hit an all-time low of $16.98.

Recovering from this low, shares formed a major uptrend and have showed strength ever since.

In October, the stock broke the major downtrend line. In doing so, it bullishly broke out of a large symmetrical triangle pattern, formed from the intersection of the uptrend and downtrend lines.

After breaking through the downtrend line, a steep accelerated uptrend line formed. Shares are currently trading near an almost two-year high. The stock is also well above the accelerated uptrend line, which intersects the chart below $28.

A strong shelf of support lies slightly below this level, near $27. This support level dates back to 2011. Important resistance lies near $34. However, between the current trading price near $30 and $34 resistance, there is little to stop the stock's ascent. If traders purchased shares now they could potentially capture about 14% returns before AVAV encounters significant resistance.

Watch the $34 level carefully; if AVAV can penetrate this barrier, shares could again approach their $40 all-time high, made in February 2009.

The bullish technical picture is supported by upbeat fundamentals.

For the upcoming fiscal third quarter, ended in January and scheduled to be reported in March, analysts project solid customer demand will cause revenue to increase 39% to $65.53 million from $47.09 million in the year-ago quarter. The revenue outlook is equally strong for the fiscal fourth quarter. Analysts expect revenue to surge to $72.59 million, a 34% increase from $54.11 million in the comparable year-earlier period.

For the full 2014 fiscal year, analysts anticipate revenue of $246.05 million, a 2.5% increase from last year's $240.05 million.

The earnings outlook is similar. For the fiscal third-quarter, analysts anticipate a nearly 18% year-over-year increase in earnings per share (EPS) to $0.20 from $0.17. In the fiscal fourth quarter, analysts expect earnings to dramatically turnaround from a loss of $0.32 per share in the prior fourth quarter to $0.32 this year.

For the full 2014 fiscal year, the company projects higher product demand will cause earnings to increase dramatically, reaching a range of $0.35 to $0.50 per share. The lowest end of this range represents a jump of 84% from $0.19 per share last year.

In addition, the company has a healthy balance sheet with $128.8 million in cash and no long-term debt. This liquidity should give AVAV the continued ability to develop innovative new products for a growing market.

Risks to consider: While AVAV is a leader in drone systems, the company's future success may be largely tied to government policy. Although the federal government has mandated the FAA to determine regulations for commercial drone operation by 2015, changes in this timeline could set the company back.

Recommended Trade Setup:

-- Buy AVAV at the market price
-- Set stop-loss at $26.79, just below important historical support
-- Set initial price target at $33.95 for a potential 14% gain by spring

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