Drones: Doing the Obvious

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It is easy for those of us with a contrarian bent to make a basic mistake. While it is fun to point out when a move is overdone or when possibility overtakes reality, the search for such opportunities can often result in missing or ignoring the obvious. When two of the biggest, most successful companies of the last 20 years both appear to be embracing an idea I guess you could say that investing in that idea is obvious, but that doesn’t mean that it shouldn’t be done.

A few months ago it was revealed that Amazon (AMZN) was experimenting with drone delivery. Now, this morning, comes news that Google (GOOG) is doing the same thing. There are many who dismiss the idea of automated aerial delivery and point out the security, safety and logistical problems. On the other hand, if both Google and Amazon are prepared to spend money on an idea then I am inclined to believe there is something to it, and I certainly don’t want to bet against them. From an investing perspective, drone delivery doesn’t even ever have to become reality; just the prospect of it will drive some related stocks higher over the next few years, so some long term holdings in companies poised to benefit would seem wise.

When picking the best way to take advantage of the buzz (forgive the pun) that is coming, a couple of fundamental rules of investing should be borne in mind. Risk should, wherever possible, be diversified and hedged. Diversification is relatively easy; simply pick more than one stock to play the idea. Hedging risk can be a little more complicated. The ideal hedge is to include in your investment a stock or stocks that could still be winners even if your central theme doesn’t pan out. Drones offer such an opportunity.


The technology has, so far, found its real world application in the military, so those involved in that side of the business are by definition further along the curve. Sticking with the theme of recognizing the obvious, military drone producers who could easily adapt the technology for civilian use would be the first place to start. The two most obvious would be Northrop Grumman (NOC) and Lockheed Martin (LMT).

 

As you can see, both stocks have had an outstanding year and contrarians would naturally be looking for a reason to sell rather than buy, but we are looking for the obvious. The possibility of civilian drone applications may have had something to do with the performance of both stocks but it is more likely to be as a result of their core defense business. That basic function is what provides a degree of hedging, even if the civilian drone play peters out.

 Of course it is possible that humankind could be struck with a wave of love and understanding that would bring peace and harmony to the world and hard times to defense contractors. Alternatively nations could continue to wage war, or threaten to, and ongoing global economic recovery could result in less focus on military cuts thereby allowing politicians to pay enormous amounts to defense companies in return for jobs in their districts.  Which do you see as more likely? As I said, this is about the obvious.

As an added bonus, neither NOC (Forward P/E 12.73), nor LMT (Forward P/E 14.84) looks expensive, despite the gains over the last year.

The defense element, however, is also a negative for these stocks as a way to play a potential boom in civilian drones. Earnings fluctuations in that field could reduce or negate any impact that one’s central thesis has on the stock. There is also the risk that both Google and Amazon do proceed, but elect to build, rather than buy, their drones. Both are certainly big enough.

With that possibility in mind, an overall investment that includes a manufacturer of parts makes sense, and that is where IXYS Corp. (IXYS) comes in.

 

IXYS is a supplier of electronics to the industry, most notably power controllers and chipsets. There is also a hedging element to this company, as their products are used in robots, wearables and other electronic applications as well as drones. Once again, given the potential of the drone business, the stock is not particularly expensive at 17.4 x forward earnings.

Highlighting opportunities that are obvious and therefore not particularly original goes against my natural inclination, but when the possibility of a major transformation in the way we do business is staring you in the face you have to pay attention. Drone deliveries offer just that potential and, as obvious as allocating some capital to the idea may be, it is still a good idea.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , Technology

Referenced Stocks: GOOG , AMZN , IXYS , NOC , LMT

Martin Tillier


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