The rules of modern warfare are changing quickly. Traditional
battle lines have been replaced by global terror networks with no
boundaries or state affiliations.
That's one of the biggest reasons for the huge growth of the
unmanned aerial vehicle (UAV) industry, with U.S. spending
jumping to $5 billion from $550 million in just the past 10
But looking forward, it's not just the military that is
unlocking the incredible potential of drones. Law enforcement
agencies, homeland security and the private sector are all
driving an incredible boom in the drone industry that is still in
the very early stages. That has the Federal Aviation
Administration predicting the global drone market could grow to a
staggering $90 billion in less than a decade.
But while the drone industry is set to benefit from surging
demand, some of the best technology is coming from the major
defense contractors, where drone-segment revenue can be buried
among other larger divisions. That makes it challenging for
investors to find a pure play investment in this high-growth
That's why I'm bullish on a little-known defense company that
has a big portfolio of industry leading drone technology and
systems. That has given shares a big boost, up a market-beating
26% on the year after surging 15% in the last month.
Unlike large defense contractors -- some with market caps
above $50 billion --
Elbit Systems (Nasdaq: ESLT)
is small, with a market cap of just $2.2 billion. Through a
series of mergers and acquisitions, Elbit has grown to own 90% of
Israel's non-state-owned defense sector. Elbit is also a major
supplier to the U.S. government, with 28% of its $703 million in
second-quarter revenue coming from North America.
Elbit is a major player in the global drone market, with its
Hermes 450 the serving as the foundation of the unmanned
inventories of Israel, Great Britain and other countries.
But Elbit isn't content to focus on just the U.S. and Israel.
The company has been moving aggressively to expand its global
footprint and cash in on high-growth opportunities in emerging
Elbit recently said it has teamed up with Sharp Aviation, a
South Korean company, on a jointly owned venture called Sharp
Elbit Systems Aerospace (SESA). The new company will supply
avionic systems to the South Korean military; as a Korean
company, SESA will also be allowed to offer its products and
services to foreign suppliers and OEMs (original equipment
Elbit has a 19% stake in the new venture with an option to
increase its share to 50% as well as a great platform to tap into
high-growth Asian-Pacific markets, which currently accounts for
19% of total revenue.
Elbit is also tapping into South America with an emphasis on
Brazil. In April, Elbit said it had won a contract to supply
electro-optic observation systems to a Brazilian defense
contractor focused on border technology. Although the amount
won't have a huge effect on Elbit's bottom line, it paves the way
for additional investments in Brazilian assets and
But it's not just the growing demand for drones and drone
systems that Elbit is cashing in on. The company is also seeing
strong demand from domestic and international law enforcement
agencies. That was on display in August when Elbit announced a
$32 million contract with the Australian Federal Police to supply
an investigation, intelligence and incident management system set
to be deployed over four years.
Elbit is also leading the way in unmanned ground vehicles
(UGVs) in its partnership with Israeli Aerospace Industries. The
strategic collaboration has Elbit applying its market-leading
aerial technology to a new class of machines in a virtually
Elbit is also unique because in addition to producing some of
the industry's most popular drones, it also sells electronic
control and management systems to third-party manufacturers. That
provides the company with additional revenue diversification and
reduces product-specific risk.
The string of new markets, technology and deals has increased
Elbit's order backlog by $340 million in the past 12 months, to
$5.8 billion. Nearly 60% of that is expected to be processed in
the rest of 2013 and 2014, with the balance set to be completed
Elbit has also been strengthening its financial profile, with
cash and equivalents holding steady above $200 million while
long-term debt has been cut by more than $300 million to $536
Risks to Consider: The biggest threat to Elbit and other
defense contractors is reduced defense spending in the U.S. and
Israel. Although defense spending continues to fall, Elbit's
strategic emphasis on unmanned technologies and emerging
markets should help insulate it from the biggest cuts.
Action to Take -->
Elbit Systems is cashing in on the bullish trend in drone
technology. But in spite of a 29% gain in 2013 and surging
estimates, shares still look undervalued, with a forward
price-to-earnings (P/E) ratio of 10 times below its 10-year and
peer average of 14 times. If Elbit simply traded with the same
multiple as its peers, share would jump to $76, a 40% gain from
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