Huge news for Rocket Lab investors

Rocket Lab USA (RKLB -4.44%) go to mars I mean that literally: the company just announced the completion of two planet-bound spacecraft on the Escapade mission for the National Aeronautics and Space Administration (NASA) and the University of California.

The mission is scheduled to launch in October and will study plasma and electric fields around the planet. Exciting stuff.

For Rocket Lab’s business, this mission will prove its capabilities as a supplier of custom spacecraft as it works to become a vertically integrated spaceflight company. With that news and other successful rocket launches with its tiny Electron rocket this summer, Rocket Lab’s stock has surged 30% in the past month as investors get excited about its potential growth.

Here’s what this Escapade mission could mean for Rocket Lab and whether the stock is a buy after surging 30% in August.

Demonstration of spacecraft capabilities for a key customer

Rocket Lab’s origins are with its small Electron rocket. The agile vehicle entered a launch market dominated by SpaceX in an area that lacked capabilities: small launch payloads. This allowed Rocket Lab to become the second major player in commercial launches, with the Electron taking off several times each quarter.

While this was a great development, Rocket Lab doesn’t necessarily generate significant revenue directly from launch contracts. For example, last quarter it generated total revenue of $106 million, but only $29.4 million came from launch contracts for the Electron rocket.

The other revenue comes from the development of spacecraft such as the Escapade mission. The company has built and purchased spacecraft manufacturing capabilities for commercial and government customers, valued at more than $720 million for current signed contracts.

Demonstrating its capabilities to NASA on this mission to Mars will not only generate revenue for Rocket Lab, but also serve as proof and marketing that the company can be a reliable supplier of spacecraft. My guess is that if the mission is successful, there will be an increase in contract signings in the coming years. This will allow it to further invest and expand its operations.

The next step: greater launch capabilities

The Escapade mission is launched on a rocket manufactured by Blue Origin, one of Rocket Lab’s direct competitors. In the long term, Rocket Lab would like to further vertically integrate with this mission.

This is why he builds the Neutron rocket. This second-generation rocket from Rocket Lab will have more than 40 times the payload capacity (the mass it can carry into space) compared to the Electron.

More payload capacity will allow Rocket Lab to expand its customer base and compete with SpaceX for launch contracts. Even better, the higher a rocket’s payload capacity, the more a customer pays for a launch contract. If the Neutron becomes a commercial success, it could lead to a gradual shift in launch revenue for Rocket Lab.

Neutron, now in development, will be expensive. That’s a big reason why the company burned through more than $150 million in free cash flow and $173 million in operating income over the past 12 months. Neutron is the key to Rocket Lab’s profitability, and its development is something investors should watch closely.

RKLB free cash flow; data by YCharts.

Take a measured approach to this risky stock

At a market cap of just $3 billion, there’s a lot of potential with Rocket Lab stock. Looking simply at its competitor SpaceX — which is valued at roughly $200 billion — there’s plenty of room for Rocket Lab’s market cap to grow if the business continues to grow.

Another way to look at it is the global space economy, which is expected to be worth over $1 trillion within a decade. With only a handful of competitors, Rocket Lab has a chance to capture much of that spending if it can continue to develop worthwhile rockets.

But that doesn’t mean Rocket Lab is guaranteed success. There is a risk that Neutron may experience major delays in commercial development. The company could face struggles with its spacecraft division if something goes wrong on the Escapade mission. With the space economy, nothing is a certainty. Your business can literally blow up in your face if things go wrong.

Considering both of these factors, investors who are bullish on Rocket Lab should make it a small position in their portfolio. That way, if the stock performs, it will become a larger position for you. But if it doesn’t and things go wrong, it won’t make a big dent in your fortune.