AeroVironment wins largest defense contract ever

We followed the manufacturer of military drones AeroVironment (AVAV -2.32%) for a very long time — since it was just a fledgling defensive stock after its 2007 initial public offering (IPO), in fact. And I have to tell you, in all that time, I’ve never seen AeroVironment win a defense contract as big as the one it won last Tuesday: $1 billion.

Well, $990 million to be exact.

The Aug. 27 edition of the Pentagon’s Daily Contracts Update placed AeroVironment at the forefront of the announcement, naming it the recipient of a $990 million contract with the U.S. Army “to provide an organic, long-range capability to dismounted infantry formations.” capable of destroying tanks, light armored vehicles, fortified targets, parades and personnel targets.”

How AeroVironment won the contract

The contest isn’t even over yet. Apparently this was a sole source contract where AeroVironment was the sole bidder. And the reason? While the language of the contract announcement is a bit vague, it appears to refer to a single item in the Pentagon’s arsenal — a weapon that only AeroVironment makes: the Switchblade 600 cluster munition system.

The Switchblade 600 launches from a tube, mortar-style, before extending its wings. It can fly at speeds of up to 125 mph and engage targets up to 25 miles away. The gun weighs 65 pounds — half of which is warhead. AeroVironment describes the Switchblade 600 as having “high-precision optics, over 40 minutes of wander resistance, and an anti-armor warhead for engaging larger, hardened targets at longer ranges.”

So while the Switchblade isn’t specifically named in the $1 billion contract, it seems pretty clear that the Switchblade is exactly what the military is buying.

What it means for AeroVironment

The end result is a big win for AeroVironment: a single contract worth more money than the company brought in in revenue for 2022 and 2023. mixaccording to data from S&P Global Market Intelligence and 38% higher than FY2024 revenue.

Of course, the Army’s new $990 million contract will be fulfilled in five years. (The completion date is August 26, 2029.) But even spread over half a decade, this contract has an additional $198 million in revenue per year, and should therefore deliver a 28% increase in revenue in just its first year of operation. — nearly twice the 16 percent revenue growth Wall Street was expecting.

At AeroVironment’s current net profit margin of 8%, that should come to about $0.59 more per diluted share, also on a year-over-year basis — and potentially more than $1 per share if production at scale allows AV to operate more efficiently and profit margins return. at 2019 levels. For a defense stock that earned just $2.18 per share last year, that’s a significant amount.

Is AeroVironment Stock a Buy?

But it is sufficient of a difference to make AeroVironment stock a buy? That’s where I’m a little less sure and feel a little hesitant to recommend the stock.

Consider: At $2.18 per share and a stock price of $192, AeroVironment currently costs 88 times trailing earnings. Add $0.59 to that earnings per share, and the stock would still cost more than 69 times earnings. Add a whole dollar and the stock costs another 60 times trailing earnings. Even at a 28% earnings growth rate, those valuations don’t come cheap.

Additionally, AeroVironment’s “earnings” may not be all they’re cracked up to be. Free cash flow (FCF) at the company, for example — cash profit — has been negative for the past three consecutive years. Of course, analysts expect AeroVironment to turn FCF positive in 2025, and last week’s contract win makes that outcome slightly more likely. But if the analysts are right, it won’t be until 2026 that the company approaches $100 million in real free cash flow. And with the company’s market cap currently over $5 billion, it’s hard to argue that the stock’s valuation would be cheap even then.

In short, this contract is great news for AeroVironment. But it needs to win even more contracts and grow its profits (and free cash flow) even faster before AeroVironment stock becomes an attractive buy.