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Dollars and Drones

For some, the idea of electric drones buzzing overhead is downright dystopian. Science fiction teaches us that these “eyes in the sky” are the foundation of surveillance culture. They can follow us everywhere we go, and there is nothing we can do about it, asserts growth stock expert John Markman, editor of Pivotal Point.

But to business leaders, they represent cost efficiencies. Amazon.com (AMZN) CEO Jeff Bezos began talking about drones in 2013. Amazon Prime Air, a separate subsidiary, started working with NASA to develop an air traffic management system.

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The big idea was to fly next-generation drones at low altitudes, 400 feet or less, in locations that that were not accessible by road or fixed routes.

The FAA granted the Seattle, Wash., e-commence giant permission in 2015 to begin testing a prototype. The wild idea of flying parcels seemed imminent.

However, Amazon has never been able to push its concept across the finish line with regulators. Controlling hundreds of drones at once, the strength and speed of the operating network and the drones’ susceptibility to strong weather shelved any hopes of commercial release.

But recently, executives at UPS (UPS) got there. The agreement with the FAA is the first of its kind, setting the stage for the Atlanta-based logistics company to set up fleets of drones and pilots on the ground.

Its Flight Forward subsidiary will begin with the shipment of medical supplies and specimens across various campuses in North Carolina. CEO David Abney says the operation will grow to 100 or more hospital complexes within months.

As the expansion unfolds, managers expect drone delivery for UPS packages to become a reality for rural communities that are difficult to service conventionally.

While progress from trial-run to standard service is pretty straightforward here, the play for investors is less direct.

UPS is a giant company. Drone delivery will play a very small role in future sales and earnings. And while being the first mover is an advantage, it’s going to take some time for this to be reflected in the share price.

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In the interim, the best way to invest in the development of commercial drones is through the companies providing the components.

In September 2017, Heico Corp. (HCI) acquired AeroAntenna Technology, which makes high-performance active antenna systems for the defense industry and commercial aircraft.

The press release for the acquisition noted the deal was the largest ever for the niche-market aerospace contractor. But managers at Heico saw a big, new market on the radar.

The Hollywood, Fla., company has been a consistent grower because managers has always been two steps ahead of competitors when moving into new markets. AeroAntenna allows Heico to become an instant player in drone subsystems.

The company is growing annual sales in the middle teens. Revenues reached $1.8 billion in 2018, up 16.6% year-over-year. At the same time, managers have maintained gross margins of 40%, and operating margins above 20%.

This story is similar to what is transpiring at Sony (SNE) at it’s image sensor business. Today, the Japanese consumer electronics company has 50% market share in the sensors found in cameras, smartphones and commercial drones.

Its scale, substantial intellectual property portfolio and best-in-class devices limit competition. It’s simply more cost-effective for companies to buy the sensors from Sony than build their own custom units.

All this is coming at an opportune time. As commercial drones move from testing to reality, a new market for those sensors will take shape. An important piece of the future of logistics is up in the air. It’s time for investors to begin taking stakes.

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