How to profit as drones prepare for take-off

Drones are no longer the sole preserve of the military. Backing firms exploiting their commercial potential could pay off nicely, says Matthew Partridge.

What do you think of when you hear the word “drone”? The chances are it’ll be something to do with security – perhaps the drone-guided missile systems that play such a key (and controversial) role in modern warfare. Or you might think of the recent security scare involving a drone that crash-landed in the grounds of the White House.

However, while military spending accounts for most of the estimated $6.4bn spent on drones last year, the commercial drone sector – which covers civilian and business-related applications for these Unmanned Aerial Vehicles (UAVs) – is growing fast. The technology is progressing so rapidly that both regulators and society are struggling to catch up with the privacy, security and safety issues raised.

This is, of course, pretty standard for new technology – widespread near-permanent access to the internet has raised many of the same issues, with the sheer convenience of the technology so far overriding the impulse to rein it in.

Some may understandably be worried about the prospect of an army of drones swarming the skies, but the trend is in favour of looser regulation. While the US has some of the strictest rules in the world, the Federal Aviation Administration (FAA) has recently released a draft of its revised guidelines.

The new rules would make it far easier for individuals and firms to get a permit allowing them to carry out regular drone flights. The FAA has also shown a willingness to compromise on some issues, such as a rule that demands the drone operator has line-of-sight to the drone at all times. The FAA estimates that around 7,000 firms will apply for licences once the new guidelines come into effect in 2017.

Other nations already adopt a light-touch approach, notably Japan and Australia. In Japan the only major restrictions are around airports, and the government is working closely with the industry. To encourage innovation, it is even considering turning part of Fukushima into a special “field test zone”.

As radiation has rendered much of the area off-limits to humans, it makes sense to use it as a location where makers of robots and drones can experiment to their hearts’ content.

In short, the commercial use of drones is only likely to increase in the future. This will affect a wide range of industries – and four sectors in particular.

Law enforcement and private-security firms are expected to take advantage of drones for surveillance. Farmers will use them to monitor crops. On the logistics front, several companies have plans to use them for deliveries. Finally, drones are becoming consumer goods in their own right, with a growing hobbyist market.

Logistics

In December 2013, Amazon unveiled plans to create a drone delivery service that could transport parcels of up to 5lb in weight at speeds of up to 50mph. If the service ever goes ahead, subscribers to its Amazon Prime service could receive orders in as little as 30 minutes after they press “buy”.

Six months before that, takeaway pizza chain Domino’s released a video showing a drone delivering pizza. Google has also invested in drone technology. Of course, these announcements are as much about PR as anything else – there are many regulatory hurdles to overcome. For example, the FAA recently forced a Minnesota brewery to stop drone deliveries to people fishing in a nearby lake.

However, in Germany, parcel delivery firm DHL has been steaming ahead. Around the time of Amazon’s headline-grabber, it was quietly starting tests on its own drone delivery service. Now it regularly transports medicines and other essentials to the North Sea island of Juist when the weather is too rough for more conventional transport. This service, which runs with the full approval of Berlin, uses autonomous drones backed by a human pilot who can take over by remote control.

Even if pure drone delivery ends up being blocked by regulators, truck maker AMP Holding has come up with an idea that uses drones to ease the workload of delivery people. Goods would be transported in special trucks, and drones used to carry parcels from the truck to the door. Another possible use is within warehouses. German researchers at the Fraunhofer Institute for Material Flow and Logistics are working on a system to allow mini-drones to check inventories with mobile scanners.

Law enforcement and security

Contrary to the impression you might get from the news, most drones run by the US military are primarily for surveillance, not missile delivery. The best-known is the ‘Predator’. This large, dual-purpose (surveillance and combat) drone can fly at heights comparable to smaller civilian jets for nearly two days. Predators have been used to gather intelligence around the world, most recently on the Iraq-Turkey border. At the other end of the size and cost scale, the military is turning to mini-drones, which can be used by ground forces to map out the immediate area.

This technology is now being adapted for use by civilian law enforcement. In America, the Department of Homeland Security has been using Predators for several years to tackle drug smuggling. As of last month, the agency had ordered nearly half a billion dollars’ worth of extra drones. More locally, several police forces have received permission from the FAA to operate surveillance drones – in some cases, buying surplus military units.

Perhaps surprisingly, opinion polls show that while the American public is generally wary of drones flying over private property, this reluctance disappears when drones are used by law enforcement.

According to an Ipsos poll conducted last month, two-thirds support the use of drones to fight crime, while just under half would be open to using them to keep track of their children – lending a somewhat sinister new meaning to the term “helicopter parenting”.

While the American approach is by far the most aggressive, the idea of using drones in police work is catching on elsewhere. The first drone-assisted arrest in the UK was made five years ago near Liverpool. Currently, three police forces have permission to operate them.

Even private detectives are getting in on the act, with several private surveillance firms receiving licences to fly craft. Meanwhile, the European Union has spent £320m on developing drones for use by member states’ law enforcement agencies. While plans to use drones at the 2012 Olympics in London were eventually vetoed on safety grounds, they played a key role at the World Cup in Brazil two years later.

Agricultural uses

As well as logistics and surveillance, drones could transform agriculture. Many farmers (especially in America) use light aircraft to dust their crops with pesticides. This is expensive – one 2010 study showed that more than $200m is spent each year on agricultural aviation in the state of Iowa alone.

It’s wasteful too, since it can be extremely hard to ensure the chemicals get to where they should be going. Flying at low altitudes can also be very risky – crop-dusting regularly makes lists of the “most dangerous jobs” in America.

This is why the University of California, Davis is working with the Yamaha Motor Corporation to develop crop-dusting drones. While America is only just waking up to the possibilities, Japan has used the technology for decades. Yamaha developed the first unmanned crop-duster, the R-50, as early as 1987.

It was approved for general use above rice fields in 1991. By 1998, Yamaha was selling a far more powerful model, the RMAX, which was simpler to control. Because of Japan’s high labour costs and hilly terrain, Yamaha can sell the RMAX at prices ranging from $86,000 for the simplest version to $1m for a fully autonomous system.

The possibilities go far beyond crop-dusting. Drones could enable farmers to get bird’s-eye views of their fields without using expensive satellites. This “precision agriculture” can help farmers target resources more accurately and spot problems before crop yields are hit.

One estimate from Dr Richard Baker of Indiana State University suggests that using drones in this way could slash pesticides and chemicals use by around half. Not only would this save money, but it would also improve crop quality and reduce the impact on the environment.

PrecisionHawk, a privately owned Canadian company, offers the first drone-based system that takes detailed photographs of farmers’ fields then collates them to produce a 3D map of the farm. The images are processed automatically to produce accurate data on moisture, crop length and other key variables. Interest in the package has been so high that the company is already looking to branch out into related sectors, such as mining and oil and gas.

Media and hobbyists

Until recently, the cost of drones limited their potential uses. But as the cost of the technology slides – even casual users can acquire basic models for as little as a few hundred pounds these days – photographers, filmmakers, and general hobbyists are finding ever moreapplications for them.

Most of the 300 firms currently allowed to fly drones in the UK, for example, are media or photography related. Sky is using them to help film the current Cricket World Cup in Australia and New Zealand. They were also used to capture footage during the Winter Olympics in Sochi.

In some cases, irresponsible use of drones by mischief-makers has caused problems. For example, last year, a football match in Belgrade between Serbia and Albania had to be abandoned after a drone flying the Albanian flag flew over the pitch in the first half, triggering rioting.

But aviation authorities and the policeadmit there is little they can do to stop individual users (as opposed to companies) and have focused on basic measures, such as keeping them out of sensitive areas.

The five stocks to buy now

On the drone hobbyist front, GoPro (Nasdaq: GPRO) makes digital cameras for extreme sports fans who want to take videos while skydiving or climbing. It has invested heavily in mini-drones (“quadcopters”) that can carry GoPro cameras, and is widely expected to announce a wider range of drone-related products soon.

It also plans to capitalise on its brand by moving into television production. Like many technology stocks, it trades on a huge price/earnings (p/e) ratio of 47. But explosive growth means this is expected to fall to 25.7 by 2016.

If GoPro continues to be successful, chipmaker Ambarella (Nasdaq: AMBA) should also do well – GoPro’s cameras account for around 25% of component sales. Ambarella also makes processing equipment for advanced security cameras, wearable technology and rear-view cameras (to enable drivers to see what’s going on behind them more easily).

Ambarella chief executive Fermi Wang wants his firm to become a key supplier to the drone industry as a whole. Sales are growing by around 67% a year, bringing the p/e down from 42 now to 22 within three years.

AeroVironment, Inc (Nasdaq: AVAV) produces several experimental aircraft for the American military and Nasa. While it produces one small-scale missile drone that targets individual enemy soldiers, its range of drones is mostly about surveillance, rather than combat – its best-known product is the AeroVironment Nano Hummingbird.

This drone, which takes its name from the fact that it looks (and flies) like a small bird, provides soldiers with an extended view of the surrounding area. AeroVironment is also developing drones to allow scientists to monitor the atmosphere.

London-listed Strat Aero (Aim: AERO) provides support and consulting services for the drone industry. It currently operates a training facility for American military drone pilots in Roswell, New Mexico. However, it hopes to expand its service to the commercial and law-enforcement side of the industry.

It is currently in advanced talks with the Dutch government to buildthe first training centre for drone pilots in northern Europe. Demand for such training should grow rapidly if governments force drone operators to get a licence. While current revenue is below $500,000 a year, it is growing very quickly.

One of the best punts on the hobbyist end of the market is French company Parrot SA (Paris: PARRO), known for the best-selling Bebop Drone, as well as a range of mini-drones. Parrot gets around half its revenue from car-related products, including Bluetooth kits, but broker Natixis thinks that strong competition is likely to force it to quit this business, allowing it to solely focus on drones. It trades at 13 times 2017 earnings, making it a relatively cheap play on drone technology.

• This article was first poublished in MoneyWeek magazine, and available to subscribers on 12 March 2015. Take a free four-week trial to read all our subscriber-only articles now.