We are moving into a new era of defense that will see the use of AI-powered military drones that can operate without human operators. And they are a huge source of U.S. government funding that will benefit various companies. Unmanned systems—that is, platforms in the air, land, sea, and space that operate remotely or autonomously using AI or some other form of pre-programmed technology—are becoming a growing focus for the U.S. Department of Defense, according to BTIG Vice President and Analyst Andre Madrid, due to increasing global interpersonal conflicts, the rise of AI technologies, and ongoing security efforts in the Indo-Pacific region. “The Department of Defense is currently undergoing a generational shift of its unmanned fleets… Recent conflicts in Nagorno-Karabakh, Ukraine, and the Middle East have demonstrated the invaluable impact of unmanned systems that extends well beyond the air domain,” Madrid said in a recent note, adding that the funding focus remains on both high- and low-tech systems. According to BTIG, the Department of Defense has requested $5.3 billion for unmanned systems in fiscal year 2025, with the majority of that for acquisition programs. The firm projects that total Department of Defense funding requests for unmanned systems will grow at a compound annual growth rate of 9.5% through fiscal year 2029. Most of those requests come from just one program: the Collaborative Combat Aircraft (CCA), a program embedded in the Air Force’s Next Generation Air Dominance initiative, which is designed to maintain U.S. air supremacy in future conflicts. The CCA aims to develop a new generation of AI-powered, lower-cost unmanned combat aircraft, also known as UCAVs or military drones, to operate alongside manned fighter jets and enhance their capabilities. The U.S. Navy is currently the biggest beneficiary of the Defense Department’s funding request because it is also the most expendant, with most of the money going to aerial drones and sea-based vessels, Madrid said. The U.S. Air Force, however, is expected to see the largest funding growth over the next five years, he added, noting that the Pentagon expects the Air Force’s unmanned funding to grow 34% annually between fiscal year 2024 and fiscal year 2029 — with that growth driven entirely by the CCA program. “The Defense Department is really thinking about how it can use unmanned technology and autonomy to do a lot more missions in the near future,” Madrid said. “A lot of people look at unmanned technology as just the hardware and forget to consider the brains behind it that could go into it, which is also a big focus of the Department of Defense… Traditionally, the Department of Defense has never really procured software on this scale.” “They’ve never really procured anything of this nature,” he added. Stocks Riding the Trend Madrid said companies likely to benefit from increased spending on unmanned systems include AeroVironment, General Dynamics, Kratos Defense & Security Solutions, Northrop Grumman and Lockheed Martin. Other analysts, including Morgan Stanley analyst Kristine Liwag, are more optimistic about the defense sector as a whole after it underperformed last year amid supply chain and inflation concerns, as well as worries about a decline in U.S. defense spending. “Defense could prove defensive in the current market environment as geopolitical tensions remain high,” Liwag said in a recent note. Major American weapons manufacturer Northrop Grumman is one of the main beneficiaries of this increased focus from the Defense Department, according to BTIG’s Madrid. Northrop has “strong expertise in the unmanned and unmanned aircraft sectors,” the analyst said, citing the Northrop Grumman X-47B and X-47, both demonstration aircraft that made their first flights in the early 2000s. Northrop could benefit from the Collaborative Combat Aircraft program as the Air Force considers how a CCA could work with Northrop’s B-21 Raider stealth bomber. It also allows the company to compete for upcoming CCA production contracts. (For the initial phases of CCA development, the Air Force chose defense startup Anduril and drone maker General Atomics over Northrop, Boeing and Lockheed Martin.) Still, Northrop has significant exposure to unmanned systems through several systems, including its autonomously operated, high-flying and long-endurance MQ-4C Triton unmanned aerial vehicle (UAV) built for the U.S. Navy and its RQ-4 Global Hawk unmanned aircraft system (UAS) in service with the U.S. Air Force. Madrid rates the stock a Buy and has a $565 price target, implying 11.5% upside from Friday’s closing price. That’s more bullish than the $520.35 consensus price target held by analysts surveyed by FactSet. Northrop’s shares are up about 8% this year and more than 17% in the last month alone. While Northrop is a larger, diversified player on the trend, AeroVironment is an “unmanned pure play” and the biggest competitor in the drone market for military applications, especially among publicly traded ones, Madrid said. “AeroVironment is kind of the dominant player. You can see that by the amount of international orders they’ve received for switchblades from both Ukraine and France and a number of other U.S. allies,” he said. Madrid has a buy rating and a $245 price target on AeroVironment, suggesting the stock could gain more than 28%. Analysts’ average price target of $204, meanwhile, implies potential upside of about 8%. Shares have roughly doubled this year. Kratos, on the other hand, has only about 20% of its business in unmanned systems, mostly target drones, with the rest focused on microwave electronics, missile testing, space training and other markets, Madrid said. He rates the stock Neutral – a position he believes could change if Kratos develops a larger program in the unmanned systems space. The company’s CEO confirmed during the Aug. 7 earnings call that Kratos’ Apollo drone is under contract and that its Athena drone is expected to be contracted later this quarter, which Madrid viewed as developments that could bolster his investment thesis for the stock. Kratos has also operated an unmanned, AI-powered combat drone, the Valkyrie XQ-58A, since 2019. The company has also expressed interest in bidding for upcoming CCA contracts. General Dynamics is another unmanned systems stock rated Buy by Madrid. It is one of the companies that could benefit from increased unmanned spending given its product portfolio that includes small and medium-sized unmanned underwater vehicles, unmanned S-MET ground vehicles for the U.S. Army, and littoral combat ships for the U.S. Navy. The Defense Department awarded multimillion-dollar contracts to General Dynamics, Lockheed Martin and Northrop Grumman late last year to secure parts of the Navy’s Littoral Combat Ship (LCS) fleet. Morgan Stanley’s Liwag is similarly bullish on the stock. It upgraded General Dynamics to Overweight from Equal Weight and raised its price target by $52 to $345 in an Aug. 9 note. It said the company has a “top-notch balance sheet and strong return on capital prospects.” Strong demand for its defense products, including ammunition and ground vehicles, also points to earnings growth potential, the analyst added.
