Big News for the Future of Commercial Drones

Don't focus on the burrito-by-drone gimmicks that keep appearing in headlines -- there are huge, systemic changes quietly sweeping the commercial drone industry. In this episode of Industry Focus: Energy and Industrials, host Sarah Priestley and Motley Fool contributor Daniel Kline break down where the business-use drone industry is today, where it's headed, and what investors should know about buying in now.

Click play to find out details behind four of the 10 projects approved by the Federal Aviation Administration, and what they'll mean for the industry; some of the most exciting and useful applications we could see in the future; what hurdles drones still have to overcome before becoming the norm; and more.

A full transcript follows the video.

This video was recorded on May 24, 2018.

Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking Energy and Industrials. It's Thursday, the 24th of May. I cannot believe it's nearly the end of May already. We're going to be checking in on drones. I'm your host, Sarah Priestley, and joining me in the studio is Motley Fool contributor, big-time friend of The Fool, Dan Kline. Dan, how are you doing?

Dan Kline: I'm good. Like you, a little bit tired. Flew in this morning. You flew in yesterday from farther away.

Priestley: It wasn't so much the eight-hour flight home for me, it was the two-hour drive in traffic in D.C.

Kline: I understand. I flew in to Baltimore at 08:00 AM this morning, and had a delightful two hours to get to the office.

Priestley: Yeah, absolutely. We talk about toll road operators a lot on this show, and I experienced my fair share of tolls yesterday. Dan, thank you very much for joining me today. You pitched this show because you follow the industry quite closely. 

If you're unfamiliar with drones and you're listening to this, the strict definition is an unmanned aircraft that can fly without a human in control. But many people, including myself, say "drone" to mean any aircraft without an on-board pilot. You've probably heard some crazy stories about the future for drones. One recent headline that I saw is that Uber is kicking off a test program, which is kind of what we're talking about today, to make food deliveries in under five minutes. So, no more cold pizza delivery.

Kline: I think it's fair to say that drones are one of those topics that lend themselves to sensational headlines, and a lot of companies have capitalized on that. There have been, Domino's and Chipotle have both put out drone tests, which are literally buying a drone at a hobby store, taping a burrito to it, and doing it for publicity purposes.

Priestley: [laughs] Yeah, I was going to ask you, what are some of the craziest headlines or applications that you've seen?

Kline: Well, Chipotle did do a test on a college campus. The reality is, we're going to get into this later, that's probably going to happen at some point. But, there are a million hurdles -- well, not a million, but there's a lot of hurdles before that can happen. Right now, you've been able to buy a drone for 20 years at your local hobby store. I used to run a giant toy store, and people would buy drones and they would use them for aerial photography, probably for taking pictures they shouldn't be taking. 

It's always been sort of a complicated thing. There's no pilot, but they still had to be flown. As we move into commercial drones, it's going to be figuring out, are there pilots? Are they automated? It's really taking something that was just a toy and making it something that has commercial applications.

Priestley: Yeah, absolutely. As you've said, this tech, as we talked about, so sci-fi, but, it has so many practical applications, specifically for our sector in energy and industrials. Drones can be used in agriculture to monitor large farms, they have security and defense applications, which is a big part of the market right now, and maintenance and inspection of a lot of industrials like oil and gas, and bridge inspections, and things like that. In fact, last night, actually, I saw Chevron's keep DOERS doing TV commercial, and they were using a drone for an inspection purpose in one of those commercials. So, you're seeing it more and more. The size of the industry and range of the potential applications is pretty big. It's expected to get a compound annual growth rate of 19% between now and 2020, very soon.

Kline: Yeah. Right now, though, you're talking a very small industry that has the potential to be enormous. When you marry a drone to the Internet of Things, you theoretically have the ability to be more places than a person can be. So, you could be doing everything from inventory to security to checking to see if there's a leak in the back corner of your factory, and have it all be completely automated. Which, we're going to see those types of applications that don't involve flying over cities or bringing you a pizza. It's a little bit tricky for an airplane to bring you a pizza as opposed to an airplane reading RFID tags to know that you're low on inventory on, I don't know, stuffed teddy bears, and you have to order a crate of them.

Priestley: Yeah, absolutely. Just in case anybody at home doesn't know, Internet of Things?

Kline: The Internet of Things is the world of connected devices. It's basically everything from a smart refrigerator to the watch you're wearing that can send your doctor your heartbeat information.

Priestley: So, the total market size for drones, as you said, right now, is pretty small. For business solutions, which is what we're talking about today, rather than the more gimmicky things, is pegged at $127 billion. I think that might have been by a Bank of America study. So, yeah, a ton of applications, predominantly in infrastructure, agriculture and transport. As you said, it's not even 20 years ago that drones were this sci-fi concept. How much have modern drones that we're talking about using in these tests changed from what you were selling 20 years ago?

Kline: The test ones are absolutely more involved. When you look at the Amazon (AMZN -1.14%) footage of their theoretical delivery drone, it's super-duper high tech. A lot of what's being used out there now, though, in terms of testing, is really just an extension of the original high-end hobbyist. Not the $300 model, but the $900 model that hung on a high shelf in the store. It really is just a way to be more places. A lot of the uses right now are camera-based. There might be sensors, but it's just, there's a guy and he's looking at the field to see where things are. 

Absolutely, what you can add to your drone has changed, because not everyone used a smartphone when I was in the toy store business a decade ago or whatever it was. But, certainly, the underlying technology for the piloted drones is the same. And when you start getting into the unpiloted ones, of course, it's a leap.

Priestley: The whole reason that we're doing this today is because you've been closely tracking a lot of the behind-the-scenes goings-on with the regulation, and the Federal Aviation Administration, the FAA, has announced something new for us to talk about. The industry is heavily, heavily regulated, things like needing a remote pilot license from the FAA to use some of these drones. What other current regulations affect usage?

Kline: Basically, right now, drones aren't legal, except for, as you said, you need a pilot license, the drone itself has to be under 55 pounds, you need to be within line of sight of the drone, which dramatically limits its usefulness. Though, when you're talking something that has to be piloted, and I'm holding my hands like I'm carrying one of those controllers, if you can't see it, it's gone. So, that's more practical at this point. You're also not allowed to fly it near aircraft or near people.

Priestley: That seems sensible.

Kline: Well, it suggests, I could have your burrito delivered to a remote location where you could then go pick it up. It seems a lot less efficient than just driving to Chipotle. Then, they can only fly during daylight and below 400 feet. 

These rules were created basically with them saying, "We're going to have a hard line on this so nobody gets hurt, and then we're going to take proposals for how we push these standards." It's a lot like the autonomous driving market, where we know it's coming, we know there will be all of these crazy drone applications, but we need to set a framework for what they're going to be. So, let's start from, you pretty much can't use a drone, except in very controlled circumstances.

Priestley: And what are the key things that we need to overcome if we're going to make it a competitive market?

Kline: Have you ever been driving in a car and you see a helicopter and it's not a weather copter? Your brain goes to, "I wonder what's going wrong."

Priestley: Police.

Kline: Yeah, is that police? Is that the army? If there are drones buzzing above your head, you are going to think something is up. You have to figure out the parameters for making this common. At first, it's not going to be commercial, city usage. It's going to be in warehouses, in fields. Then, you're going to build out the pipeline for, nobody gets scared when a bus drives by, so, how are you going to identify what the drones are? How are you going to explain, yep, at 02:00 in the morning, is that legal? Or is it only during daylight hours? Well, that's not going to work for pizza delivery. 

So, really, this is building, it's a new method of transport, and you have to figure it out. I mean, helicopters are rare. That's why they surprise us when they're there. Nobody thinks twice when a plane flies overhead. You have to figure out how you get this from, "Oh, my God, is that a drone?" to, "Oh, OK, a drone."

Priestley: So, increasing comfort. And then, also, as you mentioned, the line of sight thing will be a huge deal. Right now, that's a big limiter.

Kline: Ultimately, these drones are not going to be piloted. Certainly, some of the agricultural uses, some of the security uses, could have a human that can take control or move it. But, when you're talking delivery or inventory or some of these other things, these are going to be automated. They're going to be GPS-based and programmed. 

So, you also have to figure out, how's that going to work? If, theoretically, Amazon is delivering to my door, are they dropping it via balloon? Are they literally knocking on my door? And then, could someone just walk up and snap it in half? They have to figure out all sorts of parameters for this. 

Again, it's really funny to think you could put a parachute on a bag of tacos and drop them. That's not going to work! [laughs] So, there's a whole lot to figure out from a practical, from a legal, and from a comfort and safety point of view.

Priestley: But these are the first steps toward doing that. The FAA has given the go-ahead to ten proposals from local state and tribal governments, which they then partner with private sector participants to safely explore further exploration around how drones will operate, as we've talked about. Apparently, they were inundated with projects.

Kline: They got 149 applications and picked ten. There was no standard for how many they were going to pick, and they actually could still, later on, approve other uses.

Priestley: These have all been approved just on the basis of the plans, but they haven't gone into detail on what will actually be involved. So, there's still an approval process to come.

Kline: This is an absolute hand-holding process, and you have to understand why. If I'm going to test a drone in a remote field, that's one thing. If I'm going to test a drone in a busy FedEx (FDX 0.11%) warehouse, and some pilot error or something goes wrong, these aren't small. Let's pretend it's a 54-pound drone. You could cut someone's head off with that. Having been around these things, they're not toys -- I mean, some of them are toys, but these aren't. So, they're being almost too careful, but if you look at it, we've seen in the driverless car industry, the statistics are overwhelmingly that they're safe, that they're much safer than regular cars. But if there's an accident, it's on the front page of every newspaper.

Priestley: It's a perception thing.

Kline: That's what they're trying to do here, is make sure that every I is dotted and T is crossed when it comes to safety.

Priestley: The first project I wanted to talk about is the University of Alaska Fairbanks project. They'll be looking at pipeline inspection in remote areas, specifically how harsh weather conditions affect drone usage. As an oil and gas enthusiast, the focus is on this aspect, it could be a game-changer because a lot of oil and gas operations are in harsh weather environments, specifically offshore rigs, desert environments that you have in, like, Saudi Arabia. I'm assuming this project will focus more closely on cold weather. Assuming. I don't know.

Kline: Wind.

Priestley: Wind, yes. But, hugely important, and very, very encouraging. Anybody that's worked in the oil and gas industry will undoubtedly have heard about health and safety accidents that arise from inspection because you're dealing, often, with highly pressurized, sometimes volatile commodities. So, yeah, absolutely, from a safety perspective, we could improve a lot. And the frequently having to access these pipelines is so difficult when you're talking about people, and the drone is going to expand that length that --

Kline: And, this test is more about drone engineering. These are not easy to fly in good weather. If you're talking, it's a storm, the human inspectors who check the various points can't go out, that's a heavy-duty drone you have to engineer. So, this is certainly not the public safety issue. These are generally remote areas where these things are being tested. This is much more about, can we create a drone that can put up with cold weather, the weight of snow and ice. I mean, your plane doesn't take off in extreme weather, so building a drone that can inspect a pipeline during height of a storm is a feat.

Priestley: And long-term for this, we're talking a few years down the line, there were a lot of companies like Total and pipeline operators Kinder Morgan and TransCanada that were already using this technology. But, it has the potential to save a huge amount, just because of the frequency of inspections. It can get safer for less cost, eventually, which is wonderful.

Kline: And it also has applications in, call it, municipal use. When power is out because we had a hurricane in Florida, which we tend to do all the time, you can't send people out until weather conditions are in a certain place. But if you could send a drone out and diagnose before you send the people out, in theory, you could be saving time. Every one of these projects, the goal isn't the specific project, the goal is to create a use for drones that can then be used in other areas with other companies.

Priestley: Yeah. The second project we want to talk about is the Memphis-Shelby County Airport Authority. They're working in partnership with FedEx, which is headquartered in Memphis. The drones will be used to inspect planes, deliver parts. Plane downtime for this company is a serious issue, considering that 60% of its revenue comes from air shipping. But, as you said, it opens it up to other applications for this, and you can't help but think delivery when you hear FedEx.

Kline: Yeah. And the word delivery. Obviously, for FedEx, and extend it to Amazon, last mile delivery is the ultimate prize when it comes to drones. So, the delivery tests are going to be very specific. Business-to-business. They're not delivering plane parts to your door, they're more likely delivering plane parts from a warehouse to the plane. But, it's the first steps of testing this for the practicality of it. Your drone shows up with the piece of the wing that's missing, how does that work? How does the guy take it off? How does he account for it all? So, you're starting to see the framework with this test.

Priestley: Notably, Amazon wasn't included in any of these projects.

Kline: I question that. Amazon's application -- they did apply -- was for testing delivery in New York City.

Priestley: That's ambitious. [laughs] 

Kline: They had to know that that wasn't going to get approved. Amazon has been supportive of the FAA's efforts, they continue their own private testing of drones. I believe they've tested drone delivery in England. So, I think this is one where, given the current political climate, Amazon threw its hat in the ring knowing it was going to lose and will probably be supportive of, and perhaps involved with, some of these projects, even though they're not the main company.

Priestley: OK. The third one that we want to talk about -- and as I said, there are ten, we're just touching on four today -- is the Kansas Department of Transportation. They'll be studying applications for BVLOS. I'm not sure if there's a better way to pronounce that. It means beyond visual line of sight. Which, as we've talked about with the line of sight rules, it would be a huge change. 

They're testing a variety of applications, but one that's interesting for me is the precision agriculture application, which is to use drones to measure, observe and correct variabilities found in crops. This is technology that's actually been used for years in Japan, in the rice fields. It's to allow farmers to, a farmer can't always see, from the top down, what his vast area looks like. This is to address these areas of low productivity. You can have patches where the soil composition may not be quite right, or some other pest has gotten into the crop. Then, they can address the issue. This market specifically, just the agricultural element is suspected to be worth about $32.4 billion.

Kline: This is going to be the area where approvals come fastest. You're not talking populated areas. Yes, your drone goes crazy, it takes out a small section of your crop, that's probably pretty trivial compared to the upside of it.

Priestley: Yes, absolutely. Risks are lower, the operating area is huge, and the upside is potentially great. Pesticides, looking at doing water sample testing, soil sample testing, pesticides, has a huge amount of applications that could be, really, a great time saver and efficiency driver in agriculture.

The last project we wanted to mention is that AT&T is involved working with the city of San Diego in California. They will test 4G LTE cellular network and AT&T's FirstNet, which is the new national public safety network, I think. They're doing other things, as well. In San Diego, they're looking at border protection, delivery of packaged goods, international commerce, the smart city, Internet of Things that we've been talking about.

Kline: This is the most wide-open of all the proposals. It basically says they're going to do everything. When they say 5G and 4G, what they mean is, when you go to, say, a football game here, AT&T will sometimes have, it's usually a blimp, a small blimp, that will be giving added capacity so the network doesn't get overwhelmed. Of course, there are stadiums that have that built in. But, when you have something at a place where it normally isn't as crowded -- let's say a fairground -- that's the type they'll be testing. This is already being done, it's just being done with things that are tethered. So, this is going to give you the capacity to have that.

Everything else on here is wide open. Testing delivery of packages in a city is pretty much as close to what Amazon and FedEx would want. I think we're going to see some very slow rollout on that, whereas the 4G and 5G, as long as you can prove that it's going to stay in the air, I don't think it's all that different from having a tethered flying device.

Priestley: Yes, absolutely. Applications in developing nations, too, could be huge, in terms of bringing connectivity to areas that don't have it.

Kline: And, again, bringing up storms. I think you remember, last year, we had our big hurricane. I had planned to work through it, then realized that all of the cell towers were down. Even though we had no power, I had assumed, "Oh, I'll have internet through my phone." Absolutely nothing. So, it would be very easy for AT&T to go, "OK, here's this. Let's get a drone up in the air." And that's going to save lives. When you look at some of these areas globally that have been devastated by weather, the ability to very quickly restore cell service or even internet service ... And, again, those are going to be things where the reward is significantly bigger than the risk. So, you'll see that kind of thing approved pretty quickly.

Priestley: Absolutely. I'm sure people listening might be interested in how they can sort of get a piece of this nascent technology. It's kind of difficult. There's not many pure-plays that are publicly traded. For example, DJI, which is a big drone maker, they're private. But, there are ways that you can get a piece of the pie through other companies that are operating in it.

Alphabet has a subsidiary that's working on a lot of drone technology. I'm going to pronounce this incorrectly, AeroVironment makes drones for military applications. Similarly, Northrop Grumman and Lockheed Martin also offer military and defense application drones. Boeing has a subsidiary called Insitu, which is a big player in the medium-sized drone market. But, obviously, it's difficult, because that's not a pure-play. You're getting access to a lot of the different things, and it's not really contributing very much to the income, at the moment, of a company like Boeing.

Component makers like Ambarella are another way into the industry, but I'm definitely stepping on Dylan Lewis of the Tech show's sphere of knowledge with that. But, at the moment, it's kind of difficult to invest purely in drones. But, it's something that people should bear in mind.

Kline: Yeah. It's an emerging technology, not in terms of the actual technology, but in terms of how you use it. In theory, buy Amazon and FedEx, those are going to be the people who benefit. But, again, it's going to be one spoke in the wheel for those companies. You said it best, not an easy way to invest.

Priestley: No, absolutely not. There's a ton of private companies that are doing amazing things like delivering medicine to places, and a lot of the things that we've talked about, in terms of weather, helping in disaster zones. But they're private. So, it's a wait-and-see thing, but it's definitely worth talking about. It's definitely worth being aware of, particularly in this sector, because, as you said, the Chipotles of the world get the headlines for delivering a burrito, but it's really applicable in this industry.

Kline: It's a timetable thing. Again, like driverless cars, this is coming. You are absolutely going to get a pizza, a burrito, whatever it is, Chinese food -- it amazes me, by the way, that they're going to figure out how to deliver these things via drone, but not how to create a material where you get them and it's as good as if you ordered at the restaurant. It's still going to show up in Styrofoam and the fries are going to be soggy. 

But, it really is a question, and these projects are going to start to create a path toward actual application. And it may happen very quickly as some of these things start to work, or it may not. They may be a lot of pushback once you start getting into populated areas. Again, I don't see how you have drones buzzing around New York City without people getting freaked out pretty fast.

Priestley: Yeah. So, a lot to overcome, but hugely interesting. Thank you very much for joining me today, Dan!

Kline: Thank you for having me!

Priestley: That's it from us today. If you would like to get in touch, please feel free to email us at [email protected], or tweet us on Twitter @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thank you to Austin Morgan --incidentally, a drone user himself -- for producing the show. For Dan, I'm Sarah Priestley. Thanks for listening and Fool on!