DPRO - Draganfly: The Recent Spike In The Market Valuation Seems Unjustified

Summary

• In Q3 2022, Draganfly was losing $5 for every $1 of its revenues.
• Cash used in operating activities during the first nine months of 2022 was $9.24 million, and DPRO could run out of cash around the middle of 2023.
• The short borrow fee rate is 6.21%, and opening a small short position seems viable.
• However, the lowest available strike price for call options is $2.50, and it could be best for risk-averse investors to avoid this stock.

Introduction

In June 2022, I wrote a bearish article on SA about Draganfly (DPRO) in which I said that I didn't expect revenues for the full year to surpass the $10 million mark and that cash could run out by the end of 2023.

I was surprised to learn that this is among the best performing stocks on NASDAQ since the start of the year as the market valuation of Draganfly has more than doubled. In my view, the fundamentals of the company haven't improved, and I think this could be a good time to open a small short position as the short borrow fee rate is just above 6%. Let's review.

Overview of the recent developments

In case you haven't read any of my previous articles about Draganfly, here's a brief description of the business. The company has been manufacturing drones since 1998 which makes it the oldest commercial drone maker in the world. Its offering includes delivery, medical response, and rescue drones among others. Draganfly also specializes in the provision of contractor engineering services for military contractors and its offering includes flight services, and artificial intelligence and data solutions.

In case the name Draganfly sounds familiar to you, it could be because the company gained media attention in March when it announced an order for 200 medical response and search and rescue drones for delivery to a non-profit organization in Ukraine.

Draganfly is listed on NASDAQ, the Canadian Securities Exchange, and the Frankfurt Stock Exchange and its share price has soared by 107% since the start of 2023 despite a lack of any significant news.

Overall, the global drone market is rapidly growing and fragmented. According to data from Drone Industry Insights , the size of this industry is expected to reach $55.8 billion by 2030.

However, Draganfly hasn't managed to capture a significant market share despite having a first mover advantage and releasing several new models in 2022. Looking at the company's latest available financial results, revenues for the first nine months of 2022 rose by 16.1% to just C$6.29 million ($4.71 million). In addition, the growth could be coming from cross-selling opportunities created by Dronelogics, a reseller of lower-priced, third-party drones as well as other third-party products such as light detection and ranging (LiDAR) sensors which Draganfly bought in 2020. This potential boost to sales has already faded off as Q3 2022 revenues inched down by 1.1% year on year to C$1.88 million ($1.41 million). In addition, Draganfly is losing its position in the U.S. market and product sales came in at just C$1.36 million ($1.02 million).

I find it disappointing that revenues for the first nine months of the year were at this level considering Draganfly announced in January 2022 a minimum C$9 million ($6.75 million) manufacturing agreement for an AI consumer companion robot drone with a company named Digital Dream Labs. The latter was supposed to order at least 50,000 units annually with delivery starting in 2022. At the Q3 2022 earnings call , Draganfly Chief Operating Officer Paul Mullen said that the company expected to start seeing revenue from that partnership through early Q1 2023, likely with some sort of prototype or collector edition sale, which doesn't sound material to me. It's unclear when the scaling up into larger volumes will take place.

Looking at the income statement, Draganfly is in dire straits financially as revenues are lower than salaries and wages alone. In Q3 2022, the company was losing $5 for every $1 of revenues and I just don't see how it could turn things around anytime soon.

Turning our attention to the balance sheet, cash used in operating activities during the first nine months of 2022 was C$12.33 million ($9.24 million) which led to a slump in cash and cash equivalents to just C$11.72 million ($8.79 million) at the end of September 2022. At this rate, there could be significant stock dilution around the middle of 2023 as Draganfly runs out of cash. In my view, the company is overvalued from a fundamentals standpoint despite its market capitalization standing at just $56.3 million as of the time of writing.

Considering the fundamentals of Draganfly seem to have deteriorated since the last time I wrote about the company, I expect the share price to return to about $0.80 in the near future. So, how do you play this? Well, short selling seems like a viable idea as data from Fintel shows the short borrow fee rate is 6.21% as of the time of writing. The short interest is just 0.96% of the float, and it takes 0.43 days to cover, so the short squeeze risk seems negligible. However, hedging could be an issue as the lowest available strike price for call options is $2.50. It could be best to limit the size of short positions.

Looking at the risks for the bear case, I think there are two major ones. First, it's possible that Draganfly will finally start delivering larger volumes of products to Digital Dream Labs in the near future, which could provide a significant boost to revenues. Second, the share prices of microcap companies can sometimes increase for spurious and unknown reasons. This has already happened here in the past on a few occasions.

Investor takeaway

Draganfly's revenues are declining, and the company is running out of cash fast. Draganfly was losing $5 for every $1 of revenues in Q3 2022, and I think that the recent large increase in the market valuation of the company seems unjustified. In my view, the short borrow fee rate is low enough at the moment to make opening a small short position viable. However, the lowest available strike price for call options is $2.50. In my view, it could be best for risk-averse investors to avoid this stock.

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