June 29, 2022
  • June 29, 2022

NASDAQ Clean Edge Smart Grid Infrastructure ETF for your portfolio

By on May 14, 2022 0

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According to SmartGrid.gov, the electrical grid began to be built in the 1890s and over the years has been improved as technology has advanced. Today, over 9,200 generator sets with over 1 million MW of generating capacity are connected to over 300,000 miles of transmission lines. Much of this expansion has been on a regional and disparate basis. Today, the power grid is stretched to capacity not only by its historic disparate nature, but by the transition to intermittent renewable power generation as well as increasing demand for electricity from electric vehicles as well as by growth in demand driven by increase in population, demand from industry and increased use of electronics due to digital transformation. In the future, a new type of power grid (i.e. a “smart grid”) is needed: a grid designed to support renewable energy generation, increased demand due to electric vehicles, and that can automate and manage the growing complexity of generating and delivering electricity in the 21st century. This is where the First Trust Clean-Edge Smart Grid ETF (NASDAQ: GRID) Between.

Investment thesis

A 21st century “intelligent grid” must enable:

  • Efficient transmission of electricity
  • Rapid restoration of electricity after electrical disturbances
  • Reduce costs for utility companies and electricity costs for consumers
  • Integration of large-scale renewable energy systems
  • Integration of two-way consumer-owner renewable energy generation systems
  • Increased capacity to support increased use of electric vehicles and electronics
  • Improved security

All of these requirements will drive increased demand for all of the electrical components that will actually make the smart grid a reality. These include common but often overlooked widgets such as transformers, relays, fuses, circuit breakers, switches, and power quality monitoring and metering devices – just to name a few- one. These are exactly the components provided by the companies held in the GRID ETF.

And remember, it’s not an infrastructure problem in the United States. Per capita, the United States continues considerably delays China and the EU in terms of adoption of electric vehicles. However, significant national spending will be required if the market share of electric vehicles reaches the 50% of new vehicle sales expected by 2030. Also note that most of the companies held in the GRID ETF portfolio have strong ESG policies as they fully align with the solutions they offer as well as the fact that globally adopting strong ESG policies to help mitigate the worst impacts of global warming would lead to strong growth for most of these companies.

So let’s take a closer look at the fund and see if it would make sense for you to allocate capital to it.

Top 10 holdings

The top 10 holdings of the GRID ETF are shown below and correspond to what I consider to be a relatively concentrated concentration of around 59% of the entire portfolio:

GRID ETF Top 10 Holdings

First Trust

I have no problem with such a high concentration as investors still enjoy excellent diversity in the sector, but let’s face it: the electrical component supplier sector is dominated by a handful of companies, and this fund holds all the big ones.

Take outfit #1 eaton (ETN) in which the fund has an allocation of 8.4%. Eaton, headquartered in Dublin, Ireland, is a global leader in energy management. The Company’s Electrical Americas & Electrical Global segment manufactures electrical and utility-scale power distribution components, residential products, wiring devices, circuit protection products, power reliability equipment, power, emergency lighting, fire detection, explosion proof instrumentation and structural support systems. ETN also operates an Aerospace segment as well as an eMobility segment (see chart below). The eMobility segment manufactures a plethora of components for the automotive and electric vehicle industry: voltage inverters and converters, fuses, chargers, circuit protectors, vehicle controls, power distribution systems, fuel tank and commercial vehicle hybrid systems.

Eaton Business Lines

eaton

ETN is currently trading with a forward P/E of 18.8x and yielding 2.3%.

Schneider-Electric (OTCPK:SBGSF) is the #2 position with a weight of 7.8%. Schneider is losing 2.6% and has a TTM PE of 20.8x. Seeking Alpha contributor Stephen Simpson thinks the recent pullback in Schneider shares is an opportunity for investors (see Schneider Electric stock slips as investors dim the light on electrification and automation).

Schneider operates two segments: Energy Management and Industrial Automation. The company is one of the world’s leading suppliers of circuit breakers and switches, protective relays, electrical protection and control products, energy management software solutions, transfer switches, protection products surge protection and power conditioning. The company also provides power monitoring and control products, power quality and power factor correction products, pushbutton switches, distribution boards and mounted electrical panel enclosures. on rack.

Holdings #3 and #4 – ABB (ABB) and Johnson Controls (JCI) – are similar to the first holding companies in that they are the world’s leading suppliers of electrical components and systems. From my perspective, the top 4 holdings of the GRID fund are the dominant global companies operating in the large-scale electrical component industry. Unsurprisingly, given GRID’s top 4 holdings, the entire portfolio composition is skewed in favor of electrical component manufacturers:

Composition of the GRID ETF portfolio

First confidence

Outfit #5, Aptiva (APTV) has a 6.5% allocation and is a bit different compared to the top 4 holdings. Aptiv focuses on security technology components and solutions for the automotive and commercial vehicle markets. It operates in two segments: Signal & Power Solutions and the Advanced Safety & User Experience segment. Aptiv is expected to show significant improvement in earnings this year:

Aptic Revenues and Profits

Looking for Alpha

Farm No. 10 with a weight of 3.9% is Enphase Energy (ENPH). Enphase designs home energy solutions for the global solar photovoltaic market. The company’s hallmark is its semiconductor-based microinverter. The microinverter converts energy at the individual solar module level into useful electricity at the home and utility level. ENPH also provides proprietary software and networking technologies for cloud-based energy monitoring and control services. Enphase also offers battery storage systems.

Performance

As mentioned in the bullet points, GRID has underperformed the S&P500 for the past 12 months, but has significantly outperformed the S&P500 for the past 3 years:

Chart
Data by YCharts

As can be seen in the chart above, the GRID ETF also significantly outperformed the Utilities Select Sector SPDR ETF (XLU). Looking further ahead, the GRID ETF has a strong 10-year average annual return of 13.45%:

GRID ETF performance history

First Trust

Risks

The GRID ETF could be affected by all the normal macro-environmental risks of the day, including high inflation, higher interest rate outlook, COVID-19 lockdowns in China leading to weaker global economic growth and a supply chain disruption, Putin’s horrific war of choice in Ukraine, and the resulting sanctions imposed on Russia by the United States and its Free Democrat allies. Each of these risks alone could lead to weaker economic growth, while together they could lead to a global recession (or worse).

The GRID ETF has a high expense ratio of 0.63%. This is fine when the fund was outperforming, but such a high expense ratio could significantly reduce investor returns in a slower global growth scenario.

Meanwhile, and despite relatively attractive returns from some of the top holdings, the fund as a whole has only generated income of 0.88% over the past year (ending 04/29/2022). The takeaway here is that the primary investment opportunity in GRID isn’t income – it’s capital appreciation.

On the other hand, GRID could be seen as a relative value against the overall market:

GRID ETF Valuation Metrics

First Trust

GRID’s price-to-book ratio of 3.1x compares very favorably to the S&P 500 4.0x.

Summary and conclusion

While I appreciate the investment thesis behind the GRID ETF’s fundamental outlook, the relatively high expense ratio worries me given the risks in the current macro investment environment. That being the case, I’m going to give GRID a HOLD. However, as I mentioned in my recent article on portfolio management in volatile times (See “The Four Horseman”), I would try to take advantage of market volatility to, perhaps, pick up the GRID ETF “on sale”. Anyway, given the daily fluctuations in today’s market, I wouldn’t go “all in one” but rather scale over time to make sure you don’t miss a better opportunity if the market were to go even lower.

I’ll end with a 10-year chart of the GRID ETF versus the S&P 500 and the XLU Utility ETF:

Chart
Data by YCharts