XAR - ARK Space Exploration & Innovation ETF: Can It Rebound?

2023-10-17 12:43:12 ET

Summary

• The ARK Space Exploration & Innovation ETF focuses on investment opportunities in space exploration and associated technologies.
• The ETF holds stocks in companies involved in orbital and suborbital aerospace, enabling technologies, and aerospace beneficiaries.
• The ETF has a strong focus on U.S.-based companies and has a relatively high expense ratio compared to other ETFs in the sector.

Overview

The ARK Space Exploration & Innovation ETF (ARKX) aims to capture investment opportunities centered around the theme of space exploration and associated technologies.

This includes companies involved in orbital aerospace, which refers to companies that launch, make, service, or operate platforms in the orbital space such as satellites or spacecraft. Suborbital aerospace includes companies that launch, make, service, or operate platforms in the suborbital space, including drones, air taxis, and electric aviation vehicles.

There are also enabling technologies, which are companies that develop technologies used by space exploration-related companies for successful value-add aerospace operations, such as artificial intelligence, robotics, 3D printing, materials, and energy storage. Lastly, aerospace beneficiaries are companies that stand to benefit from aerospace activities, like agriculture, internet access, global positioning system ((GPS)), construction, and imaging. The ETF is managed by ARK Invest and has an expense ratio of 0.75%, representing the annual costs when investing in the ETF. The ETF currently manages roughly $250 million in total assets.

Holdings

Geographically, the vast majority of the ETF's investments are in the United States, representing 84.08% of the holdings. The fund also has exposure to France (6.39%), Japan (4.79%), and Hong Kong/China at 1.68%. This composition indicates ARKX's strong focus on the Electronic Technology sector and its significant investment in U.S.-based companies. The ETF currently holds 37 stocks.

Trimble Inc (TRMB): Trimble Inc. is a globally recognized company that specializes in advanced location-based solutions. These solutions combine positioning (like GPS) with wireless communications and software to create tools for a wide range of industries, including agriculture, construction, transportation, and telecommunications, among others. Despite beating its latest earnings estimates, shares fell 7% year-over-year (YoY).

AeroVironment (AVAV): The leading technology company specializes in the design, development, production, and support of unmanned aircraft systems (UAS) and electric transportation solutions. The company is benefitting from increased military spending in the U.S. as a result of global conflicts. Here, revenue for the first quarter of fiscal 2023 was $108.5 million, an increase of 7% from the first quarter of fiscal 2022 revenue of $101.0 million. Shares are trading 46% higher year-over-year.

Kratos Defense & Security Solutions (KTOS): Kratos is known for its cutting-edge unmanned aerial systems (UAS) and target drones used for threat representation and weapon system evaluation by the U.S. military and its allies. Similarly to AeroVironment, Kratos benefitted from increased military spending in recent years, as revenues in the second quarter of 2023, increased 15% to $256.9 million. This marks an increase of 14.6% when compared to the revenues of $224.2 million that the company reported in the second quarter of 2022. As a result, shares surged 74% from last year.

The ETF also includes other well-known aerospace and defense stocks such as L3Harris Technologies (LHX) and invests 4.6% of its assets in its own 3D Printing ETF (PRNT). The only international company is Komatsu Ltd. (KMTUY), which manufactures and sells construction machinery and makes up roughly 4.5% of the total assets.

Performance

ARKX returned 14% in one year, as many technology and growth stocks rebounded from the sell-off towards the end of last year. Still, the ETF underperformed the broader market, as the S&P 500 returned 26% YoY. This is mainly because large-cap Tech stocks such as Microsoft (MSFT), Alphabet (GOOGL) and Meta Platforms (META) drove its performance.

The ETF also underperformed SPDR S&P Aerospace & Defense ETF (XAR), which tracks an equal-weighted index of aerospace and defense companies in the U.S. and returned 24% YoY. While the ETF shares a few names such as L3Harris Technologies, it is mainly focused on pure military defense stocks such as Northrop Grumman (NOC) and General Dynamics (GD). Its expense ratio is also notably lower at 0.35% annually.

However, ARKX outperformed space competitor Procure Space ETF (UFO), which has many similar holdings such as Trimble and Iridium Communications (IRDM). Nevertheless, its largest holdings differ from ARKX with Sirius XM (SIRI) making up its largest holding, which fell 22% from last year. The ETF's expense ratio of 0.75% is comparable to ARKX.

Valuations

As the ETF includes many small caps, many of the holdings are difficult to value, based on traditional valuation metrics. Many of the companies such as Kratos generate less than $1 billion in annual sales and thus do not have a large enough scale yet to generate significant profits. Thus, Kratos and AeroVironment trade at a 48 times and 45 times forward P/E ratio, respectively. However, the ETF also includes more established companies such as Trimble and L3Harris, which trade at reasonable valuations of 19 times and 15 times forward earnings, respectively. While these companies offer more value, they are less likely to grow earnings at the same pace than smaller peers such as Kratos. Thus, the ETF offers a diversified approach between value and growth.

Overall, the ETF has an average P/E ratio of 38.3 and a weighted average market cap of $91.5 billion. Thus, it trades at a discount compared to UFO ETF, which trades at 85 times earnings. However, compared to the S&P 500 index ( SPY ) and the Nasdaq Index ( QQQ ), ARKX trades at a slight premium. Here, SPY boasts a P/E ratio of 22.6x and QQQ a P/E ratio of 33x.

Takeaways

ARK Space Exploration & Innovation ETF offers a diversified portfolio that aims to tap into the potential of space exploration and associated technologies. However, when comparing ARKX with other ETFs in the sector, such as the SPDR S&P Aerospace & Defense ETF, a clear distinction arises in terms of the expense ratio. ARKX sports a relatively high expense ratio, especially when set against XAR, even though both funds incorporate similar companies within their portfolios.

It's also worth noting that many of the genuine pioneers in the realm of space exploration remain private companies. Their decision to stay private often stems from valid strategic or financial reasons, which means public market investors can't always access the true vanguard of space innovation.

While ARKX does feature an array of intriguing companies, its elevated expense ratio can render it less appealing for long-term investors who are particularly cost-conscious. Instead, this fund might be more suited for momentum-driven investors who are banking on short-term trends or the specific investment strategies ARK employs.

Like any investment, ARKX is not without its challenges. Given the emerging and fast-paced nature of the space exploration sector, there's an inherent unpredictability. Investors might encounter considerable volatility due to technological changes, regulatory shifts, or market dynamics. As always, it's crucial for investors to consider these uncertainties, along with the associated costs and potential returns, before committing to the ETF. Thus, while the ETF still trades well below its issuing price, I believe it is unlikely to rebound any time soon.

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