FTXL - FTXL: Reinvesting In America's Semiconductor Industry Could Embolden This Fund

Summary

• First Trust Nasdaq Semiconductor ETF (FTXL) tracks an index of the most liquid US semiconductor companies.
• The US currently accounts for 12% of the global semiconductor market, but that could be poised to grow.
• I rate FTXL a Buy, based on a combination of long-term valuation and secular trends I find favorable, as well as this ETF's construction methodology.

Summary

The US semiconductor industry is poised to grow at its fastest rate in some time. According to expertmarketrearch.com, the market size for semiconductors in the United States reached a value of more than USD $67 billion in 2021, and is expected to grow at a calendar annual growth rate of more than 8% between now and 2028.

First Trust Nasdaq Semiconductor ETF (FTXL) tracks an index of U.S. semiconductor manufacturers based on liquidity. That would seem to put it in the proverbial sweet spot, given the anticipated growth of that specific segment of the global semiconductor market. Despite FTXL's recent rally, this geographically focused ETF still sits about 25% below its early 2022 high. That, at a time when the S&P 500 is roughly 15% below its all-time high.

I rate FTXL a Buy on an intermediate to long-term basis. As I explain below, there are multiple events in progress that should tilt the playing field more toward the US semiconductor industry from a competitive standpoint.

Strategy

FTXL selects stocks in the semiconductor industry based on how liquid those stocks trade (measured as average dollar volume). The portfolio is then weighted based on a composite score that blends three factors for each stock: volatility, value and growth. More specifically, those factor results are determined as follows:

• Volatility - trailing 12-month price fluctuation.
• Value - cash flow to price.
• Growth - the 3-, 6-, 9-, and 12-month average price appreciation.

The securities are weighted based on their score on the three factors. Also, the index weighting methodology includes "caps" or limits on how large a weighting a stock can be when the index is reconstituted. That reconstitution is performed annually, and the existing holdings in FTXL are rebalanced quarterly.

Holding Analysis

FTXL only invests in companies based in the United States. Larger companies make up the majority (63%) of this ETF, with the balance allocated among mid cap and small cap stocks. The result is a focused, 30-stock portfolio, that currently concentrates about 60% of assets in its top ten holdings. Drilling down a bit further, just five stocks account for nearly 40% of FTXL.

Strengths

Semiconductors are materials which have an electrical conductivity value falling between that of a conductor, such as copper, and an insulator, such as glass. They appear in every piece of electronics from rocket ships to transistor radios and everything in between. To a large extent, they really do make the modern world run.

While China is the largest overall producer of semiconductors, Taiwan is currently the world's largest manufacturer of advanced semiconductors , with some 55% of the world's contracts. However, that market share is under constant threat, given longstanding tensions between Taiwan and China. That uncertain environment is causing Taiwanese microchip manufacturers to seek alternative sites for manufacturing. Recently US President Biden announced that the US government, under something called the CHIPS program, will invest $50 billion in the chip manufacturing sector in the US.

This represents a potential comeback of sorts for the United States semiconductor industry. The US was the manufacturing leader for a long time, but has seen that position erode over the last 2 decades. With signs of a renewed commitment to manufacturing, including significant new investments from non-US semiconductor makers to produce more in the US, could put FTXL in a position to capitalize.

Weaknesses

FTXL reflects its underlying portfolio's historical volatility. Its 5-year Beta is around 1.3, which means it has been 30% more volatile than the S&P 500 over that time. There is no obvious reason I can see that this won't continue. Thus, investors should understand that this ETF could be a bumpy ride, even if that is on the way to long-term success.

FTXL is not a very liquid ETF in terms of daily trading volume, with less than $700,000 traded in a typical day. The ETF is far from the largest one in its peer group at under $100 million in assets. Still, if the underlying stocks in the ETF are themselves liquid, that is likely more important, given how ETF buying and selling mechanisms work.

Manufacturing in all sectors has moved away from the United States. America has gravitated toward more of a consumer country, and less of a producer nation over the past several decades. As such, the US hasn't had a trade surplus since 1970. There is a myriad of reasons why this has occurred, but the trend is not likely to reverse in the foreseeable future.

This is because some small niche areas of the manufacturing sector require a highly-skilled labor force, that demands a high wage. That may come back to some extent, but probably not at a pace that will completely reverse the 50-year trend noted above.

Opportunities

FTXL's portfolio actually trades at a slight price-earnings ratio discount to the S&P 500 (roughly 19x to 20x trailing earnings). It is also much further south of its 2022 high, sitting about 25% below that peak. In contrast, the S&P 500 is only about 15% below its all-time high. That creates a potential discount opportunity for FTXL versus the broad stock market. That, and the possible catalysts from increased foreign investment and US government (CHIPS act) funding directed toward the industry, all make for an encouraging future.

Threats

It may take some time before reality meets aspiration. Despite the increased attention the semiconductor industry is getting, it could be several years before investors see positive results reach the individual stock earnings and revenue levels. This is a capital intensive sector, and semiconductor manufacturing is a complex process requiring unique skill sets. So, FTXL, which represents a volatile and changing industry, is not a quick-flip trading situation. This is multi-year outlook.

Conclusions

ETF Quality Opinion

FTXL checks many of the boxes I look for in a long-term growth ETF investment. The US-focused, concentrated portfolio makes me feel that I know what I own in terms of specific stock holdings. And, I know that those stocks will only change once a year, and will be rebalanced back to the ETF's model portfolio weightings every 3 months.

ETF Investment Opinion

FTXL is a well-constructed ETF in terms of its limited scope, holdings and prioritization of a very limited number of industry leaders. I consider it to be selling at a discount to the broad stock market, especially when I take into account the potential geopolitical tailwinds that could accrue to this sector. As a result, I am rating FTXL a Buy in this article, my initial report on an ETF that has not been covered on Seeking Alpha since June of 2017.

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