JCI - GRID: Excellent Smart Grid ETF For The Global Electrification Theme

2023-07-28 19:03:13 ET

Summary

• The GRID ETF holds a portfolio of leading global electrical component makers that are required to build-out electrical transmission & distribution infrastructure growth and to support a smart-grid.
• That being the case, the GRID ETF is well positioned to benefit from the global transition to clean-energy, EVs, and the electrification of the planet.
• Meantime, the GRID ETF has not only outperformed its direct competitors and the S&P500 over the past 5-years, but has also - somewhat surprisingly - outperformed the Nasdaq-100 as well.

The First Trust Clean Edge Smart Grid ETF ( GRID ) has delivered total returns of 23% since my Seeking Alpha BUY-rated article from April 2021 - outpacing the S&P500 by ~13% during that time frame. Indeed, over the past 3-years, the fund has significantly outperformed the S&P500 as represented by the Vanguard S&P500 ETF ( VOO ) (see below). Going forward, the GRID ETF is well-positioned to benefit from the ongoing transition to clean-energy electrification by owning the large global companies that build the components required to build-out electrical infrastructure and renewable energy capacity and support. These are companies like Eaton Corporation ( ETN ), Johnson Controls ( JCI ), and ABB ( ABBNY ).

Investment Thesis

According to Precedence Research ,

The global electric power transmission and distribution equipment market size was reached at $216.14 billion in 2022 and it is expected to hit around $385.25 billion by 2032, expanding at a CAGR of 5.9% over the forecast period 2023 to 2032.

Their research shows that the AsiaPac region will be responsible for the majority of growth in the power transmission & distribution sector, driven recently by growth in renewable energy capacity.

Meantime, the Biden Administration was able to, finally, get a meaningful Infrastructure Plan (see FactSheet here ) passed through Congress in 2021. In the following year, the Biden Administration got the Inflation Reduction Act (the so-called "IRA ACT") passed, which in my opinion could much better be described as the "Clean Energy Act" (see FactSheets here ). The combination of the two pieces of legislation allocated $100's of billions of dollars for expanding U.S. electric power transmission and distribution infrastructure, the build-out of clean energy capacity, and the implementation of a smart grid which can better support and integrate the intermittency of solar, wind, and battery backup power capacity, smart homes, and EV charging capacity:

With that as background, let's take a closer look at the GRID ETF to see how it has outperformed the S&P500 of late and how it has positioned investors for success going forward.

Top-10 Holdings

The top-10 holdings in the GRID ETF are shown below and were taken directly from the First Trust GRID ETF webpage where investors can find more information on the fund:

Dublin, Ireland-based Eaton Corp. ((ETN)) is the #1 holding with an 8.5% weight. Eaton is an intelligent power management company that designs and manufactures electrical components and equipment for the electrical power transmission and distribution, aerospace, and EV & eMobility sectors:

According to a recent company presentation , Eaton has significantly improved its margin and free-cash-flow profile by executing $7 billion worth of higher-margin acquisitions and $5 billion worth of lower-margin divestitures. The result has been steady margin expansion and a well-performing stock price:

The #2 holding, also with an 8.5% weight, is Johnson Controls ((JCI)). Johnson Controls is also headquartered in Ireland and designs data-driven smart building solutions for non-residential building and industrial applications. JCI also offers control software & services for residential and commercial applications. In May, JCI released strong Q2 results , with revenue of $6.69 billion (+9.7% Y/Y) - a $180 million beat . The backlog was a record $11.7 billion and grew 9% organically yoy. The stock is up 31% over the past year.

Schneider Electric ( SBGSF ) is the #4 holding with a 7.7% weight. Schneider is a leading global provider of electric components for the electric transmission and distribution industry: circuit breakers and switches, contactors and protection relays, EV chargers, and energy management software solutions. Last year, Schneider announced it was going forward with a full takeover of Aveva Group ( AVEVF ), a UK-based software company valued at ~$10 billion. This week, Schneider announced half-year results that saw net income grow 33% yoy:

Like Eaton and JCI, Schneider Electric stock is also up more than 30% over the past year.

The top-10 holdings also includes, in aggregate, 6.4% of the portfolio allocated to solar-centric companies Enphase Energy ( ENPH ) and SolarEdge Technologies ( SEDG ). After a very strong multi-year run, PV-solar microinverter specialist Enphase has been struggling of late, missing expectations. The stock of PV-solar specialist SolarEdge has also been disappointing of late (-32% over the past), despite expectations for strong revenue growth this year and next:

The portfolio as a whole has a high allocation to the electrical components sub-sector (expected and desirable in my opinion), but is otherwise nicely diversified across a number of sub-sectors:

Performance

The GRID ETF has a strong long-term performance track record, with an average 10-year total return of 14.1%:

The chart below compares the 5-year total returns of the GRID ETF versus some direct competitors - the Global X U.S. Infrastructure ETF ( PAVE ), the iShares Global Infrastructure ETF ( IGF ) - and also against the broad market averages as represented by the VOO ETF and the Invesco Nasdaq-100 Trust ( QQQ ):

As can be seen in the graphic, and somewhat surprisingly, the GRID ETF not only has out-performed its direct competitors and the S&P500, but also outperformed the Nasdaq-100.

Risks

The companies in the GRID ETF would be negatively affected by a global economic slowdown as a result of the potential impact of rising inflation and rising interest rates.

From a valuation perspective, and despite the fund's excellent appreciation, GRID's P/E = 26.8x is roughly in line with the S&P500, while its price-to-book ratio of 3.3x still trades at a significant discount to the S&P500 (price-to-book = 4.5x ).

Summary & Conclusion

I typically refrain from recommending ETFs that have a relatively high expense ratio. However, the GRID ETF's 0.58% expense fee appears to be well justified given its strong returns. Meantime, the portfolio is well positioned to benefit from what will be a multi-decade transition of the planet's electric transmission and distribution grids to a more clean-energy friendly smart-grid. GRID is a BUY.

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