First Trust Cloud Computing ETF Should Benefit From Near-Term Surge In Demand Due To COVID-19 – Seeking Alpha

ETF Overview

First Trust Cloud Computing ETF (SKYY) owns a portfolio of cloud-services stocks in the United States. The fund seeks to track the ISE CTA Cloud Computing Index. Besides a long-term secular growth trend, these stocks should benefit in the near-term from the outbreak of COVID-19 as more and more people use cloud-related services from home. Stocks in SKYY's portfolio are trading at valuations below their historical averages. Therefore, we think investors may want to take this opportunity to add more shares.

Data by YCharts

SKYY's portfolio includes high quality companies

SKYY's top-10 holdings are mostly high-profile companies around the world. As can be seen from the table below, these top 10 stocks represent about 41.7% of its total portfolio.

Morningstar Moat Status

Financial Health Rating

% of ETF

Amazon (AMZN)

Wide

Strong

5.40%

Microsoft (MSFT)

Wide

Strong

5.20%

Oracle (ORCL)

Wide

Moderate

4.49%

Alphabet Inc. Class A (GOOGL)

Wide

Strong

4.34%

Citrix Systems (CTXS)

Narrow

Strong

4.27%

Alibaba Group (BABA)

Wide

Moderate

3.99%

VMware (VMW)

Narrow

Moderate

3.85%

Akamai Technologies (AKAM)

None

Strong

3.61%

MongoDB (MDB)

N/A

N/A

3.55%

Cisco (CSCO)

Narrow

Strong

2.97%

Total:

41.67%

Source: Created by author

Most of these stocks have products or services that are not easy for its competitors to replicate. In some cases, they operate in oligopoly as well. For example, Amazon, Microsoft, Google, and Alibaba together hold roughly 61.4% of total worldwide cloud market share in Q4 2019 (see chart below).

Source: Parkmycloud.com

Besides having a sizable market share in the cloud market, these stocks also offer other services to continue to attract subscribers. For example, Microsoft's Office 365 subscription service provides a stable and predictable income as it is difficult for its customers to switch due to compatibility and familiarity issues. Similarly, Google also provides a suite of cloud services (Gmail, Google Drive, etc.) to its customers. Likewise, Amazon offers video services and quick delivery services to its Prime members.

COVID-19 is driving significant demand for cloud-based services

SKYY invests in companies that provide cloud-based services to their customers. This sector should experience strong revenue growth in the next few years. In fact, a report published by Gartner late in 2019 points to significant growth opportunities in the next few years. As stated by Gartner,

The cloud managed service landscape is becoming increasingly sophisticated and competitive. In fact, by 2022, up to 60% of organizations will use an external service provider's cloud managed service offering, which is double the percentage of organizations from 2018.

As can be seen from the table below, worldwide public cloud services revenue is expected to jump from $227.8 billion in 2019 to $354.6 billion in 2022. This represents a growth rate of 55.7% from 2019.

Source: Gartner

This growth rate will likely accelerate further due to the COVID-19 pandemic. Since the outbreak of COVID-19 and the implementation of social distancing, many people are forced to work from home or stay at home. Therefore, the need to do their everyday activities (work, shopping, entertainments) online is increasing sharply. In fact, SKYY's second largest holding Microsoft has seen 775% increase in demand for its cloud services in regions enforcing social distancing. Its largest holding Amazon is also seeing overwhelming influx in orders. Cisco's Webex video conferencing app drew record 324 million users in March. The app usage grew by 2.5 times in Americas, 4 times in Europe and 3.5 times in Asia.

SKYY is now undervalued

Now, let us take a look at its top-10 holdings and compare these stocks' forward P/E ratio with its 5-year average P/E. As can be seen from the table below, these stocks' weighted average forward P/E ratio of 23.75x is much lower than the 5-year average of 28.87x. Given these stocks' strong growth outlook, we think its shares are trading at a significant discount.

Forward P/E

5-year Average P/E

% of ETF

Amazon

64.52

85.85

5.40%

Microsoft

24.69

22.36

5.20%

Oracle

11.79

14.57

4.49%

Alphabet Inc. Class A

20.08

22.72

4.34%

Citrix Systems

6.08

12.82

4.27%

Alibaba Group

22.03

27.28

3.99%

VMware

17.86

20.25

3.85%

Akamai Technologies

19.57

20.45

3.61%

MongoDB

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First Trust Cloud Computing ETF Should Benefit From Near-Term Surge In Demand Due To COVID-19 - Seeking Alpha