Come spring and there is a boom in construction activity, following a lull in the cold winter months. After the first-quarter slowdown, the spring season generally brings in improving sales trends. The season usually warms up in March and sees maximum business until the back-to-school season in September.
Key housing data for April – housing starts and permits – came in better than expected indicating a pickup in construction activity.
Homebuilders like D.R. Horton, Inc. DHI, PulteGroup, Inc. PHM, Lennar Corporation LEN, and Toll Brothers, Inc. TOL saw relatively stable housing market conditions in the first quarter. They also seem to be quite optimistic about improving demand in the spring and summer months.
Their optimism is backed by some solid fundamentals – higher job numbers, a recovering economy, moderating home price gains, affordable interest/mortgage rates, rising rentals, recent federal initiatives to increase mortgage availability and a limited supply of inventory – all pointing to a housing recovery.
Due to slow but stable demand trends in the construction end market, construction material companies Vulcan Materials Co. VMC and Eagle Materials Inc. EXP; building products makers like Masco Corp. MAS and Headwaters Inc. HW; equipment rental companies like United Rentals, Inc. URI; engineering design firms like AECOM ACM and KBR Inc. KBR and security products and solutions provider Allegion plc ALLE have been seeing rising demand for their products since last year.
Positive trends in new home construction activity and improvement in repair/remodel businesses in North America boosted sales and profits in the broader construction sector. With the U.S. economy expected to improve – after faltering slightly in the first quarter – construction trends should gain momentum.
3 Stocks to Build Your Portfolio
We’ve zeroed in on three stocks in the broader construction sector with a Zacks Rank #1 (Strong Buy) or #2 (Buy) and a Value Style Score of ‘A’ with the help of our new style score system. These stocks have excellent prospects and might prove to be profitable for long-term investors. And since we love big houses, all three stocks have a market capitalization of over $1 billion.
Our Value Style Score condenses all valuation metrics into one actionable score that helps investors steer clear of ‘value traps’ and identify stocks that are truly trading at a discount. Our research shows that stocks with a Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential.
AECOM
Leading architectural and engineering design firm, AECOM has a Zacks Rank #2 (Buy) and a Value Score 'A' with a market cap of around $4.9 billion. Its Construction Services segment provides namesake services for energy, commercial, industrial as well as public and private infrastructure clients.
AECOM has been benefiting from considerable contract wins, with about $4.6 billion of contracts won in the second quarter of fiscal 2015. Apart from this, strategic acquisitions like the 2014 purchase of URS Corp. has made it one of the largest companies in the engineering and construction industry.
AECOM is an excellent buy, possessing a forward P/E of 9.90x, P/S of 0.37x and P/B of 1.35x, all lower than the industry. Further, for fiscal 2015 ending September, earnings are estimated to grow 29.1%. Over the last four quarters, AECOM has delivered an average positive earnings surprise of 6.54%.
United Rentals, Inc.
Stamford, CT-based United Rentals has a Zacks Rank #2 (Buy) and a Value Score 'A.' With a market cap of more than $10 billion, United Rentals is the largest equipment rental company in the world with an integrated network of 888 rental locations in the U.S. and Canada.
The company did well in the first quarter, helped by higher rental revenues. Management expects a continued rebound in construction activity through the rest of the year.
It trades at a P/E of 12.53x and has a PEG ratio of 0.73, which are better than the industry. The company has an earnings growth estimate of 20.5% for this year. Additionally, it has delivered a positive earnings surprise of about 11.13% over the past four quarters.
Thor Industries, Inc. THO
Thor Industries also has a Zacks Rank #2 (Buy) and a Value Score 'A.' With a market cap around $3.3 billion, Thor, together with its subsidiaries, is one of the world’s largest manufacturers of recreational vehicles.
Though the stock is a bit pricey on a forward P/E and P/B basis, its EV/EBITDA ratio of 10.94 is higher than 8.64 for the industry. Interestingly, it generates cash flow per share of $3.78, which is significantly better than the industry. Further, for fiscal 2015 ending July, earnings are estimated to grow 21.3%. Additionally, it has delivered an average earnings beat of about 5.13% in the trailing four quarters.
Conclusion
Albeit there are headwinds in the form of intense competition and cost inflation amid moderating home prices, construction companies are in the “Ready, Steady, Build” mode. And there are plenty of reasons to be constructive about the broader sector over the short and the long term.
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