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What Is Driving the Construction Market Boom?

Zacks

With hurricane season in full swing, it makes sense to take a look at the construction market, since it has historically been one of the beneficiaries. This year is expected to be a normal storm year, unlike 2017, which was one of the ten worst years for storms. So the usual uptick in demand for construction supplies and labor may be expected to continue.

Overall, commerce department statistics indicate growth in private residential construction (following a period of multifamily overbuild) as well as certain pockets of non-residential construction (both public and private), such as office, commercial, and non-building construction like water supply, conservation & development, and transportation. Manufacturing is a notable area of weakness in both private and public construction segments.

Demand Is Going Up

Residential


New residential construction starts, permits and completions have trended up over the last five years although the growth rates are only moderate as the impact of the recession and resultant foreclosures led to an inventory glut that was hard to burn. This in turn impacted prices, making recovery difficult.

But prices have recovered significantly since the recession, driven by a growing population, millennials finally settling down and rising employment and income levels. The Tax Cuts and Jobs Act of 2017 was a disincentive, since it limited deductions for state and local property taxes, adding to the cost of ownership.

Rising interest rates are another disincentive since they raise borrowing cost for home buyers. But JPMorgan analysis indicates that the higher rates are the result of economic growth, which includes more jobs and higher wage rates, so the two will offset each other. In any case, 30-year mortgages are already adjusting.

There is also a likelihood that construction activity will pick up across the U.S. (even in the Midwest), as areas like New York become out of reach for many.

A rising business cycle normally leads to increase in skilled immigrants, which also increases demand for housing.

Non-Residential

The strength in the economy is driving demand for offices and commercial buildings, a trend that will likely continue in the near to mid-term at least. Public infrastructure spending also benefits from this.

Costs Are Going Up

The number one factor here is the rising cost of non-supervisory construction labor, as aging takes out a large section of the workforce even as supply of skilled labor to take its place remains limited. But with wage rates on the rise, more people are likely to go back to the profession, which will ultimately bring demand-supply into balance. But it won’t happen now and now is when demand for housing, especially affordable housing is climbing.

Other than the normal level of low-single-digit cost inflation from year to year, there’s the impact of President Trump’s tariffs on aluminum and steel, of which rising domestic steel prices as an offshoot to limited supply of cheap imports is the more important factor for the sector.

Both these factors can make project completion more difficult; especially in case of building contracts that don’t have escalation clauses. And of course this further limits supply, increases prices and further drives construction demand.

Automation Is the Future

While a certain amount of automation has already entered the picture with robots helping in routine things like brick laying, concrete dispensing, welding, demolition, etc. but constrained budgets aren’t conducive to increased investment in technology. So the sector remains a laggard with respect to technology adoption.

But a cost benefit argument is in the making. For instance, AI systems can survey a proposed construction site and create 3D maps, blueprints and construction plans in a single day whereas a manual endeavor would take weeks (BDC magazine).

Other than the planning stage, AI can help in project management, building information management (BIM) and decision making, making for a safer, less wasteful jobsite, minimizing operational errors and increasing on-time completions. Moreover, as is the nature of AI, the system will get better the more it’s used and the more data it’s fed.

However, putting together sufficient data to train a system is a challenge because only the very large contractors or the government generates/controls the necessary data volumes. So unless there is a shared database, many will not be able to use it.

Recommendations

An industry discussion doesn’t seem complete without recommendations for investors, so here they are:

D.R. Horton, Inc. DHI

D.R. Horton, Inc. is engaged in the construction and sale of high-quality homes through its diverse brand portfolio that includes D.R. Horton, Emerald Homes, Express Homes and Freedom Homes. D.R. Horton also provides mortgage financing and title services for homebuyers through its mortgage and title subsidiaries.

Zacks Rank #1

VGM score A

Current year revenue and earnings estimates represent a respective 15.4% and 41.2% increase from 2017

Surprise history is positive with the 4-quarter average surprise at 8.9%

Gates Industrial Corp. PLC GTES

Gates Industrial Corporation PLC is a manufacturer of engineered power transmission and fluid power solutions. The company offers portfolio of products to diverse replacement channel customers and to original equipment manufacturers as specified components. It serves agriculture, construction, manufacturing, energy and consumer applications industries.

Zacks Rank #1

Current year revenue and earnings estimates represent a respective 11.8% and 42.2% increase from 2017

Surprise history is positive with the 4-quarter average surprise at 29.1%

Norbord Inc. OSB

Norbord Inc. is a producer of wood-based panels operating primarily in the United States, Europe and Canada.

Zacks Rank #1

VGM score A

Current year earnings estimate represents a 27.0% increase from 2017

Surprise history is positive with the 4-quarter average surprise at 9.3%

PulteGroup, Inc. PHM

PulteGroup, Inc. has grown into one of the largest and most successful homebuilding companies by delivering an outstanding home and buying experience. Through its brand portfolio that includes Centex, Pulte Homes, Del Webb, DiVosta Homes, and John Wieland Homes and Neighborhoods, the company is one of the industry's most versatile homebuilders able to meet the needs of multiple buyer groups and respond to changing consumer demand.

Zacks Rank #1

VGM score A

Current year revenue and earnings estimates represent a respective 17.0% and 61.2% increase from 2017

Surprise history is positive with the 4-quarter average surprise at 14.3%

North American Construction Group Ltd. NOA

North American Construction Group Ltd. provides heavy construction and mining services primarily in Canada. It offers services to large oil, natural gas and resource companies.

Zacks Rank #1

VGM score A

Current year revenue and earnings estimates represent a respective 22.1% and 228.6% increase from 2017

Surprise history is positive with the 4-quarter average surprise at 35.4%

Also see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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