3 Stocks to Benefit from the Coming Non-Residential Construction Boom
All year long, the monthly Architecture Billing Index, or ABI, has suggested that the non-residential construction market would boom in the next year. So far, the actual gains haven't showed up -- but that may only be a matter of time. Whether difficulty in obtaining project financing is slowing down the actual construction, or a lack of confidence in the U.S. government is giving potential builders pause, the ABI work will eventually occur.
The companies that will benefit from a boom in non-residential construction will naturally be construction equipment manufacturers and equipment rental firms. Based on recently released results, United Rentals is already seeing a boom as construction firms look to rent more in a shaky business environment.
Another favorite has to be the crane manufacturers of Terex and Manitowoc , which haven't seen the same rebounds that other machinery manufacturers have witnessed. Even large customer United Rentals has powered to new highs above its pre-financial crisis levels.
Part of the reason is that Terex and Manitowoc rely more on a global rebound, and the weakness in Europe has held them back. In addition, construction companies' focus on renting has likely helped increase utilization while pressuring pricing on typical construction equipment.
ABI monthly report
This week will be big for the group. The ABI monthly report drops on Oct. 23, updating the progress of architectural work, while Terex reports Q3 earnings that same day.
The ABI is a diffusion index of U.S. architecture firms that serves as a leading economic indicator, forerunning non-residential construction activity by approximately nine to 12 months. The August score of 53.8 reflected the strongest growth in activity in six months, and marked the 12th time in the last 13 months that activity increased. Based on these results, a construction survey forecast a non-residential construction pickup accelerating through 2014.
Over the last several months, several sub-components of the index have reported multiyear highs. In July, the index for new project inquiries hit 66.4, signifying the strongest growth in new inquiries since late 2005. Back in February, the overall index hit 54.9, marking architectural firms' strongest billing growth since early 2008. In general, pent up demand seems to exist in several areas, including health care facilities and not-for-profit cultural buildings placed on hold during the financial crisis.
Rental firms already benefiting
United Rentals expects constant price increases and increased utilization to lead it to record profits. Construction firms continue to opt for renting equipment instead of buying it, since renting's cheaper, and they're still leery about the economy. With United Rentals trading at all-time highs, one has to wonder whether a boom in non-residential construction might actually be a negative. Will these renting firms switch to purchasing equipment once a boom takes hold?
For the last quarter, United Rentals generated an 8.3% increase in rental revenue on higher demand and a 3.2% increase in rental rates. With time utilization increasing 100 basis points year over year, the company was able to generate record EBITDA margins of 49%. The combined increased revenue and utilization rates led to a roughly 21% increase in adjusted earnings per share.
The $5 billion company is so confident in the business environment that it initiated a $500 million share buyback.
While the equipment rental firms have been booming, the equipment manufacturers have been holding steady. Pricing pressures and lower revenue have kept profits below the financial crisis levels. In the case of Terex and Manitowoc, the prolonged weakness in international demand for cranes is a factor as well.
Back in June, Terex downgraded its yearly earnings forecast to a level only slightly above last year. Its aerial work platforms segment is steady, but the company is only seeing replacement demand from rental firms. The market needs a boom in non-residential construction to grow Terex's order book. Analysts still forecast 50% earnings growth next year, and the ABI could be the ticket to meeting those numbers.
Analysts expect similar results in 2014 out of Manitowoc. Again, limited revenue growth should lead to strong profits from margin expansion. If Europe improves and non-residential construction in the U.S. picks up meaningfully in 2014, the company could easily beat estimates. While the company has a material foodservice equipment business, the stock typically trades based off the cranes segment.
The ABI continues to signal a rebound in non-residential construction in the next few quarters. The construction machinery stocks of United Rentals, Manitowoc, and Terex should benefit significantly from a rebound. With the recent strong gains in the rental sector, a strong rebound in demand could shift the balance of power to the manufacturers such as Manitowoc and Terex. With more confidence in demand, construction firms are likely to shift capital toward buying the equipment, instead of renting.
The article 3 Stocks to Benefit from the Coming Non-Residential Construction Boom originally appeared on Fool.com.Mark Holder has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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