Robust construction activity along with elevated construction spending in the United States have been triggering demand for the heavy construction industry since the past few quarters. During the first six months of 2018, construction spending amounted to $619.9 billion, 5.1% above the $589.6 billion for the same period in 2017.
The industry is poised to gain from significant amounts of project awards across multiple segments comprising oil & gas, communications, transmission and power, and other infrastructural projects across the domestic as well as international markets.
Backed by an improving commodity price environment and a strong U.S. market including the shales and an improving environment in the rest of North America, Oil & Gas business is currently poised well to deliver growth in the coming years. Again, owing to increased renewable project activity and expansion of services into biomass and other smaller production facilities, the power generation and industrial construction market will show sizable growth.
Meanwhile, construction work for communications is expected to gain strong momentum given huge network investments. Given the proliferation of smart phones, higher demand for network bandwidth and mobile broadband are expected to act as strong catalysts. As telecommunication networks face increased demand, customers need to expand the capacity and improve the performance of existing networks and in certain instances deploy new networks, creating significant opportunities for heavy construction players.
Importantly, Trump’s long-awaited $1.5-trillion infrastructure plan will likely call for more building and infrastructure spending in the near future, in turn boosting revenues and profitability of construction companies. On the flipside, higher material costs and a constrained mortgage environment are indeed restricting construction stocks from responding to growing demand.
The steel and aluminum tariffs announced earlier in 2018 continue to impact material costs. Again, the Trump administration’s tit-for-tat trade tariffs with its major partners like China, Canada, Mexico and the European Union cannot be ignored. Speculation is rife that tariffs could disrupt supply chains, undercut business investment and potentially wipe out the fiscal stimulus from a $1.5 trillion tax cut package.
Industry Lags in Terms of Shareholder Returns
Looking at shareholder returns over the past year, it appears that rising construction spending along with economic recovery wasn’t enough for boosting investors’ confidence in the industry’s growth prospects. Higher raw material costs and concerns over trade tensions remain challenges.
The Zacks Heavy Construction industry, a 11-stock group within the broader Zacks Construction Sector, has underperformed the S&P 500 index as well as its own sector over the past year.
While stocks in this industry have gained 8.4%, the Zacks S&P 500 Composite have rallied 17.9% and the Zacks Construction Sector has grown 8.9%.
One-Year Price Performance
Heavy Construction Stocks Trading Cheap
Thanks to the underperformance of the industry over the past year, the industry's valuation picture looks attractive. One might get a good sense of the industry’s relative valuation by looking at its price-to-earnings ratio (P/E), which is the most appropriate multiple for valuing Heavy Construction stocks.
This ratio essentially measures a stock’s current market value relative to its earnings performance. Investors believe that the lower the P/E, the higher the value of the stock will be.
The industry currently has a forward 12-month P/E ratio of 13.49X, which is equal to the lowest level over the past year.
The space also looks equally cheap when compared with the market at large, as the forward 12-month P/E ratio for the S&P 500 is 17.32X and the median level is 17.63X.
Price-to-Earnings Ratio (F12M)
However, a comparison of the group’s P/E ratio with that of its border sector reveals that the group is trading at a premium. The Zacks Construction Sector’s forward 12-month P/E ratio of 13.05X for the same period is below the Zacks Heavy Construction Industry’s ratio.
Price-to-Earnings Ratio (F12M)
Improving Earnings Outlook to Drive Outperformance
Indeed, higher material costs and a rising rate environment have been haunting the heavy construction market. If this wasn't enough, Trump’s steel and aluminum import tariffs, announced earlier this year, have raised further apprehensions.
Nevertheless, the construction space looks attractive this year given solid economic, consistent job growth and Trump’s vow to boost infrastructure spending. Strong industry fundamentals and expectations of solid top-line growth should continue to generate positive shareholder returns in the near future.
However, what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead.
One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.
Price and Consensus: Zacks Heavy Construction Industry
Zacks Industry Rank Indicates Bullish Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.
The Zacks Heavy Construction industry currently carries a Zacks Industry Rank #82, which places it at the top 32% of 256 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry’s rank over the past five weeks.
Industry Heat Map
Industry Assures Long-Term Growth
The Zacks Heavy Construction industry has promising long-term prospects. The group’s mean estimate of long-term (3-5 years) EPS growth rate has remained stable and above the market at large to reach the current level of 11.8%. This compares favorably to 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of this long-term EPS growth could be the recovery in top line that the Zacks Heavy Construction industry has been showing since the beginning of 2016. The adverse impact of higher material costs as well as interest rates on the bottom-line numbers is expected to reduce gradually and be well compensated with Trump’s massive infrastructural plans.
A major boost in infrastructural and construction spending should continue to favor the industry’s performance. Solid growth in the end markets like oil & gas, communications, transmission and power, and other infrastructural projects should provide support.
Undeniably, rising costs and a constrained mortgage environment are limiting construction stocks from responding to growing demand. That said, optimism surrounding the sector remains intact given increasing construction spending that will contribute to overall growth through the balance of 2018 and 2019, despite rising interest rates.
Keeping the solid prospects in mind, investors can bet on a few heavy construction stocks that have a strong earnings outlook.
Currently, two stocks in the Zacks Heavy Construction industry carry a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Primoris Services Corporation (PRIM - Free Report) ): Dallas, TX-based specialty contractor and infrastructure company sports a Zacks Rank #1. The consensus EPS estimate for the company has increased 15.4% to $2.10 for 2019, over the past 60 days.
Price and Consensus: PRIM
EMCOR Group, Inc. (EME - Free Report) : This Norwalk, CT-based one of the leading providers of mechanical and electrical construction carries a Zacks Rank #2. The consensus EPS estimate has increased 4% to $4.67 for the current year and 2% for 2019, over the past 60 days.
Price and Consensus: EME
Investors can also consider stocks that currently carry a Zacks Rank #3 (Hold) but have solid earnings growth prospect.
MasTec, Inc. (MTZ - Free Report) : This leading infrastructure construction company currently carries a Zacks Rank #3 but the consensus EPS estimate has increased 0.3% to $3.68 for the current year and 0.7% to $4.24 for 2019, over the past 30 days.
Price and Consensus: MTZ
Orion Group Holdings, Inc. (ORN - Free Report) : This is a Houston, TX-based specialty construction company. The consensus EPS estimate has increased 6.5% to 33 cents for the current year and 2.7% to 38 cents for 2019, over the past 30 days.
Price and Consensus: ORN
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