The positive momentum witnessed in the U.S. construction sector at the start of 2017 has been partially hurt by the inching up of mortgage rates since the November presidential election. Optimism surrounding Donald Trump’s plans to spur economic growth through tax cuts and easier regulations prompted a rise in Treasury yields and a corresponding rise in mortgage rates.
A rise in mortgage rates is undeniably the most dampening factor for the homebuilding industry. Mortgage rates were up significantly in December to 4.32% from 3.5% in early November. Rising interest rates and housing prices are probably diluting demand for homes in the U.S. as affordability is becoming an issue.
Meanwhile, in the homebuilding industry within the broader construction sector, existing home sales and new home sales data from Dec 2016 throw light on the adversities plaguing the industry. U.S. existing home sales fell 2.8% in December to a seasonally adjusted rate of 5.49 million units. Again, on Jan 26, the Commerce Department said that new home sales fell 10.4% to a seasonally adjusted annual rate 536,000 in the same month.
Nevertheless, the bigger picture is strikingly different. Sales of new homes rose 12.2% in 2016 from a year earlier − marking the best in a decade. Sales growth during 2016 was majorly boosted by affordable mortgage rates and a steadily improving job market.
Then again, on the campaign trail, both Democratic nominee Hilary Clinton and Trump had been calling for increased infrastructure investment. In fact, just after winning the election, Trump outlined his priorities as President and promised to boost economic growth and build the U.S. into the strongest economy in the world.
Particularly, he laid emphasis to rebuild highways and other significant infrastructure like bridges, tunnels, airports, schools and hospitals. His plans to boost infrastructure as well as to build an "impenetrable, physical, tall, powerful, beautiful, southern border wall" have put the spotlight squarely on stocks related to the sector.
Quarter So Far
Overall, the picture isn’t that dreary after all. As per the Zacks latest Earnings Preview report, the construction sector’s earnings are expected to increase by 11.1% in Q4 as compared with 7.1% earnings growth in the preceding quarter. Revenues are also expected to improve 6.6% (5.5% growth in Q3). For 2016, earnings will probably rise 6.8% (versus 7.1% seen in 2015) on 4.8% revenue growth (2% a year ago) while margins are expected to decline to 0.12% from 0.31% a year ago.
In spite of the economic woes, it is a profitable strategy to zero in on a handful of construction stocks that are poised to beat earnings this quarter. An earnings beat would also pave the way for stock price appreciation.
Which Are the Right Picks?
Picking the right stock for your portfolio could appear to be a daunting task given the wide range of companies in the construction space. One easy way is to look at stocks that have a solid Zacks Rank accompanied by a favorable Earnings ESP. The combination of a favorable Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) with a positive Earnings ESP usually hints at an earnings beat.
Earnings ESP is our proprietary methodology for determining which stocks have the best chance to pull a surprise in their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.
Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.
For investors seeking to apply this strategy to their portfolio, we have highlighted three construction stocks that may stand out this season.
Fluor Corporation (FLR - Free Report)
Headquartered in Irving, TX, Fluor Corporation provides engineering, procurement, construction and maintenance services (EPCM) through a number of subsidiaries. It is slated to report Q4 numbers before the market opens on Feb 17.
A sneak peek at Fluor’s preliminary Q4 results, which was released last week, will likely reinstate investors’ confidence in the stock. The company now projects adjusted earnings per share at around 82 cents per share, which is ahead of our expectations. We believe that the company’s restructuring initiatives, industry-leading franchise within the U.S., diligent management and a proven business model are its key strengths, which will likely boost its fourth-quarter results.
Shares of Fluor gained almost 28% in the last one year.
The combination of an Earnings ESP of +5.13% and a Zacks Rank #3 raises the possibilities of an earnings beat for the company. You can see the complete list of today’s Zacks #1 Rank stocks here.
For the fourth quarter, the Zacks Consensus Estimate for earnings is pegged at 78 cents a share, reflecting a rise of 14.3% year over year, while the consensus for revenues is at $4.82 billion, implying 10.2% year-over-year growth.
Meanwhile, the company boasts a decent VGM score of “A” and has a solid 3-5 year EPS expected growth rate of 14% (read more: What's in Store for Fluor this Earnings Season?).
Summit Materials, Inc. (SUM - Free Report)
Summit Materials, a leading vertically integrated construction materials company that supplies aggregates, cement, ready-mix concrete and asphalt primarily in the U.S. and western Canada, will release its fourth-quarter results on Feb 22 before the opening bell.
This Zacks Rank #3 stock has an Earnings ESP of +8.70%. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.
The company’s gross margin improved across all lines of business on a year-to-date basis through the third quarter, a trend that is expected to continue in the fourth quarter as well with strong cash generation. Meanwhile, full-year 2016 EBITDA is expected to grow 25–28% year over year.
Summit Materials, with decades of heavy materials experience and a proven acquisition strategy, is expected to deliver strong results in the fourth quarter.
The Zacks Consensus Estimate for the quarter’s earnings is pegged at 23 cents, down 32.3% year over year. The consensus for revenues is pegged at $403.7 million, reflecting 12.3% year-over-year growth.
The company has a long-term EPS growth rate of 10.50%. In addition to an encouraging outlook, Summit Materials’ recent history has been impressive. The stock topped earnings consensus in each of the last four quarters, having an average positive surprise of 9.45%.
If investors are looking to benefit from the increased infrastructure outlay by the federal government, Summit Materials is a promising pick. Shares of Summit Materials climbed 44.1% in the last one year.
Lyon William Homes (WLH - Free Report)
This homebuilder is mainly engaged in the design, construction, marketing and sale of single-family detached and attached homes in California, Arizona, Nevada and Colorado.
This leading homebuilder in the Western U.S. ended the third quarter with a backlog of 1,071 units and an associated value of $591.0 million, the highest in over 10 years.
Shares outpaced the broader industry, gaining nearly 92% in the last one year.
For the fourth quarter, the Zacks Consensus Estimate for earnings is pegged at 66 cents on revenues of $466.2 million.
For the upcoming release, Lyon William has an Earnings ESP of +1.52% and a Zacks Rank #2. The company is slated to report fourth-quarter results at around Feb 22, before the opening bell.
So far, the construction sector has an earnings beat ratio of 64% for the Q4 season.
However, we are a little cautious about the rate hikes scheduled in the days ahead. Following the modest 25-basis point hike last month, the Fed has expressed its confidence in the U.S. economy and forecasts three hikes in 2017, up from the two projected in Sep 2016. Also, a booming economy boosts income. In view of this, it is worth mentioning that if the rise in income offsets the increase in mortgage payment, the housing market is likely to do just fine.
A close look at the space for some outperformers, backed by a solid Zacks Rank and a positive Zacks Earnings ESP, could be a great idea for investors to tap into the optimism in the sector.
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