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Investors lamenting the end of the residential-construction boom should soon find they have a new home away from home in the commercial-construction market.
Everywhere you turn in America today, new skyscrapers, industrial parks, factories and roads are being built, and at a record-setting clip. The Commerce Department reported Monday that total U.S. construction spending in March climbed to $1.2 trillion on an annualized basis, beating the previous high set in February. Spending in the month rose by three times economists’ estimates, or 0.9%.
The drive to build is spawning a tremendous variety of small-cap and mid-cap equity plays -- as you’ll see in a moment with my list of top picks -- that are on the move but have not yet come anywhere close to fulfilling their potential. To get an idea of the scope of the building boom, just type the words “commercial construction” into a Web news search engine. You will find a roadmap of major projects from coast to coast that will help you forget that whole residential real-estate bubble thing.
In southwestern Pennsylvania, spending on nonresidential construction in the first three months of this year hit $637 million -- up 95% from the same period in 2005, according to a report in the Pittsburgh Tribune-Review. The area is on track for $2.8 billion in new nonresidential construction this year, paced by contractors’ backlogs that are “exceptionally high,” according to a local construction research firm. Much of the new money is going into downtown bank, retail and condo projects.
In Bismarck, N.D., new commercial construction in the first quarter was clocked at its highest level since records have been kept, according to a city report. Wire services said construction totaled $66.2 million for the year ending Feb. 1, up 73% from the previous year. Major projects included two Wal-Mart
(WMT, news, msgs) stores, a Best Buy(BBY, news, msgs) store and a Lowe’s(LOW, news, msgs) store.In Newtown, Conn., a local newspaper reported that although residential construction is down by about 40%, commercial construction in the past year has almost doubled.
In San Diego, Calif., the construction of retail and office projects has tripled in the first quarter of the year, compared with last year, according to a local business paper.
In Santa Cruz, Calif., a local newspaper reported last week that “new commercial buildings are sprouting up around the county” and noted that vacancy rates along a key stretch of highway are down to 5% from 35% four years ago.
The urgency of the new commercial construction boom is accelerating demand for all kinds of industrial metals and plastics, not to mention skilled workers and architects. Indeed, the Architecture Billings Index -- a gauge of work currently on the boards of registered architects nationwide -- is on its longest monthly positive streak of the millennium. A trade association economist told reporters that the strong figures for nonresidential construction were following a path similar to the late 1990s, the last boom time for the industry.
A resilient recovery
When you consider that the news comes right behind word that homebuilding growth is sinking like a rock, you realize how resilient the U.S. economic recovery really is. The commercial-construction revival follows six years of recession-like conditions, during which sector spending plunged 25% and as much as a quarter of all offices in major markets were vacated.
As you might expect, our ever-expanding government is helping. According to Bloomberg News, state and local governments issued a record $406 billion in bonds last year to refinance debt and to finance construction projects such as roads, sewers and schools. More than half of the money will go to new construction.
Now that space is at a premium and rents are up, industrial, pharmaceutical and shopping-mall real-estate investment trusts like AMB Property
Your strategy needs to be a bit different than with residential construction, where the most highly leveraged stocks were the actual homebuilders, such as Toll Brothers
The names to know
Here are a few to consider:
NCI Building Systems
(NCS, news, msgs) . This is the country’s leading maker of metal building components and systems for commercial construction. Based in Houston, it builds things like metal roofs, structural beams and doors in 35 manufacturing plants in 16 states and Mexico, and it sells through 1,400 dealers worldwide. NCI recently bought major rival Robertson-Ceco, and can now gain better pricing power both from suppliers and customers. An increase in manufacturing capacity nationwide plays directly into NCI’s strength, as the construction of new buildings inevitably follows. Earnings are likely to rise about 30% this year and next, yet its forward price-earnings multiple is still a paltry 15 times my 2007 estimate of $4.40 a share. It has a solid balance sheet, relatively low debt load and generates a lot of cash, so there is a considerable margin of safety and little financial risk. If the stock can trade at 20 times earnings next year, it will trade in the high $80s, which would be a 35% move up from today’s quote.Genlyte Group
(GLYT, news, msgs) . This is a Kentucky-based manufacturer of light fixtures and controls, mostly for commercial buildings, that I first profiled on Jan. 11 ("17 stocks that always go up"). Shares are up 28% already this year, but I think they have a good shot at rising another 21 percentage points, to the $82 area, as Genlyte gets a lot of operating leverage out of its manufacturing plants. Genlyte reported first-quarter earnings on Monday of $1.70 a share, compared to 64 cents last year, which blew away consensus estimates even after you take away a one-time gain of 86 cents. It said it would raise prices up to 10% on June 1 to account for rising commodity prices, and forecast a boost in revenue. When you consider that lighting installations follow construction starts, and Genlyte is the consolidating industry’s leader, this play still seems like a gimme for growth investors. I’m looking for at least 20% earnings-per-share growth to $4.10 next year. With the stock trading at a 17 price-earnings multiple now, there is plenty of headroom in the valuation for new buyers.Florida Rock Industries
(FRK, news, msgs) . This cement and construction-aggregates manufacturer was also recommended in my Jan. 11 column. Even though it’s already up 23% this year, I still like it a lot as a play on commercial construction. Cement is in tight supply worldwide, and there is tremendous demand not just domestically but overseas. Florida Rock is a low-cost leader that runs 150 plants along the eastern seaboard and south. Earnings reported last week were terrific, and guidance was very positive on both increasing volumes and prices. My earnings estimate for 2007 is $4 a share, which implies growth of about 25% and a forward P/E of 15. Since this is a highly reliable, low-debt manufacturer in the middle of a growth cycle that is still a couple of innings from its peak, it could easily trade at a 23 P/E multiple. That gives us a $92-to-$100 target for the next 12 months, or up as much as 45% from today’s price.
There are many more ideas that I could propose, including structural steel maker Chaparral Steel
Fine Print
To learn more about NCI Building Systems, read here. ... Learn more about Florida Rock here. ... Here is more information about Genlyte. ... Check out Lamson & Sessions here.
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