Private nonresidential construction may pick up this year, as demand grows for new U.S. projects.
The Architecture Billings Index held at 52 last month, a sign of expansion, according to the American Institute of Architects. The commercial and industrial component -- a proxy for private building activity -- climbed to 54.1 in December, the highest in 10 months, the Washington-based association said Jan. 18.
The monthly survey of U.S.-based architecture firms is a leading indicator of nonresidential construction, said Kermit Baker, chief economist for the association. “Pretty solid readings in November and December suggest some modest improvement” may be afoot, he said.
The Federal Reserve echoed that outlook in its Jan. 11 Beige Book report, where it noted that demand for nonresidential real estate has “improved in a number of districts.”
Spending on lodging, office, commercial and manufacturing buildings grew 8.2 percent in November to $9.2 billion from a year ago on a nonseasonally-adjusted basis, data from the Census Bureau show. These types of commercial and industrial projects are historically the first part of the nonresidential industry to improve during economic expansion, Baker said.
Other indicators -- including vacancy rates -- “are pointing toward a modest recovery,” said Rob McCarthy, a Chicago-based analyst for Robert W. Baird & Co., who forecasts “mid-single-digit growth” for nonresidential spending this year.
Falling Office Vacancies
U.S. office vacancies fell in the fourth quarter to 17.3 percent, the lowest since 2009, from 17.4 percent in the prior period and 17.6 percent a year earlier, according to Reis Inc., a New York property-research company.
Inquiries for commercial building projects -- another component of the Architecture Billings Index -- also suggest “we are likely past trough,” as a multi-year recovery “could begin to gain some traction in 2012,” Ann Duignan, a New York- based analyst at JPMorgan Chase & Co., wrote in a Jan. 18 report. The index of inquiries for new work was 64 in December, after reaching an almost five-year high of 65 the previous month, the association said.
This makes stocks of companies that design privately-funded projects in industries such as manufacturing and utilities particularly attractive, said Burt White, chief investment officer at LPL Financial Corp. in Boston. Caterpillar Inc. (CAT), the world’s largest manufacturer of construction and mining equipment, is the “poster child” for this industry, he said.
Caterpillar reported fourth-quarter earnings Jan. 26 that beat analysts’ estimates, as revenue in its construction industries grew 31 percent, to $5.355 billion, from a year earlier. The Peoria, Illinois-based company is forecasting total U.S. construction spending “to finally begin to recover” this year after declining since 2004, with nonresidential-building construction up 5 percent, it said in a statement.
“It’s hard to go wrong with these companies,” said White, who helps oversee about $315 billion. “We have a big infrastructure and industrial theme in our portfolio right now.”
For Caterpillar, “demand for construction equipment is improving,” as customers continue to rebuild their fleets, it said Jan. 26. McCarthy has an “outperform” recommendation on the company, which is forecasting that total revenue will be in the range of $68 billion to $72 billion this year.
Westport, Connecticut-based Terex Corp. (TEX) and Oshkosh, in Oshkosh, Wisconsin, also provide “upside to earnings estimates in the mid-term” because of their exposure to the U.S. construction industry, Duignan said. She raised these stocks to “overweight” from “neutral” earlier this month; McCarthy also recently upgraded Terex to “outperform” from “neutral.”
Shares of Terex, which makes aerial work platforms and cranes, and Oshkosh, a commercial-truck manufacturer, have outperformed the market by 98 percent and 55 percent since Oct. 3, 2011, when the Standard & Poor’s 500 Index fell to a one-year low. This followed almost 7 months of underperformance, when Terex and Oshkosh shares lagged behind the S&P 500 by 59 percent and 43 percent.
Manitowoc Co. (MTW), Ingersoll-Rand Plc (IR) and Illinois Tool Works Inc. (ITW) also have large end-market exposure to this industry, said McCarthy, who maintains “outperform” recommendations on these companies. Manitowoc makes cranes used in construction; Ingersoll-Rand’s products include air-conditioning systems.
‘Mood is Changing’
The “mood is changing now” for nonresidential construction, according to Eaton Corp. (ETN), and the electrical- products maker is forecasting “continued recovery into 2012,” Chairman and Chief Executive Officer Alexander Cutler said on a Jan. 26 conference call.
Even so, the Cleveland-based company reported operating earnings of $1.08 a share for the period ended Dec. 31, missing the average analyst estimate of $1.11, in part because customers in its U.S. electrical business delayed shipments, Cutler said in a statement. The revenue shortfall probably was driven by temporary factors and shouldn’t have “a significant impact” on sales this year, he said. McCarthy has an “outperform” recommendation on the company.
Nonresidential construction exhibits “late-cycle” growth because the design and building process may take several years from inception to completion, said Russell Price, a senior economist at Ameriprise Financial Inc. in Detroit. As a result, companies planning projects must have confidence in the economic outlook, he said.
“Developers have to see not only that demand has improved, but that the improvements are sustainable,” Price said.
Expanding U.S. Economy
The U.S. economy grew at a 2.8 percent annual rate in the three months ended Dec. 31 after rising 1.8 percent in the previous quarter, which was less than the median forecast of 3 percent in a Bloomberg News survey. Meanwhile, payrolls expanded by 200,000 in December, following a revised 100,000 gain in November, Labor Department data show.
“The tone in nonresidential construction is changing” after years of pessimism, Price said. “We’re finally starting to see this sector perk up.”
Even so, the jobless rate remains elevated by historic standards -- at 8.5 percent in December compared with less than 5 percent before the 18-month recession began in late 2007 --and private nonresidential spending is about 33 percent below its January 2008 peak, so “there’s still a ways to go,” Price said.
Lackluster construction spending is a result of the economy’s sluggishness, Baker said. The architecture association’s billing index historically has led improvements in building activity by about nine to 12 months; because this recovery has been so weak, a construction rebound is coming later in the economic cycle as “companies don’t need to add new facilities until they’re seeing growth,” he said.
Illinois Tool Works, which makes fasteners, is forecasting a “modest recovery” this year, with global growth in its construction-products segment between 3 percent and 5 percent, Vice Chairman David Parry predicted at the Glenview-based company’s Dec. 2 investor meeting. “I think we’ve hit bottom,” he said.
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