3 Construction Stocks Capitalizing on the Recovery
Aug 23rd 2013 3:27PM
Updated Aug 23rd 2013 3:28PM
Construction activity continues to face challenging conditions in the past few months driven by the softening in housing starts, recent public spending austerity and wet weather. However, there is light at the end of the tunnel and each of these factors have been offset by a gain in renovation spending, increase in economic growth and the end of a severe winter. In the second quarter the economy grew at a 1.7% pace, above consensus expectations of 1%.
International network of operations provides scale advantages
CRH PLC manufactures cement, concrete products, aggregates, roofing, insulation and other building materials such as clay products and tempered glass. Half of the company's revenue in 2012 came from Europe and the other half from the US. With high barriers to entry, this international network of operations provides scale advantages in purchasing and logistics management and synergies in procurement and cost management.
CRH's revenue is also diversified through residential, commercial, and infrastructure activities. This, combined with a strong balance sheet, gives the firm a healthy position to cope with heavy headwinds coming from European and public spending cuts. Improving markets in the US will more than offset a continued weakness in European markets and help CRH capitalize on a rebound in construction activity over the long run.
The greatest risk to CRH is a lack of recovery in the housing market and further cut in public spending on infrastructure, in either the US or Europe. In addition, the firm has a substantial exposure to currency fluctuations and changes in tax regulations. CRH uses significant amounts of diesel fuel in both its manufacturing operations and distribution services. Price increases in this commodity could significantly jeopardize targeted costs savings.
The firm has remained focused on organic growth and continually reinvests capital into higher-returning projects while returning cash to shareholders in the form of dividends. Trading at about 22.4 times its earnings, 10% below the industry average, I would recommend shares of CRH as Buy.
Relatively strong balance sheet
Martin Marietta Materials is the second largest producer of construction aggregates in the US, along with producing magnesia-based chemicals and dolomitic lime. It's most important market is infrastructure, particularly federal highway spending which is driven by the multi-year transportation bill. Highway construction is financed by the Highway Trust Fund, which receives money primarily from a flat user tax that motorists pay on every gallon of gasoline and diesel purchased.
Construction activity is highly cyclical. Therefore, the biggest risk for Martin Marietta is weak construction activity due to cuts in federal and state budgets, fall in employment, lower vacancy rates, and higher interest rates. On the bright side, politicians know that infrastructure spending creates jobs and improves key macroeconomic variables in the long term. So, it is expected to see long term policies that encourage the construction industry. Besides, Martin Marietta's relatively strong balance sheet serves as a dose of protection during these challenging times.
I recommend Buying Martin Marietta shares based on consistent growth and acceleration in EPS. Last year EPS grew 19%, while this year it's estimated to increase 22% and later to speed up to 45% in 2014. ROE as of June 17 is 7%, whereas the industry average has been 5%, which shows that the company earns investors a better rate of return on their equity stake than peers. .
Benefited by repair and remodel activity
Masco Corporation makes plumbing and decorative and architectural products, such as cabinets, paint, windows, and other home products under familiar brand names, sold for example at Home Depot. Currently around 75% of Masco's top line is related to repair and remodel activity and the remaining 25% is derived from new home construction. Approximately 80% of the company's sales are generated from operations in North America and 20% outside the US, mainly in Europe.
Even though the last economic crisis capped growth at Masco, the company has recently implemented consolidation plans that will likely increase profitability. Forecasting an increase in renovation spending, the company has focused its improvement efforts on the Installation and Cabinet section. In addition, it has solidified its market position and leveraged its brands. By launching new products, reducing excessive costs and paying off its debt, Masco's balance sheet will continue to strengthen.
Last quarter, earnings rose by 109.1% YoY driven by strong performance in the US, solid margin expansion, and profit improvement initiatives. Overall, the stock is attractive, especially given its ROE of 23.6% (TTM), compared to the 18.5% industry average return. Trading at about 39 times its trailing 12-month earnings (a 4% premium to the industry average of 37.2 times) while offering a moated brand, I would recommend Buying shares of Masco.
CRH, Martin Marietta and Masco operate in an industry that holds key barriers to entry. All three stocks are expected to deliver strong growth figures in the future based on signs of an ongoing recovery in the residential and nonresidential construction activity. Follow the link to a great blog article to find other solid companies with good prospects and durable "moats".
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The article 3 Construction Stocks Capitalizing on the Recovery originally appeared on Fool.com.Damian Illia 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.