Construction Stocks Build On Real Estate Rebound

A robust construction market not only benefits builders, developers and real estate professionals, it also gives a lift to companies that supply products used in construction.

Look no further than IBD's Building-Construction Products/Miscellaneous group, which is trading near record highs amid optimism over the nation's residential and commercial construction markets.

Leaders in the group — including Mohawk Industries (NYSE:MHK), Acuity Brands (NYSE:AYI), Masco (NYSE:MAS) and Caesarstone Sdot-Yam (NASDAQ:CSTE) — supply everything from floor and lighting products to kitchen cabinets, countertops and plumbing goods.

Trends Track Up

All benefit from favorable trends that have pushed overall construction in the U.S. to its highest point in seven years, while builder confidence this week hit its highest since 2005.

"You're seeing a lot of growth drivers right now," said James Armstrong, an analyst at Vertical Research Partners whose coverage includes Mohawk, Masco and Owens Corning (NYSE:OC).

"You've seen very good numbers in nonresidential construction," he told IBD. "New housing construction has come back, and you're seeing a lot of activity in the repair/remodel market. There's been really good general activity in a lot of end markets."

The National Association of Home Builders/Wells Fargo Housing Market Index for July came in at a level of 60 on Thursday, and June was revised upward to 60. Anything over 50 means that more builders view conditions as good than poor.

Earlier this month, the Commerce Department reported that total U.S. construction spending in May climbed 0.8% from the previous month to a seasonally adjusted annual rate of $1.04 trillion, the highest level since October 2008.

Increases were reported across major categories such as private nonresidential building, which led the way with a 1.5% gain in May as the sector benefited from higher spending on hotels, manufacturing facilities and amusement parks. That gain followed increases of 4% in April and 3.3% in March.

Private residential construction in May climbed 0.3% month-over-month, while spending on government projects rose 0.7%. Residential activity was led by an 0.9% increase in spending on renovation projects. Spending on single-family homes was flat from a month earlier, while spending on apartment projects rose 0.2%.

On Friday, the Commerce Department reported that U.S. residential building permits jumped to near an 8-year high in June. The seasonally adjusted annual rate came in at 1.3 million, 7% above May and up 30% from a year earlier.

Midyear Improvement

The recent gains came after a sluggish start to the year, said Megan McGrath, an analyst at MKM Partners. The slow start was partly because of severe weather and partly because of weaker-than-expected first-quarter economic growth.

"But it does appear that that the pace is starting to pick up again," McGrath told IBD.

Multifamily building permits have seen a particularly big spike. Permits for buildings with five or more units reached 621,000 in June, a gain of 16% from May and 79% from a year earlier. In contrast, single-family home permits rose 0.9% from May and 6% from a year earlier, to 687,000.

Not every building supply sector will benefit from a rise in multifamily construction, however — especially if it comes at the expense of single-family homes.

An apartment typically takes up a lot less square footage than a single-family house, which means less demand for lumber, roofing products and other structural materials.

In addition, cabinetry, countertops, sinks and other furnishings "tend to be larger and of higher quality in a single-family unit," McGrath said. "If you see the mix of new housing go more toward single-family and away from multifamily, it would be a positive for building products suppliers."

For the most part, however, the trends are all working in the industry's favor. This is reflected in the recent performance of IBD's Building-Construction Products/Miscellaneous group, which ranks No. 24 out of 197 industries tracked. The group hit a record high on Tuesday and is up about 20% since the beginning of the year.

The three biggest stocks in the group by market cap — Mohawk, Acuity and Masco — have each reported at least four straight quarters of double-digit earnings growth. Mohawk and Acuity both set new stock price highs this month. Masco set a new high in June, but then gave up some gains in July. All have strong IBD Composite Ratings above 90, out of a possible 99.

Some other sizable names in the group with Composite Ratings of 90 or higher are Caesarstone, Trex (NYSE:TREX) and Apogee Enterprises (NASDAQ:APOG).

These companies might supply similar markets, but their product lines vary widely.

For example, Acuity makes light-emitting diode (LED) and other lighting products for the industrial, commercial and residential markets. Its products run the gamut from traditional lighting systems to high-tech digital systems tied to the Internet of Things.

The company has posted double-digit sales and earnings growth in eight of the last nine quarters as it benefits from rebounding commercial real estate markets and rising demand for new, advanced lighting systems.

"Institutional-related project activity appears to be settling after several years of decline, which should provide additional top-line momentum and potentially greater opportunities for installation of higher-margin product," analyst Brent Thielman of D.A. Davidson noted in a recent report on Acuity.

There has been similarly high demand for floor covering products that Mohawk supplies to residential and commercial developments; home security, kitchen and bath products that Fortune Brands Home & Security (NYSE:FBHS) supplies to homebuilders; windows and doors that PGT (NASDAQ:PGTI) supplies to renovation and new-build contractors; and the cabinets, plumbing products and related gear that Masco supplies to Home Depot (NYSE:HD) and other customers.

Meanwhile, building supply companies are doing a better job on the operational side, analysts say. That's partly because of lessons that they learned during the recession and financial crisis, when construction markets tanked.

"Suppliers of building materials got their costs in order, adjusted how they operate and shrunk their capacity base," Armstrong said.

Roofing suppliers are "still seeing margins significantly off from their peak levels," he said. "But in most other sectors, you're beginning to see margins back in order. Most of these companies don't need the same level of new housing construction to see the same margins as before, so they're in a much better position now than a few years ago."