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5 Construction Stocks That Crushed the Market in 2017

Zacks Equity Research

As we bid adieu to 2017, let’s take a look at how the construction sector fared this year and what’s in store for 2018.

Overall, 2017 was a great year for the construction sector buoyed by robust gains from home building investments and a rebounding U.S. economy. Especially, optimism surrounding the construction sector grew manifold post President Donald Trump’s victory, since one of his key priorities was driving infrastructure investments. This optimism is likely to continue in the near term, thanks to the long-awaited tax cuts, which are likely to be passed this week.

In total, spending on construction increased 4.1% year over year in the first 10 months of the year, per the latest report from the U.S. Census Bureau. Although spending on government projects declined 3.4% year to date, it grew 3% in October, the biggest one-month gain in three years, with spending at the federal, state and local levels rising. Government project spend is expected to increase in 2018 with the Trump administration’s $1-trillion infrastructure spend program, which is yet to materialize. On the other hand, residential spending increased 6.6% in the first 10 months of 2017. While a few projects like multifamily housing are gradually losing ground, others like office buildings, education facilities, and transportation terminals are in high demand.

Insights Into the Sector’s Prospects for 2018

U.S. construction starts are expected to climb slightly in 2018, according to Dodge Data & Analytics’ 2018 Dodge Construction Outlook. A 3% increase to $765 billion is expected, following a similarly modest 4% rise to $746 billion, is estimated for 2017.

The forecast further entails 3% increase in public works construction spending, higher than 1% growth in 2017. Highways and bridges projects are likely to get a boost as federal funding is rising owing to the FAST Act. Again, reconstruction efforts related to hurricanes Harvey and Irma are also adding to the expectations.

Also, residential construction activities stepped up this year and the trend is expected to continue in 2018, courtesy of improving economy, modest wage growth, low unemployment levels, positive consumer confidence, a tight supply situation and escalating rent costs. Per the study by Dodge Data & Analytics, 4% gain is expected for residential building, 2% for nonresidential building, while nonbuilding construction is expected to stabilize following two years of decline.

However, a few market pundits are of the opinion that the Trump administration’s efforts toward overhauling the tax code could undermine any potential improvements in affordability in the housing market and make housing less attractive. The GOP tax bill allows interest payment deductions on mortgage debt up to $750,000, down from the current $1 million.

That said, the December reading of the confidence level of homebuilders speaks of the industry’s strength. The confidence level among the nation's homebuilders ended 2017 on a high note as the housing market index (HMI) was at 74 in December. This marks the highest reading since 1999.

Builders seem to be shaking off worries related to the Republican tax plan, and apparently believe that the business incentives in the plan are likely to offset the negatives. The legislation promises many practical changes in a number of areas, but it will surely have a major positive impact on corporate profitability.

Per the Zacks Earnings Trends, earnings for the construction sector are likely to witness 20.3% growth in 2018, up from the expected 14.9% increase in 2017. Revenues are likely to improve 9% in 2018, compared with 9.5% growth estimated for 2017.

Strong Economy and Labor Market Act as Catalyst

Trump had vowed to double economic growth through an ambitious stimulus program featuring tax cuts, deregulation and higher infrastructure spending. Both markets and investors responded positively to this. The aura exists, as is evident from the broader market’s performance.

The S&P 500 index topped the milestone of 2,500 for the first time in mid-September, surpassing the 266% rise during the 1949-56 run, per Bloomberg. Notably, the surge came in the aftermath of hurricanes Harvey & Irma, depicting strong complacency in the stock market. Again, the Dow Jones Industrial Average has moved up 5,000 points this year — the biggest annual gain in its history — and is moving closer to another major milestone of 25,000.

The world’s largest economy expanded at an annual rate of 3.3% in the July-September quarter (2nd estimate), marking the fastest pace since the third quarter of 2014 and up from the second quarter's 3.1%. Again, further decline in unemployment (4.1% in November) will keep the momentum alive for the construction sector. The November figure came in the lowest since December 2000.

All these positive factors have helped the construction sector to grow more than 24% this year, higher than the broader market’s (S&P 500) rally of 20.1%. We note that the construction sector has been a major contributor to the S&P 500’s growth story.

Investing in the Construction sector might sound profitable right now, as it falls within the top 31% (5 out of 16 sectors) of the Zacks Industry Rank, which hints at further growth.

5 Construction Stocks that Outpaced the Market

We bring five construction stocks that not only outpaced the market (S&P 500) in 2017 but also are expected to outperform in the coming years. We have taken help of the Zacks Stock Screener to zero in on stocks that gained more than 20.1% this year. These stocks have a market cap of $1 billion or more and a Zacks Rank #1 (Strong Buy) or 2 (Buy).

Sterling Construction Company, Inc. STRL – Up 100.6%

Sterling along with its subsidiaries, operates as a heavy civil construction company in Texas, Utah, Nevada, Colorado, Arizona, California, Hawaii, and other states in the United States. It carries a Zacks Rank #2 and has a long-term earnings growth rate of 11%. You can see the complete list of today’s Zacks #1 Rank stocks here.

In the last two years, the company has successfully turned around, and dramatically improved its balance sheet and overall financial health. Thus, the company is well positioned to generate substantial earnings growth in the future. Looking beyond 2017, the company expects to benefit from a steady stream of heavy civil project opportunities across its geographies as well as its residential business. We expect Sterling to post year-over-year earnings growth of an astounding 211.3% in 2017 and 119.1% for the next.

NVR, Inc. NVR – Up 104.9%

NVR is engaged in the construction and sale of single-family detached homes, townhomes and condominium buildings. NVR has delivered stellar performance so far this year, driven largely by its disciplined business model, focus on maximizing liquidity and minimizing risk.

This Zacks Rank #2 stock has a long-term (three-five years) expected EPS growth rate of 17%. The company’s 2017 earnings are expected to grow 42.5% and 16.8% for 2018.

D.R. Horton, Inc. DHI – Up 85.8%

Texas-based D.R. Horton is one of the leading national homebuilders. The company remains committed toward achieving continued double-digit annual growth in both revenues and pre-tax profits, while generating positive cash flow and improved returns. Further, its SG&A expenses are continuously decreasing due to cost control and better fixed-cost leverage.

The stock currently has a Zacks Rank #2 and the homebuilder’s current year’s earnings are expected to grow 17.4% and 14.6% for the next.

Boise Cascade Company BCC – Up 80.6%

The company is a wood products manufacturer and building materials distributor. The stock holds a Zacks Rank #1 and earnings for the current year and next year are expected to grow 85.7% and 7.2%, respectively.

The company remains optimistic about improvement in demand for its products to continue as household formation rates and residential construction surges further.

United Rentals, Inc. URI – Up 59.4%

United Rentals is one of North America's largest equipment rental companies. The stock sports a Zacks Rank #2 and has surpassed earnings estimates consistently in the past seven quarters. United Rentals enjoys strong brand recognition, which enables it to draw customers and enhance customer loyalty.

The company, with a solid ROE of 44.8%, is also expected to witness earnings growth of 22.1% for 2017 and 18.1% for 2018. The stock has a long-term (three-five years) expected EPS growth rate of 18.5%. (Looking for the Best Stocks for 2018? Be among the first to see our Top Ten Stocks for 2018 portfolio here.)