Construction Rises as Architects Signal Nonresidential Rebound

January 30, 2012, 3:53 AM
EST

By Anna-Louise Jackson and Anthony Feld

Jan. 30 (Bloomberg) -- 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., the
world’s largest manufacturer of construction and mining
equipment, is the “poster child” for this industry, he said.

Beating Estimates

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.

CNH Global NV, which manufactures agricultural and construction
equipment, and Oshkosh Corp. are scheduled to report earnings
for the quarter ended Dec. 31 tomorrow.

“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.

Earnings ‘Upside’

Westport, Connecticut-based Terex Corp. 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., Ingersoll-Rand Plc and Illinois Tool Works Inc.
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., 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.

Later Rebound

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.

--Editors: Melinda Grenier, Daniel Moss

To contact the reporters on this story: Anna-Louise Jackson in
New York at ajackson36@bloomberg.net; Anthony Feld in New York
at afeld2@bloomberg.net

To contact the editor responsible for this story: Anthony Feld
at afeld2@bloomberg.net

Read the rest here:
Construction Rises as Architects Signal Nonresidential Rebound