The non-residential construction data in the U.S. has had a "wow" factor this year. It's more than offset highly visible declines in residential construction. So, even though the housing market is weakening, stocks like Caterpillar (CAT +2.85%), Trimble (TRMB +2.39%), and Stanley Black & Decker (SWK +4.26%) are set to do well. Here's why all three are attractive stocks right now.
Non-residential construction spending
Let's start by looking at data from the U.S. Census Bureau. It's no surprise to see rising interest rates biting into residential construction spending. However, non-residential construction spending remains excellent. Within the data for May, there are some particularly bright spots, including private non-residential spending up 21%, private manufacturing construction spending up 77%, and private lodging spending up 23%.
Data source: Census Bureau.
1. Caterpillar, a construction-focused stock
That's great news for a company like Caterpillar. Back on the company's last earnings call in April, CFO Jim Umpleby told investors, "We expect growth in non-residential construction in North America due to the positive impact of government-related infrastructure investments and a healthy pipeline of construction projects." It looks like the data is supportive of his viewpoint.
Moreover, in case investors are worried about Caterpillar's exposure to real estate, Umpleby also noted, "We estimate that North American commercial real estate accounts for about 1% of total construction industry sales."
As such, its construction industry sales could improve in 2023. That would boost Caterpillar because its other two segments' retail sales (Caterpillar primarily generates sales to dealers who then sell to the retail market) were already in growth mode in 2023. Moreover, relatively high mineral and metal prices support spending on its resource industries' equipment, as does the oil price (above $70 a barrel at the time of writing) for its energy-related sales.
Data source: Caterpillar presentations.
All told, don't be surprised if Caterpillar reports an excellent second quarter when it releases earnings in a few weeks.
2. Trimble benefits from non-residential construction spending
The positioning and modeling technology company might seem a strange choice, but its buildings and infrastructure segment is its most significant revenue and earnings generator. The segment was responsible for 41% of revenue and 48% of income in 2022.
It's also expected to be its vital growth driver over the next five years. For example, on its investor day presentation in the fall of 2022, management outlined expectations for its overall annualized recurring revenue (ARR) to grow at a mid-teens rate annually over the next five years. However, its buildings and infrastructure ARR is expected to grow at a high-teens- to low-20s-percentage rate over the same period.
Image source: Getty Images.
Trimble manufactures and sells hardware and software used for positioning and modeling customers' assets. Its key end markets are buildings and infrastructure (e.g., technology that helps monitor, model, and manage projects), resources and utilities (e.g., precision agriculture), geospatial (e.g., mapping the earth), and transportation (e.g., monitoring and managing fleets).
Its roots lie in hardware, but its future lies in the software and analytics capability, making it an increasingly important part of its customers' workflow. For example, its analytics can significantly improve productivity and reduce construction project waste.
Plus, its buildings and infrastructure business tends to have a higher-than-company-average mix of higher-margin software and services revenue, meaning the segment's growth should improve its margin profile.
Trimble looks set to generate significant cash flow in the coming years, and the strength in non-residential construction and infrastructure spending could boost its earnings in 2023.
Image source: Getty Images.
3. Stanley Black & Decker's turnaround plans are being helped by construction spending
Lastly, this tools and industrial products maker's turnaround plans will likely be aided by an improving non-residential construction market. To be clear, a declining residential market is definitely not good news for a DIY tools manufacturer. However, there's more to Stanley Black & Decker than the DIY market.
"Tools is running probably ahead of our projections, driven by Pro tool consumption," CFO Pat Hallinan said about the second quarter during an investment conference in early June. Interestingly, Hallinan also noted that although the new home construction market was in decline, it's "still much stronger than anybody anticipated this year."
As such, it's reason to believe the company's restructuring plan, which involves significantly reducing its inventory in 2023 and cutting costs by $2 billion by 2025, is on track, just as Hallinan said it was at three conferences in June.
Ongoing strength in the non-residential market will help Stanley Black & Decker with its plans, and the stock's valuation may be low enough to attract investors willing to be patient for the turnaround plan to work.
