Since 2009, the global economic recovery has been uneven and unpredictable. Possibly the worst hit segment of the economy was the commercial construction sector which has certainly seen its share of ups and downs over the years. However, uncertainty often creates opportunities for forward-thinking investors. Let's take a look at the dynamics in the sector and the stocks that could benefit from an extended recovery.
Uneven but positive recovery
The most important set of data in the nonresidential construction industry is the Architectural Billings Index, or ABI, from the American Institute of Architects. A score above 50 in the index indicates that firms in aggregate are reporting increased billings -- indicating the increase in future construction activity.
As you can see from the following chart residential activity led the way in the recovery but has turned negative in the last few months. Meanwhile, commercial activity has had a good year only to turn negative in May, and institutional continues its strong recovery over the last year.
Source: American Institute of Architects
Moreover, a look at the Senior Loan Officer Survey from the Federal Reserve reveals that domestic banks continue to report strengthening demand for commercial real estate loans -- albeit at a slightly reduced level in recent months.
As you can see in chart below, demand for commercial real estate loans has historically followed overall demand for commercial and industrial loans, but the relationship has seemingly weakened since 2012. The good news is that demand for commercial real estate loans remains in positive territory.
Source: Federal Reserve. A reading above zero indicates net positive response. *Data from the fourth-quarter of 2013 is for commercial real estate loans with construction & land development purposes as original data (green line) was discontinued.
From a top-down perspective the picture is broadly positive, but recent weakening in the commercial ABI data plus demand for C&I loans in the Federal Reserve survey is a cause for concern.
Bottom-up perspective
Indeed, the bumpy nature of the recovery is also apparent in the recent results from some leading companies in the industry. For example, Johnson Controls only reported a 4% revenue increase in its Building Efficiency segment in its recent second quarter, and management sees a strong order book. On an adjusted basis its overall orders were up 8% with North American orders up an impressive 11%. The stock is a good option for investors, but note that the majority of its earnings come from the automotive sector not commercial construction.
Another company that reported a similar story in its recent first-quarter results was commercial real estate services company Jones Lang LaSalle (NYSE: JLL). As the linked article details, gross absorption (an industry term that just refers to the percentage of total office space that is leased) in the Americas fell 6% in the quarter -- something that management believes is an anomaly.
Indeed, just as with Johnson Controls, management believes that conditions will get better later in the year. Jones Lang LaSalle represents one of the purest ways to buy into the idea of a global resurgence in commercial property activity.
Growth stocks
I know what you're thinking. Are there any company's in the sector with legitimate growth prospects? Fortunately, there appear to be three. The first two are Hubbell Incorporated (NYSE: HUB-B) and Acuity Brands (NYSE: AYI) Hubbell has heavy exposure to the North American nonresidential construction market through its electrical segment which produces wiring devices and lighting products. As the linked article outlines, the company is a strong cash generator and has attracted the interest of Soros Fund Management.
In addition, Hubbell has growth opportunities thanks to the shift from conventional to LED lighting, and press speculation is suggesting the company may become easier to buy for a potential bidder. If Hubbell is a potential takeover then Acuity Brands must also be in the frame as well.
Acuity is a leading distributor of lighting products to the North American commercial and industrial markets, and has a long-term growth opportunity in the LED market as well the the LED market needs the company's controls which are sold alongside LED lighting.
The last stock with legitimate growth prospects is security products manufacturer Allegion (NYSE: ALLE). If the commercial construction market is booming then its highly likely that Allegion will see the benefit with increased sales of its security doors and systems. Moreover, the company's long-term growth opportunity from embedding wireless and Web-enabled technology in its locks.
The major benefit is that companies can better control and monitor who is accessing various areas of their buildings -- a major plus in combating internal theft.
The takeaway
In summary, investors in the sector are no doubt hoping that the current slowdown in commercial construction activity is temporary. Investors interested in the commercial construction sector can take heart as Johnson Controls and Jones Lang LaSalle's managements have publicly stated that they believe better days are ahead. The latter is a bit more of a global play, but Hubbell and Acuity are heavily focused on North America, while Allegion is an interesting way to play the 'Internet of things' investing theme.
