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Thursday 21 November 2019

Time for investors to take notice of changing tide in construction


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Brian Flavin

After the financial crisis, when management teams talked about corporate spending they mostly meant share buybacks. Growth in traditional investment (the kind that went towards manufacturing, buildings, machinery and so on) declined - and for good reason. Demand just wasn't there to justify the spend.

However, in the quarter just gone, one notable trend is the better-than-expected pick-up in capital expenditure. Another notable trend is how management teams responded when asked how they might use the proceeds from recent US tax reforms. The most prevalent response was that they would spend more money on capital expenditure. Right now, the big technology firms are driving this spend as they build data centres and headquarters, but we are also starting to see traditional companies ramp up spending on structures and manufacturing capacity.

If this is the beginning of a trend, then one industry which has been left out in the cold by investors - but which should benefit from increased capital expenditure - is construction. Ten years on from the Great Recession, US construction markets have yet to reach their prior peaks in real terms. Construction is in a long, slow recovery. This is not surprising, considering the scale of wealth destruction that preceded it. However, it also means that there is plenty of room for upside - and that is not something you can say for all sectors of the stock market at this stage of the cycle.

History suggests that spending on private non-residential construction (offices, commercial buildings, power infrastructure, hospitals and so on) in the US peaks around 20pc above prior peaks, in real terms. However, today, this part of the US construction market sits around 7pc below the last cyclical peak - and non-residential spending typically lags the peak in housing construction by somewhere between one and two years. Housing construction in the US has grown at an average of 9pc annually over the last 12 months, yet it is still around 20pc below what are considered normalised volumes. With household formations still playing catch-up (around five million were deferred after the Great Recession), the US housing cycle looks like it still has some way to go. So that in turn bodes well for the non-residential construction cycle.

This plays right into the hands of some of Ireland's best-known construction stocks, such as CRH and Kingspan. Both have significant operations serving US construction markets and both have been vocal about the opportunities there. Indeed, after its recent update to the market, CRH was keen to point out the growth opportunities in its developed markets (such as the US) - and management emphasised the role that acquisitions should play in capturing them.

We are finally moving away from the era of quantitative easing as central banks gradually tighten the extraordinarily loose monetary policies in place since the financial crisis. This is often called normalisation and is the most influential macro trend in today's markets.

Normalisation means we are moving towards growing demand and a reduction of the output gaps that exist in the global economy. I believe this is why we are beginning to note the growth in capital investment coming through. Given the much slower pace of investment in housing, non-residential construction and public infrastructure relative to previous recoveries, it seems clear that the construction industry is set to benefit significantly.

Brian Flavin is senior equity analyst with Goodbody

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