Construction activity continues to be a bright spot in the US, driven primarily by the residential sub-sector. This has also been a keenly followed investing theme by money managers all around the US. Many industries have been direct or indirect beneficiaries of improvements in the construction market. Some examples are home builders, paint makers, chemical producers and so on. Let’s have a wide look at the market to see how players from different industries are expected to benefit from this growth theme.
Well-balanced product mix
Eaton Corporation, PLC Ordinary Shares (NYSE:ETN) produces a broad range of products and services, from fuel-efficient systems to power-chain management tools and components that safely guide commercial aircraft. Therefore, the company’s mix of business is well balanced between early-cycle (truck and automotive), mid-cycle (hydraulics), and late-cycle (aerospace and non-residential electrical equipment).
However, in this context, I am more concerned about its exposure to residential construction. Going into 2013, investors prefer companies that have U.S. construction exposure and in particular stocks that have company-specific catalysts. In this respect, Eaton Corporation, PLC Ordinary Shares (NYSE:ETN) fits both of these criteria and is one of the top ideas for 2013.
The company acquired Cooper Industries (one of its electrical-equipment suppliers) in May 2012. Cooper’s acquisition has given Eaton ~25% exposure to U.S. construction. Eaton expects to achieve revenue synergies worth $565 million by 2016, which will serve as one of the important catalysts in the future.
That said, the stock is up 30% since the start of the year and has become an investor favorite, implying that expectations are now elevated. Any disappointment on the quarter could result in downside risk to the stock.
Trucks and the housing market
Given that trucks and pickups are used to transport building materials, a recovery in the construction market has been a good sign for truck-related industries. Commercial Vehicle Group, Inc. (NASDAQ:CVGI) has been one of the beneficiaries through this channel. The supplier of interior systems for heavy-duty trucks currently has volatility in its revenue model given low visibility in key end markets, which are expected to negatively impact earnings in the near term.
Both North American Class eight truck and construction equipment markets are expected to face near-term headwinds, with the potential for second-half 2013 recovery. Meanwhile, investments in a variety of projects continue, causing reduced cost structure flexibility in near term.
That said, acquisition activity or improvements in North American truck orders and/or the global construction equipment market would be an opportunity for Commercial Vehicle Group, Inc. (NASDAQ:CVGI) to deliver strong incremental margins once again. Currently, the risk and reward seem to be in balance.
After discussing a truck component supplier, I have picked up a truck manufacturer as the third company to be affected by improving construction dynamics. Some 29% of Oshkosh Corporation (NYSE:OSK)’s revenue is tied to construction activity. A dominant portion of this revenue is generated through the sale of Aerial Work Platforms (AWPs) and cement trucks by the company.
It is interesting to note that the revenue from construction is still down ~33% from the peak level it once achieved couple of years ago. The company is well positioned to benefit from a recovery in construction activity.
Oshkosh Corporation (NYSE:OSK)’s defense business has been a major headwind to the company. It might feel like digressing from the theme of residential construction, but it is worthwhile to discuss it in order to form an overall opinion on the company.
In its recent earnings release, management lowered the revenue outlook from a range of $3.2 billion to $3.3 billion to the $3.1 billion to $3.2 billion range. However, the bullish aspect was that the operating profit was raised from 6.5% to 7%. This highlights the company’s recently announced layoffs in the segment to curtail costs. Moreover, its recently announced share-repurchase program may help to offset larger than expected declines in defense revenue.
It is clear from the discussion that all three of the companies are expected to benefit from the recovery in housing market. However, only Oshkosh Corporation (NYSE:OSK) and Commercial Vehicle Group, Inc. (NASDAQ:CVGI) are recommended as buy as their low-digit gains for the year show that hardly any positive news has been priced in the stock. I remain on the sidelines on Eaton Corporation, PLC Ordinary Shares (NYSE:ETN) given its enormous gain on a year-to-date basis.
The article 2 Beneficiaries from the Housing Recovery to Buy, 1 to Hold originally appeared on Fool.com and is written by Zain Abbas.
Zain Abbas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Zain is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.