The building boom that has boosted publicly traded heavy construction companies shows no signs of quieting.
Spending on new skyscrapers, oil and gas plants, public transportation infrastructure, and other big projects worldwide is expected to remain strong, analysts say.
Unlike the downbeat U.S. housing market, nonresidential construction is in an up cycle.
The heavy construction industry is benefiting from the fact that many subsectors are doing well at the same time, such as hotels and casinos, oil and gas production, road construction, and commercial buildings.
Growth is especially strong overseas in places such as China and the Middle East.
“Right now the industry is in very good shape,” said John Rogers, an analyst with D.A. Davidson & Co. “There’s strong growth and strong prospects. The order books for these companies continue to expand faster than they can burn it off.”
The American Institute of Architects is forecasting 7.2% growth in nonresidential construction spending throughout all of this year, driven by hotel and office building business. That’s on top of 6% growth last year.
The institute’s closely watched Architecture Billings Index, a leading economic indicator of construction activity, revealed a spike in design activity in May. That follows three months of moderate growth.
With a nine- to 12-month lag time between architecture billings and construction spending, the forecast for the nonresidential construction market remains favorable throughout 2007 and into early 2008, the AIA said.
The U.S. Census Bureau is forecasting private nonresidential construction spending to rise nearly 9% this year to $343 billion. It sees public construction spending growing 6% to $285 billion.
1. Business
IBD’s industry group for building companies involved in heavy construction includes 26 stocks. These firms are involved in engineering, design, construction and facilities management for large-scale projects.
Leading the group are giants Fluor () and Jacobs Engineering Group. ()
What separates the winners from the also-rans in this construction segment is strong management, analysts say. The top-notch companies have a proven track record of project execution and bidding work properly.
“This isn’t a business where it’s easy to set up a shingle somewhere and open your doors,” said Richard Paget, an analyst with Morgan Joseph & Co. “People award you work based on what you’ve done in the past.”
The best performing companies have a firm grasp of local rules and regulations as well as issues associated with labor and materials.
One trend helping to improve the stability and profitability of the sector is the shift to more cost-plus contracts.
With fixed-price contracts, the rewards were higher but so were the risks. Companies often struggled when hit with unexpected increases in materials and labor costs or project delays.
Cost-plus contracts allow contractors to pass on some cost increases.
“The engineering and construction companies can push some of the risks back on to the project owners that historically they may not have,” said Steven Fisher, an analyst with UBS. “You’re seeing a decline in the amount of fixed-price work on backlog over time.”
Name Of The Game: The leading heavy construction companies have a history of satisfying their customers on big projects. They focus on choosing the right projects, meeting their goals and doing so profitably.
2. Market
The heavy construction industry is highly fragmented and dominated by many privately held companies.
The largest U.S. contractor is Bechtel Group, a privately held engineering, construction and project management company based in San Francisco.
Fluor is No. 2, according to Engineering News-Record.
The largest U.S. design firm, meanwhile, is URS, () followed by Jacobs, ENR reports.
The industry has seen a lot of acquisitions in recent years and that consolidation activity is expected to continue.
Larger companies are using acquisitions to make inroads into faster growing international markets, analysts say.
“As the bigger players generate cash, they will use it for making smaller, bolt-on acquisitions,” Fisher said.
In May, URS announced plans to buy Washington Group International () for $2.6 billion.
In March, Jacobs inked a deal to buy Edwards and Kelcey, a privately held engineering, design, planning, and construction management firm.
Last October, Perini () bought Rudolph and Sletten, an established building contractor and construction management company.
3. Climate
The heavy construction industry is a cyclical business.
But the current up trend is likely to continue, thanks to the need for more oil and gas production and refinery capacity, public infrastructure projects such as road and airport improvements and other trends.
“This particular cycle will be longer and drawn out,” Paget said. It also will be less volatile than in the past, he says.
Up cycles in the building industry typically last seven to 10 years and down cycles last two to four years, he says.
One of the big drivers lately has been the oil and gas sector, Paget says.
The high price and demand for oil has led to refinery expansion projects, oil sands ventures in Canada and petrochemical plants in the Middle East, he says. Fluor and Jacobs are two major beneficiaries of this trend.
Analysts also are seeing the start of an increase in power infrastructure spending.
With systems strained to the limit, countries need better power transmission and distribution systems, Paget says.
Eventually the market for power generation will stage a comeback, as new nuclear, coal and other plants are built, Paget says.
But about half the market for heavy construction comprises general buildings.
That includes office buildings, hospitals and schools. China and the Middle East, especially the United Arab Emirates, have seen big booms in general construction.
In the U.S., federal and state governments have recognized the need to fund more public infrastructure improvement projects.
In particular, California has pledged to spend tens of billions of dollars on infrastructure upgrades over the next decade.
4. Technology
Companies involved in the engineering and construction of big works projects have benefited from new technology to share design and planning with multiple offices.
In years past, a lot of the engineering, planning and project management staff had to be on-site or near the construction site, Rogers says.
But thanks to Internet-based project management and collaboration systems, a lot of the detail work can be done in virtual meetings.
“That’s one of the reasons some of the bigger companies are gaining an advantage,” Rogers said.
5. Outlook
The outlook for the heavy construction industry remains positive, analysts say.
Valuations for public companies in the sector are at historical highs, but there’s still room for growth, Paget says.
Since the building industry follows macroeconomic trends, analysts are keeping an eye out for signs of a slowdown.
They’re also watching trends in the energy sector and government spending on infrastructure improvements.
Possible shortages of labor and materials are a concern, too, since they could drive up costs and cause project delays and cancellations.
Upside: Lots of big construction projects are forecast for fast-growing markets in Asia and the Middle East.
Energy trends are prompting companies to add oil refining capacity and build new power generation and distribution systems.
Risks: The big risks for companies in the sector often are related to their performance on particular big projects.
Their execution on those projects can have a huge impact on their profitability.
