Hedge Funds Are Piling Into These Construction Stocks

Amid a strong economic growth and an favorable environment for investment, the US construction industry is looking at some interesting times. In 2017, the US construction industry added 210,000 jobs, an increase of 35% and construction spending has been growing since the Great Recession and amounted to $1.23 trillion last year, up by 3.8% from 2016. Spending and construction starts are expected to maintain some growth in the near future, as the tax reform allows more companies to invest in facilities. The recent wildfires and hurricanes will aid the construction industry due to rebuilding efforts. At the same time, despite the low unemployment rate, wage growth has also been low and once it picks up pace, it should offset the decline in demand for housing from higher mortgage rates cause by the Fed’s tightening monetary policy. In addition, the US infrastructure is in a bad state, with many roads, bridges, dams and other objects in dire need of repairs. The American Society of Civil Engineers estimated that the US needs around $4.5 billion in infrastructure spending by 2025 to address all these issues.

Given that the US is one of the largest construction markets in the world, construction companies are a good addition to a well-diversified investment portfolio. However, while the overall construction industry is expected to see positive growth at around 5%, individual areas within the industry show a more diverse picture. Construction of retail objects is expected to continue its decline, after construction starts fell by over 16% last year, according to some estimates. The drop is cause by the boom in eCommerce, which has significantly affected the brick-and-mortar retail. At the same time, eCommerce should help the construction of warehouses and logistics centers. Housing will be a big winner, driven by single-family housing, which are estimated to appreciate by around 9%, as millennials change their perspectives towards single-family houses. Other areas of construction expected to do well are commercial (office spaces) and non-building, which includes bridges, roads, and other infrastructure.

When looking at the hedge fund sentiment towards construction companies, we see similar conclusions, as hedge funds have been piling mostly into housing and infrastructure builders, with most popular stocks also ranking among the biggest construction companies in the world in 2017. We assess the hedge fund sentiment by taking into account the number of funds that own shares of individual companies. This allows us to get an idea about the stocks that hedge funds favor the most and, even though we can’t know the exact reasons why a hedge fund invested in a particular company, by looking at the stocks that are the most popular among the hedge funds we track, we can select those that usually perform the best among their peers over the long run.

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Assessing the hedge fund sentiment allows us to imitate hedge funds without having to actually invest in them. By compiling data from hedge funds’ quarterly 13F filings, we can identify their most popular stocks and use this information to beat the market. Our small-cap strategy, which focuses on the best small-cap stocks that best-performing hedge funds are collectively bullish on, has outperformed the S&P 500 ETF (SPY) by more than 20 percentage points since 2014. We share the stock picks that are part of our small-cap strategy in our quarterly premium newsletters alongside our monthly activist newsletter, which focuses on one of more than 140 activist funds and presents the best ways to imitate that fund.

When looking at the hedge fund sentiment towards construction companies, we see that many of the most popular stocks have seen a substantial increase in the number of bullish investors over the last year. On the next page, we will focus on five construction companies that not only rank as the most popular among hedge funds, but which also saw the largest increase in sentiment during 2017.

In William Lyon Homes (NYSE:WLH), there were 24 funds holding shares at the end of 2017, compared to 21 funds at the end of September and just 16 funds at the end of 2016. The stock of the residential construction company surged by 33% over the last 12 months as the company has been showing strong financial results with double-digit revenue growth. For the fourth quarter, William Lyon Homes (NYSE:WLH) posted revenue of $624.64 million, up by 32% on the year and almost $9.0 million above the consensus estimates. At the same time, the company’s EPS of $0.89 was higher than the expected $0.85. William Lyon Homes (NYSE:WLH)’s higher revenue came on the back of higher home sales revenue, which went up by 28% to $1.80 billion last year and the company also managed to increase its adjusted homebuilding gross margin by 30 basis points to 23.2%.

Emcor Group Inc (NYSE:EME) also saw 24 funds from our database long its stock at the end of 2017, this number growing by one fund over the quarter and by three funds over the year. Emcor Group Inc (NYSE:EME) is one of the top electrical and mechanical construction and facilities services companies in the US. The company provide design, integration, start-up, operation and maintenance services to various mechanical and electrical systems, such as electrical power transmission, voice and data communication, fire protection, plumbing, filtration, water and wastewater treatments, etc. Last month, Emcor Group Inc (NYSE:EME), a Fortune 500 company, posted record results for the fourth quarter and full year. Its fourth-quarter revenue of $2.0 billion, went up by 3% on the year and topped the estimates by $80 million, while EPS of $1.13 was $0.27 higher than expected. In addition, Emcor Group Inc (NYSE:EME) fourth-quarter full-year diluted EPS from continuous operations increased by 30.4% and 26.8% to $0.90 and $3.83, respectively. The company is expected to have a similarly strong performance this year, with 2018 revenue and EPS guidance in the ranges of $7.6 billion to $7.7 billion and $4.10 to $4.70, respectively. 

Quanta Services Inc (NYSE:PWR) is the third most popular construction stock among the funds in our database. Heading into 2017, there were 35 funds long the stock, up by two over the quarter. At the same time, Quanta Services Inc (NYSE:PWR) saw the number of bullish investors jump by 15 compared to the end of 2016, the highest increase among construction stocks. Quanta Services Inc (NYSE:PWR) is an engineering and construction company that provides contracting services to the electric power, oil and gas industries. The company generates the bulk of its revenue from the electric power infrastructure services, which include designing, installation and repair of power networks and renewable energy projects. The stock is down by 15% year-to-date, even though the company reported better-than-expected results for the fourth quarter and the management expressed optimism regarding future performance. In addition, earlier this year, Quanta Services Inc (NYSE:PWR) has acquired an electrical infrastructure services business and an education and training institution for the electric power industry called Northwest Lineman College. 

With 56 funds long its stock, Lennar Corporation (NYSE:LEN) is the second most-popular construction company among hedge funds by a wide margin. Moreover, the number of bullish investors went up by 12 over the q9uarter and by eight compared to a year earlier.  Lennar Corporation (NYSE:LEN)’s stock lost 9%, as it was hit by soft new home sales data and concerns over growing mortgage rates, which has climbed to 4.63%. In January, Lennar Corporation (NYSE:LEN) invested in Opendoor, a startup that aims to offer a “trade-in” service for houses. The idea is for buyers to offer their house as part of the payment for one of Opendoor’s houses. The company analyzes the offer using computer algorithms, buys the house, repairs it and puts it back on the market. This business model could make houses more liquid and allow people to move more frequently and, potentially, buy more expensive houses.

D. R. Horton Inc (NYSE:DHI) is at the top of the list, with 57 funds bullish on the company at the end of the last year, up by 12 funds compared to a quarter earlier and by 13 funds from the end of 2016. The increase in popularity came as D. R. Horton Inc (NYSE:DHI)’s shares surged by 85% last year, although they are down by 13% year-to-date on the back of similar concerns that affected Lennar Corporation (NYSE:LEN) and other peers. For the fiscal first quarter, in addition to reporting better-than-expected revenue of $3.33 billion and EPS of $0.49 in line with the consensus estimate, D. R. Horton Inc (NYSE:DHI) also disclosed a 16% increase in net sales orders to 10,753 homes and projected a higher pretax profit margin, now expected at 11.8% to 12%, vs the previous 11.5% to 11.7%. The company also expects closings between 50,500 homes and 52,500 homes this year. 

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