The bursting of the housing bubble late last decade led to a significant decline in home construction, which pummeled the stock prices of publicly traded construction companies. Despite that devastating blow, homebuilding has risen out of those ashes, with building starts and new home prices rising steadily over the past few years. That said, the market is not yet back up to its prior level, let alone anywhere near the peak. Because of that, the market has plenty of room to grow, which suggests that construction stocks should do well as the recovery continues to take hold.
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Image source: Getty Images.
The state of the home construction market
When the housing market fell started to fall off a cliff in 2007, it began a multiyear overcorrection in supply. As the following slide shows, the market has been undersupplying household demand for several years and projects to continue to do so for the foreseeable future:
Image source: Lennar investor presentation.
This production deficit should lead to higher prices for homes as well as increasing demand for construction-related materials and supplies.
While that steady rebound should benefit the entire construction market, some companies are in a stronger position to lead the way, with the following five standing out above the rest:
Data sources: Weyerhaeuser, Stanley Black & Decker, D.R. Horton, Lennar, and Eagle Materials.
Don't miss the forest for the trees
Most people would not consider a timberland real estate investment trust (REIT) as a construction stock. That is especially after Weyerhaeuser split-off its homebuilding business to merge it with Tri-Point Homes in 2014. That said, because Weyerhaeuser is one of the largest timber, land, and forest products companies in the world, it is in a prime position to profit from the continued recovery in the construction market.
For example, as the largest timberland owner in the U.S. -- controlling more than 13 million acres -- Weyerhaeuser benefits in several ways from a rise in new home construction. First, its timber business benefits from rising saw log prices, with every $5 per ton increase adding $75 million to its bottom line. Second, as land values rise, it can sell more of its timberlands for higher and better uses, such as residential development projects. Furthermore, Weyerhaeuser is one of the country's leading wood product manufacturers and, like its timber business, these operations benefit from increasing demand and rising prices. For example, every $10 per million board feet improvement in lumber prices due to an improving housing market drives a $40 million incremental improvement to Weyerhaeuser's bottom line. Needless to say, Weyerhaeuser has the potential to be a significant beneficiary as the construction market continues its recovery.
Image source: Getty Images.
Building a brand one acquisition at a time
Stanley Black & Decker, likewise, might not be considered a pure construction stock but it makes building possible. In fact, it is the No. 1 tools and storage brand in the world, making it the tool company to own in a housing rebound. Currently, new and existing residential construction accounts about 35% of the company's tools and storage business, while commercial construction accounts for another 12%, which gives investors plenty of upside exposure to those markets as building activities improve. Meanwhile, the company continues to acquire additional tool companies, which provides it with the potential to accelerate earnings and revenue growth should construction activities take off.
Nobody builds more homes than D.R. Horton
According to the National Association of Homebuilders, D.R. Horton is America's top homebuilder for both closings and revenue, which is a spot it has laid claim to since 2002. The company currently operates in 78 markets across 26 states, closing more than 38,500 homes over the past year. Furthermore, its homes run the gamut of $100,000 starter homes to $1 million mansions. Needless to say, an investment in D.R. Horton provides pretty broad exposure to the housing sector.
Despite its already large size, D.R. Horton has plenty of room to run. The company continues to ramp up production and currently has a huge inventory of more than 25,000 models, specs, or sold homes under construction as of the end of June, nearly double its inventory at the same time in 2012. Additionally, it controls a substantial land position, consisting of more than 200,000 acres of owned and optioned land, which supports double-digit revenue and pre-tax profit growth for the foreseeable future. Suffice it to say, America's largest homebuilder is well positioned to cash in as housing continues to heal.
Building its way to the top
Lennar is the country's second-largest home builder, which is a title it has held since 2014 when it wrestled it away from PulteGroup. However, at roughly 25,000 annual home closings, there is still a pretty wide gap between it and top homebuilder D.R. Horton. However, Lennar recently announced the acquisition of fellow homebuilder WCI Communities(and its 1,100 annual closings) to help close that divide. The WCI Communities transaction expands Lennar's footprint in several key growth markets of Florida.
Looking ahead, Lennar is moving into a mid-cycle stage where it sees its growth moderating a bit from 15% to 20% down to 7% to 10% as it harvests its strong land position. However, this pivot should drive up it is cash flow generation as it spends less to acquire land. That strategic shift, as well as the company's focus on creating operational efficiencies, should drive profit growth in the years to come.
Image source: Getty Images.
Cementing its future position
While Eagle Materials is not the largest construction materials company, it does offer investors diversification into two key building products: Cement and wallboards. Cement is a widely used building material for sidewalks, foundations, and driveways, while gypsum wallboard is the most commonly used product for interior walls and ceilings. Demand for both products should continue to grow along with the construction market.
That certainly has been the case in recent quarters, with Eagle Materials' cement business reporting record operating earnings due to rising cement prices thanks to robust demand. The company is particularly bullish on cement these days, which is why it recently spent $400 million to acquire a cement plant in Ohio to boost its annual capacity by 20%. Meanwhile, its gypsum wallboard and paperboard segment benefited from rising prices and sales volume during the quarter. It sees both trends continuing due to the general strengthening of the construction market.
While the residential construction market has improved since the financial crisis, America still isn't building enough houses to meet long-term demand. That means construction activity should continue growing, which should drive demand for building materials like wood, cement, and wallboard, as well as for tools. Meanwhile, top home builders should also win because they will need to build more houses, which they should be able to sell at higher prices, therefore capturing higher profits. Suffice it to say, a portfolio of top construction stocks should do very well in an improving construction market.
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Matt DiLallo owns shares of PulteGroup and Weyerhaeuser and has the following options: short April 2017 $20 calls on PulteGroup and short April 2017 $30 puts on Weyerhaeuser. The Motley Fool recommends Eagle Materials. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.