NEW YORK (TheStreet)-- One of the industrial themes that I have been focused on has been the recovery potential in the US non-residential construction market. Non-residential construction activity typically follows residential construction, which has seen steady improvement over the last 2 years due to an improving economy, low interest rates, improving pent-up demand, and better affordability.
The Architectural Billings Index has shown improvement in both segments of construction, and has posted a 50 or higher reading in 15 out of the last 18 months. This week, both Fastenal (FAST) - Get Fastenal Company Report and WW Grainger (GWW) - Get W.W. Grainger, Inc. Report posted double digit monthly sales and talked about an acceleration in demand. These are the quintessential reads on broad-based industrial and construction activity for the small and medium markets.
One way to play the non residential recovery is through the HVAC players - Heating, Ventilation, and Air Condition manufacturers. I analyze the HVAC players regularly and we own a few in Jim Cramer's Action Alerts Plus (AAP)- namely Johnson Controls (JCI) - Get Johnson Controls International plc (JCI) Report and Honeywell (HON) - Get Honeywell International Inc. (HON) Report. Just today, on HON's 1Q conference call management indicated they saw an uptick in non residential construction, with HVAC orders and backlog up mid-single digits year-over-year and services orders stronger. This comes on the heels of JCI announcing the $1.6 billion acquisition of ADT - one of the largest North American HVAC companies. JCI has been vocal that it wanted to increase its HVAC exposure and diversify away from being an auto parts company (it still gets 51% of its revenues in auto) under its new CEO and they are clearly making a bet on the recovery in non resi in particular since ADT gets 65% of its revenues from this segment.
We wrote about the deal yesterday for AAP subscribers and continue to buy the shares under $50 - especially since it's been such a laggard following last quarter's earnings disappointment (against exceptionally high expectations). But there are really so many names to choose from in this segment of the market - Tyco (TYC) , Lenox International (LII) - Get Lennox International Inc. Report, United Rentals (URI) - Get United Rentals, Inc. Report, Hertz (HTZ) - Get Hertz Global Holdings, Inc. Report and several others. One name that's caught my attention is Ingersoll-Rand (IR) - Get Ingersoll-Rand Plc (IR) Report story. It's not exactly unknown in the investment community, but it is down 9% from highs seen in January, trades at an attractive valuation - 15x 2015 forward estimates, and has an activist shareholder, Nelson Peltz, involved to keep management's feet to the fire on execution.
IR manufactures air conditioning systems, mobile refrigeration systems, golf carts, and industrial products under name brands like American Standard, Club Car, Ingersoll Rand, Thermo King and Trane. It just spun off its security business Allegion, and there are those that believe the company could do more of these types of events to drive shareholder value.
Post the spin, IR will have around 63% of its sales in the US - which I like given the US economic recovery underway. However, I do like the depressed results internationally that could be the next lift as those economies recover. The company reports earnings next week, so we'll get the read on the business trends then, but there were some interesting data points to last quarter that make me believe we'll see some improvement ahead.
This isn't a play on Q1 (April 23rd is the report date) and there's a chance that the rumors of an ERP system glitches impacted its earnings. Plus, the weather was uneven, at best. Yet, the stock is already down 9% year-to-date, you have Peltz involved and it has exposure to what I believe will be the next segment to rally in the industrial space. Expectations are low, and management indicated that March picked up in activity, so I'd pick at a small position to start and then hope that it falls on the earnings news to then average in with the rest.
Last quarter was actually pretty good, as earnings rose 17% year-over-year, organic growth improved 6%, Thermo King grew low teens, commercial and residential HVAC grew mid-single digits and even the company's industrial segment improved - flat vs. the negative 3% growth seen in its prior quarter. Orders rose 5%, but fell from the 8% growth in the third quarter. All this happened without the seasonal lift from housing, the bad weather, and muted non-residential trends, so I'd expect that orders and visibility could reverse pretty quickly to the upside. The company guided for earnings to rise 14-20% to $3.05-$3.20 a share, plus they are helped by the buyback program which is expected to be $1.37 billion to $1.47 billion this year, reducing the float by 7%. And guidance for revenues aren't heroic at 3-4% for the year.
So this one is on my radar next week to watch. If it dips on earnings, I think it's a buy. I'd even start here given that its already down a lot into the print. Because I think we are in early innings in non-residential HVAC where IR has strong exposure, as well as possible additional restructurings ahead. Plus, Peltz will keep the pressure on.
--Written by Stephanie Link in New York
Action Alerts PLUS, which Link co-manages as a charitable trust, was long JCI and HON at time of publication.
Chief Investment Officer, Co-Portfolio Manager of Jim Cramer's Charitable Trust, and Director of Research at The Street. Stephanie performs all portfolio management functions which includes developing a macro outlook and market strategy, thorough analysis and careful stock selection while managing the fund in a manner that allows subscribers to follow and emulate her thoughts and actions. She also writes a weekly summary report of the portfolio, highlighting strategy, latest analysis and ranking of each stock in the fund. Stephanie promotes the product through weekly videos, both independently and with Jim Cramer, which are featured on The Street's website. As Chief Investment Officer, she oversees all premium content which includes RealMoney, RealMoney Pro, OptionsProfits as well as other premium newsletters including Breakout Stocks and Stocks Under $10. Stephanie is a CNBC contributor and regularly appears on Fast Money Halftime, Closing Bell, Squawk Box and The Kudlow Report.