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Looking for traction in the construction sector

What we're looking for

The best and worst bets in the engineering, construction and machinery sector.

What we found

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Investors in this field can be forgiven for feeling a bit nervous in these uncertain economic times, particularly after all the subgroups within the sector posted earnings declines of at least 30 per cent during the last economic downturn.

The sector was "arguably in bubble territory as the recession began in late 2007," says Canaccord Genuity analyst Yuri Lynk. Backlogs had surged 82 per cent between 2005 and 2007, and profit margins had increased 52 per cent on the back of strong pricing power and high utilization rates.

This time, the downturn will be less severe because utilization rates are lower and backlogs are not as prominent, he says.

The four most attractive stocks on a reward-to-risk basis are from the engineering and construction group because the sector has "badly underperformed" broader market indexes, Mr. Lynk says.

His top picks are Aecom Technology, which is well below his potential downside target of $23.71 (U.S.); Stantec Inc., where reward outstrips risk by a ratio of 31 to 1; Aecon Group and Churchill Corp.

"By our estimates, no group offers the downside protection afforded by the construction contractors, with each showing downside no greater than Bird Construction's 14 per cent, which would be only 8 per cent, taking into consideration the 66-cent annual dividend," Mr. Lynk adds.

Equipment stocks, on the other hand, have outperformed broader indexes, as they have benefited from pent-up demand for repair and maintenance services and offer greater exposure to healthy agriculture markets.

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Construction equipment dealers dominate the list of stocks with the most potential downside. Finning International has 50-per-cent potential downside, Cervus Equipment 46 per cent, and Rocky Mountain Dealerships 38 per cent, Mr. Lynk says.

His calculations are based on trough multiples reached during the 2008-09 downturn applied to the last 12 months' earnings; earnings before interest, taxes, depreciation and amortization; cash flow; and book value.

"If this is a mid-cycle slowdown and not a full-blown recession, we recommend names with exposure to oil and metals," he said.

"With strong net cash positions and healthy backlogs, Foster Wheeler, Fluor, Jacobs, and SNC-Lavalin appear attractive for investors looking for shelter in this macro economic storm."

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About the Author
Deputy head of Audience

Sonali Verma is deputy head of audience at the Globe and Mail. She is a business journalist with more than 20 years of experience, mainly in digital media.She was previously the Globe and Mail’s senior editor in charge of audience engagement, overseeing its homepages as well as social media operations. More

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