Upbeat expectations for the construction sector’s second-quarter 2018 performance are backed by overall economic growth, solid construction spending, strong labor market, higher demand, tighter inventories and rising home prices. The estimate picture also reflects the bullishness. After all, 11 of the 16 Zacks sectors are likely to register double-digit earnings growth this earnings season, construction being one.

After the 2% economic growth in the January-March quarter, the world’s largest economy is expected to have advanced 3.9% in the second quarter of 2018, per the latest Atlanta Fed’s real-time Q2 GDP growth estimate. This solid projection holds particularly true as one of the nation’s key economic drivers, construction activity, is gradually picking up along with a declining unemployment rate (4% in June 2018).

However, higher material costs and a rising rate environment, which drove interest/mortgage rates, have troubled the sector in the first half. If that wasn't enough, Trump’s steel and aluminum import tariffs raised further apprehensions. Much like the broader market that is also battling volatility this year, the construction sector is now in the bear territory, having lost 7.8% so far this year.

Solid Construction Spending, High Demand Back Sector

Spending on construction rose 4.3% year over year in the first five months of 2018, per the latest U.S. Census Bureau report. Particularly, spending on government projects showed a remarkable 4.4% improvement while private spending rose 4.2% during the period. Notably, spending on construction projects across the United States increased 4.5% in May to an all-time high of $1.31 trillion. Importantly, spending on public works was stronger than private-sector projects in May.

Meanwhile, apart from tariffs on lumber, the U.S. Government’s recent move of imposing tariff on imported steel and aluminum stirred concerns among investors about the construction sector. According to an Associated Builders and Contractors (“ABC”) analysis of information provided by the U.S. Bureau of Labor Statistics, June construction material prices increased 9.6% year over year.

Again, the Trump administration’s tit-for-tat trade tariffs for China, Canada, Mexico and the European Union cannot be ignored. Speculations are rife that tariffs might disrupt supply chains, undercut business investment and potentially wipe out the fiscal stimulus from a $1.5-trillion tax cut package.

That said, the recent sales figure has been encouraging. According to a report released by the Census Bureau and Department of Housing and Urban Development, sales of newly constructed single-family homes hit a six-month high in May, highlighting a 6.7% rise month over month and 14.1% year over year.

Also, housing starts made a comeback in May with a 5% increase, scaling the highest level since 2007. The figure also improved 20.3% on a year-over-year basis. Single-family and multi-family starts surged in May. With solid economic fundamentals in place, the overall homebuilding picture is pretty encouraging for 2018.

Q2 Expectations

Majority of the Zacks broad sectors (14 out of 16) are expected to be in the positive territory in the second quarter of 2018. As far as estimates for the construction sector are concerned, the overall picture is indeed rosy. Per the latest Earnings Preview,

the construction sector’s earnings are expected to increase by 45% in the second quarter, slightly lower than the 49.7% growth witnessed in the first. Revenues are projected to increase by 22.4% (20.9% growth in Q1), while margins are expected to slightly rise to 1.4% (1.3% in Q1).

In spite of inventory woes along with higher materials and land/labor costs, picking a handful of construction stocks that are poised to beat earnings this quarter seems like a profitable strategy. An earnings beat will also pave the way for stock price appreciation.

Which Are the Right Picks?

Earnings ESP is our proprietary methodology for determining which stocks have the best chance to pull a surprise in their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.

Our research shows that for stocks with this combination, the chances of a positive earnings surprise are as high as 70%.

Winning Stocks

For investors seeking to adopt this strategy, we have highlighted five construction stocks that may stand out this season.

Our first choice is Foundation Building Materials, Inc. (FBM - Free Report). This specialty distributor of wallboard and suspended ceiling systems primarily in the United States and Canada topped/met earnings estimates in three of the trailing four quarters, the average beat being 196.43%.

It looks poised to beat expectations in the to-be-reported quarter as well. The company carries a Zacks Rank #2 and has an Earnings ESP of +21.05%. The Zacks Consensus Estimate is pegged at 19 cents per share with an expected EPS growth rate of 533.3%.

Foundation Building is expected to report second-quarter of 2018 results on Aug 2.

Our second choice is a global producer and seller of specialty construction chemicals and specialty building materials worldwide — GCP Applied Technologies Inc. (GCP - Free Report). Although the company missed earnings estimates in two of the trailing four quarters, with an average miss of 17.1%, it looks poised to beat expectations in the second quarter. The company carries a Zacks Rank #2 and has an Earnings ESP of +2.56%. The Zacks Consensus Estimate is pegged at 39 cents per share that has an expected EPS growth rate of 69.6%.

GCP is likely to report second-quarter results on Aug 2.

Thirdly, Lennox International Inc. (LII - Free Report)), a global leader in the heating, air conditioning, and refrigeration markets, seems like a solid bet as well. The company surpassed estimates in each of the trailing four quarters, the average positive earnings surprise being 3.17%.

For the upcoming release, Lennox has a Zacks Rank #2 and an Earnings ESP +1.41%. The Zacks Consensus Estimate for the to-be-reported quarter is pegged at $3.55 per share. EPS growth rate is projected at 25.4%.

The company is scheduled to report second-quarter 2018 results on Jul 23.

Our fourth choice is RPM International Inc. (RPM - Free Report) that manufactures, markets, and sells specialty chemical products for industrial, specialty, and consumer markets worldwide. Last quarter, the company delivered a positive earnings surprise of 16.67%. In fact, the company has surpassed estimates in three of the trailing four quarters, the average positive earnings surprise being 5.73%.

For the upcoming release, RPM has a Zacks Rank #3 along with an Earnings ESP +1.64%. The Zacks Consensus Estimate for the to-be-reported quarter is pegged at $1.18 per share. EPS growth is expected at 15.7%.

RPM will announce fourth-quarter fiscal 2018 results on Jul 19, before the opening bell.

Lastly, we choose The Sherwin-Williams Company (SHW  - Free Report) — a manufacturer, distributor and seller of coatings and related products. The company surpassed estimates in two of the trailing four quarters, the average positive earnings surprise being 1.77%.

For the upcoming release, Sherwin-Williams has a Zacks Rank #3 and an Earnings ESP +0.23%. The Zacks Consensus Estimate for the to-be-reported quarter is pinned at $5.59 per share, with an expected EPS growth rate of 23.7%.

The company is slated to announce second-quarter of 2018 results on Jul 24, before the opening bell.

Bottom Line

With a robust economy and solid job market, choosing the right construction stocks before they release their earnings numbers is quite an uphill task.

A closer look at the space puts the spotlight on a few outperformers, backed by a solid Zacks Rank and a positive Zacks Earnings ESP.