US construction clouds industrials’ profit outlook

* U.S. nonresidential construction seen weak in 2010

* Pace of recovery depends on jobs, interest rates

* Dark spot in otherwise optimistic earnings forecasts

By Nick Zieminski

NEW YORK, Jan 26 (BestGrowthStock) – Commercial construction is
likely to remain a weak spot in the U.S. economy this year,
worrying chief executives of big industrial companies that make
machinery and electrical systems.

After a dismal 2009, nonresidential construction is likely
on track for another year of double-digit percentage declines,
as tepid consumer demand, high unemployment and tight credit
markets limit the need for office buildings, shopping centers,
hotels and warehouses.

Several companies so far this earnings season have said
that nonresidential construction faces a headwind this year,
underscoring how a tentative U.S. economic recovery is likely
to be slow and gradual, with some areas of the economy
recovering much later than others.

Dutch industrial powerhouse Philips Electronics (PHG.AS: ),
the world’s largest lighting maker, told investors on Monday
that prospects for the global economy were too murky to provide
a reliable forecast of upcoming earnings, saying it needs more
clarity on construction markets.

Investors may get more of a sense of the nonresidential
outlook on Wednesday when U.S. blue-chips Caterpillar Inc
(CAT.N: ) and United Technologies Corp (UTX.N: ) report results.

Eaton Corp (ETN.N: ), a maker of electrical control systems,
said late-cycle markets like nonresidential construction and
aerospace peaked in the second quarter of 2009 before falling
off, and have further to fall.

“This is not a recovery where you’re going to see the rapid
acceleration in growth that you saw in previous ones,” Eaton
Chief Executive Sandy Cutler told Reuters in an interview.

Nonresidential construction is also weak in Europe, but the
sector has bounced back in Asia, helped in part by a Chinese
government stimulus, Cutler said.

Many parts of the economy are reliant on government
support, regulation has increased, and even outright ownership
in industries like autos, and companies do not have the same
access to capital as before the recession, Cutler said.

“All those have led us to believe that 2010 becomes a
positive year of growth but probably a transitional year. You
won’t get a one-year snap-back like you’ve often seen.”

HEADWINDS IN U.S., EUROPE

Electrical products maker Cooper Industries Plc (CBE.N: ),
which generates almost one-quarter of its sales from
nonresidential construction, said on Tuesday high vacancy rates
and restrictive lending will keep “difficult market conditions”
in place, but predicts a recovery in 2011.

Other companies citing construction as an area of weakness
include heater and motor maker A.O. Smith Corp (AOS.N: ), steel
company Nucor Corp (NUE.N: ) [ID:nN26100849], and lighting maker
Acuity Brands Inc (AYI.N: ), which reported delays and outright
cancellations of construction projects.

“This suggests headwinds will continue for all companies
serving the construction markets in North America, and we
believe Europe is in a similar situation,” Acuity CEO Vern
Nagel said on that company’s conference call.

Further insight into the construction outlook will come
with earnings reports from engineering firm Harsco Corp
(HSC.N: ), air conditioning systems maker Ingersoll-Rand Plc
(IR.N: ) and electrical components maker Thomas & Betts Corp
(TNB.N: ).

BOTTOM AHEAD?

McGraw-Hill Construction (MHP.N: ) said nonresidential
building starts fell 33 percent for 2009 as a whole, with
stores and shopping centers down 42 percent; warehouses down 62
percent; hotels down 66 percent; and offices buildings down 37
percent.

“Commercial and institutional building will continue to be
adversely affected by weak employment, tight bank lending, and
the eroding fiscal health of states and localities,”
McGraw-Hill Construction said in a report.

To be sure, diversified industrial companies are offsetting
soft demand in one area with stronger prospects in areas like
homebuilding, autos and the oil and gas markets. Most expect
construction to bottom this year and begin to recover in 2011.

For a sector earnings preview, click [ID:nN26203935]

“Industrial and residential end markets are beginning to
grow again. Utility will follow. Then nonresidential
construction in 2011,” said Cooper CEO Kirk Hachigian.

That eventual recovery, however, depends on two
hard-to-predict factors. One is jobs: with unemployment
expected to remain in double digits in next week’s government
report, it is not clear when jobs — a key driver of demand for
office and retail space — will begin to come back.

Interest rates, which determine the cost of construction
loans, are also a key unknown.

“What we’ve seen of the recovery thus far has been because
of government stimulus and liquidity provided by the Fed. They
can’t do that indefinitely,” said Jack De Gan, chief investment
officer at Harbor Advisory Corp. “This year we’ll begin to run
out of fiscal stimulus and later this year the Fed will have to
start thinking about taking back monetary stimulus. When you
remove those crutches, the economy will struggle.”

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(Reporting by Nick Zieminski; Editing by Richard Chang)

US construction clouds industrials’ profit outlook