PAVE: Infrastructure Stocks Pave The Way To New Market Highs

Here we are entering Spring in late March 2024 and the stock market indexes are making new all-time highs. Yet several Wall Street investment strategists see even higher highs by the end of the year. One of those companies that has a price target for the S&P 500 that is 5% higher than the closing price of 5,225 as of Friday March 22 is Oppenheimer.

Oppenheimer chief investment strategist John Stoltzfus now sees the benchmark index ending the year at 5,500, reflecting a roughly 5% increase from Friday’s close.

Furthermore, he notes that the market may not reach a top until 2025 and infrastructure stocks in particular currently represent a buying opportunity:

Related to this outlook, Oppenheimer also pointed to infrastructure as a buying opportunity, spotlighting the Global X U.S. Infrastructure Development ETF (BATS:PAVE).

In my recent article on global infrastructure trends discussing the abrdn Global Infrastructure Income Fund (ASGI), I discussed how global infrastructure is finding its sweet spot in 2024. And in my own research on growth stocks, I have noticed a recent trend in the stock market with some small cap growth stocks that have seen huge returns over the past one to two years due to substantial investments in infrastructure in the US especially.

Several of those companies are based in Texas, which is leading the US in infrastructure investments after passing $7.5B in statewide funds for energy, water, and broadband projects. Add to that the federal funding from the two infrastructure bills that were passed by Congress in the past two years: the Bipartisan Infrastructure Law and the Inflation Reduction Act of 2022, and there is a lot of federal and state level funding available for transportation, energy, broadband, manufacturing, and other improvements to the nation’s infrastructure.

One of those Texas-based companies is Sterling Infrastructure (STRL), which I suggested was a Buy ahead of Q4 earnings a month ago. Since that article was published, STRL stock has risen by more than 30% after reporting record earnings.

Another Texas-based company that I last covered a year ago and that has also benefited from the growing investment in infrastructure spending is Powell Industries (POWL). The price of POWL stock has risen more than 250% in the past year and still has more room to run, according to some analysts.

PAVE: An ETF for US Infrastructure Development

Rather than attempting to choose individual stocks such as POWL or STRL that will offer growth potential, one alternative investment option to consider that is likely to continue to benefit from US infrastructure spending is the Global X U.S. Infrastructure Development ETF. As the company explains on its website, there are multiple reasons to consider PAVE for investors seeking a high total return from an ETF that invests in US infrastructure development including a compelling need, multiple long-term catalysts, and an unconstrained approach to portfolio development.

The PAVE ETF has an inception date of March 6, 2017, and currently has about $7 billion in net assets. There are just over 182 million shares outstanding, and the fund holds 99 equity positions in infrastructure stocks. The fund pays a semi-annual distribution with a yield of 0.66%. The total expense ratio is 0.47% according to the fact sheet.

From the fund Overview:

The Global X U.S. Infrastructure Development ETF seeks to invest in companies that stand to benefit from a potential increase in infrastructure activity in the United States, including those involved in the production of raw materials, heavy equipment, engineering, and construction.

Fund performance has been very good since its inception and especially in the last year. This table from the fund website shows fund performance at both NAV and market price only slightly lagging the index that it follows for a benchmark, the Indxx U.S. Infrastructure Development Index.

Fund Holdings

The sectors that the fund invests in include 72% Industrials, 22% Materials, 3% Utilities, and less than 2% allocations to Info Tech, Consumer Discretionary, and Financials. The top 10 holdings as of 3/25/24 according to the fund website are shown below:

Top holding Eaton was recently reported in the news as the leading gainer among large cap industrial stocks. ETN also accounts for about 3% of the Industrial Select Sector SPDR ETF (XLI).

Eaton’s 5.9% gain for the week to a record close extended its 12-month climb to about 91%. The maker of electrical equipment has boosted its sales and profit amid strong demand in the aerospace industry and the record number of large-scale infrastructure projects in the United States. Eaton, which is domiciled in Dublin, Ireland, also is restructuring operations and investing in modernized factories worldwide.

The second largest holding, URI, is also up nearly 90% in the past year. URI is rated a Buy by SA analysts and on March 4 announced that it was acquiring Yak Access for $1.1B, which it expects to be immediately accretive to EPS and FCF.

Martin Marietta Materials (MLM) is up nearly 80% in the past year. On February 22, HSBC upgraded MLM to Hold from Reduce based on infrastructure demand.

Martin Marietta Materials on Thursday was upgraded to Hold from a previous investment rating of Reduce by analysts at financial-services firm HSBC. They said the provider of gravel and other building materials has strong long-term pricing power for its products amid higher government spending on infrastructure.

Trane Technologies (TT) is up about 65% in the past year. TT stock hit a record high after reporting an earnings beat on February 1, and subsequently increased the dividend by 12%.

Parker-Hannifin (PH) is up nearly 70% in the past year. PH stock was recently rated a top stock in the industrial machinery industry sub-sector by CFRA and made the list of Wells Fargo’s core industry leaders to stand the test of time.

Emerson Electric (EMR) is only up by about 35% over the past year but gets Buy ratings from Wall Street and SA analysts and was recently rated top electrical sub-group pick by Berenberg. I reviewed EMR in detail in October when I rated it my best value pick for dividend growth investors.

Nucor (NUE) is a steel manufacturer that is up about 30% in the past year. While NUE has not performed as well as some other materials stocks recently, it was rated one of the most underrated steel stocks by Citi, who upgraded the stock from Hold to Buy.

Hacking thinks Nucor is underrated relative to its mid-cycle return on invested capital of 15%-20%, which should justify 30%-40% higher multiples and potentially 10x-12x EBITDA vs. historical 6x-8x, supported by a track record of more than 20 years of EPS growth and positive free cash flow generation.

Quanta Services (PWR) is up nearly 60% in the past year and on February 22 reported a revenue and earnings beat with revenues up by 30% YOY. PWR also made Citi’s top 20 list of large cap stock ideas for 2024.

Fastenal (FAST) is up about 47.5% in the past year and reached an all-time high after reporting Q4 earnings.

Number 10 in the top ten holdings of PAVE is Vulcan Materials (VMC), which is up about 65% in the past year. VMC stock also rallied to a record high after Q4 earnings and a positive outlook for 2024.

“We are well positioned to deliver another year of earnings growth and strong cash generation in 2024,” Chairman and CEO Tom Hill said. “The pricing environment remains positive, and we expect pricing momentum and operational execution will lead to attractive expansion in aggregates unit profitability, regardless of the macro demand environment.”

Growth Likely to Continue

Although PAVE offered investors a total return of about 60% in the past three years, far exceeding the S&P 500 with its total return of about 33%, the growth is likely to continue as infrastructure spending in the US picks up steam.

According to a February 2023 report from Brookings, the next decade is expected to witness a substantial increase in infrastructure spending in the US.

A more recent Brookings report from November 2023 marking the second anniversary of the Bipartisan Infrastructure Law indicates that more than $300B has already been allocated to state coffers in support of infrastructure investments, yet we are still just in the early innings.

Based on our analysis of published White House data, IIJA implementation is just now hitting its stride. Formula and direct federal spending continue to move at a steady pace, already pumping $306 billion into state coffers and direct investment projects. And like an athlete who grows into a game, competitive grant making is steadily increasing, with 80% of all competitive funding still left to be awarded.

While much of the recent growth in the S&P 500 has been attributed to technology stocks that are benefiting from the AI trend, industrials are also leading the way. In fact, according to TD Asset Management as of November 2023, 27 industrial stocks were outperforming the S&P 500.

The PAVE ETF with its 72% allocation to Industrials is one way to leverage the impressive growth that many of those stocks are realizing with the coming decade of US infrastructure spending that is just getting started.