Trane Technologies plc (TT) Earnings Call Transcript & Summary

All right. Good morning to everyone joining us in the room and hello to everyone on the webcast. We're very excited to have Trane Technologies up here with us. On stage with me are David Regnery, Chairman and CEO; and Chris Kuehn, CFO. Before we go into the fire side, I think Dave was going to make just a couple of quick opening remarks. So let me pass it over to you.

Thanks, John. Is he here yet? Should we wait for him? [ Shaq ] is coming to us, right? I appreciate being here. John, your team has done a nice job putting us together. So I appreciate it. Look at Trane Technology, our purpose is to challenge what's possible and to innovate for a sustainable world. And that's fundamental to our strategy and really allows us to create differentiated returns for our shareholders over time. Look, the mega trends around sustainability and decarbonization continue to intensify. Unfortunately, the pace of global warming continues to increase. At Trane Technologies, we're scaling technologies that exist today that could dramatically reduce the carbon footprint for buildings around the world. This technology exists today. We don't have to wait for a new technology. It exists. We just need to scale it. We had a very strong third quarter. Our order rates were up 8%. Our revenue was up nearly 20%. Our book-to-bill was 103%. Our EPS growth was 26%, and we ended the third quarter with a backlog of $6.4 billion, which is roughly double what we would expect. We are very well positioned for the future. John, I'll turn it over to you for whatever questions you may have for mostly Chris, right?

Great. Well, before we kind of dive into some of those topics, maybe just I'll ask kind of what do you see as kind of the state of the union right now as we sit today?

Yes, it's a good question. I mean, like I said, we had a very strong third quarter. Order rates up 8%, book-to-bill 103% despite with the revenue growth of 20%. If I go around the world, if I start in the Americas, our commercial HVAC business continues to be very strong. Order rates in the third quarter, up over 20%, revenue growth in the mid-teens. Strength really across many verticals not concentrated, think of data centers, think of education, think of health care, all very strong for us. If I go over to EMEA, and I look at commercial HVAC business there, very strong. Revenue growth was north of 20%. Organic revenue growth was north of 20% growth. Order rates very strong in the mid-teens. We're continuing to win share in Europe with our innovative solutions around thermal management systems. Sticking with commercial HVAC, if I go over to Asia. Asia performed well. I mean the revenue number was an outsized gain just because we had some catch-up that we had get through our channel there because of the second quarter shutdown related to COVID. But strong order growth. I mean it was up low single digits in China. It was up mid-single or high single digits. So a good, nice strength there in Asia. Our Thermo King business in the Americas performed very well on a revenue standpoint. Again, it had some catch-up that it had to get through from the second quarter, so the revenue growth was very strong, but order growth was very strong as well. In EMEA, Thermo King, the order growth was a bit down. It had some tough compares, but revenue growth was in the mid-teens. In our residential business, order growth was down a bit, again, coming off some very tough compares to prior year. Revenue growth was up the mid-teens. Sell-through in the IWD channel was mid-teens. So residential performed well in the third quarter as well.

No, great. So I would say we've been having a conversation around net zero building. So maybe just remind us how Trane through, I'd be curious, equipment, software controls, how you're enabling that?

Yes. I mean this is where decarbonization of the built environment is going to be very important. I know you hear me talk about that. You're going to hear a lot of people talking about that in the coming years. And this is something that we all need to take action on. When you think of getting to net zero, it's really a consultive sale. And having a direct sales force that's well trained in solutions is a tremendous advantage that we have. You need to go with your customers and explain to them how they could progress to a net zero building over time. This is usually a journey that most of our customers are on. And we're able to help them with that journey and explain to them what should you do first? What do you do second? How do you -- how does equipment interface with BMS controls in a wireless solution that could really benefit you. So it's more of a consultant sale than we've ever seen before. We've always said that our account managers were the best at selling solutions. It's just really selling solutions now even at a higher level because it's really about matching so many different elements that are going to allow you to get to net zero.

Great. And obviously, I'm sure we'll have a conversation around some of the stimulus out there. But one of the things that I'm curious is, is this something that customers were doing even before you had things announced like the IRA in that? Or is this something that they really needed that -- the pump to be primed for them to want to do this journey.

I mean for sure, they were -- I mean, obviously, you could see with the amount of companies that have made sustainability commitments that there's been activity even before different policy that has now been implemented to help fuel this a bit. I would tell you that policy over the last 3 years, if you think about it, there's a stacking effect that's occurring. Think about all the money that's been provided through COVID. Think about what's been provided through ESSER funding to the education vertical to make our school safe and energy efficient. Think about the infrastructure bill, the CHIPS bill the -- now the IRA. This is a stacking effect that is going to continue to be a tailwind as we think about how -- specifically here in North America, we could help decarbonize the built environment. I would tell you that policies are also in existence in Europe, and that's having an impact there as well as other factors there like the fact that everyone is more conscious of fossil fuel and if we could eliminate the need for that fossil fuel in buildings, which is very, very -- the technology exists today to do that, that's obviously a catalyst as well.

Great. And maybe we could talk a little bit about that technology. I don't know if you're referring to heat pumps or some other technology that you want to highlight, but maybe just walk us through how the technology is maybe changing depending on the application.

Yes. I mean if you think about it, 5 years ago, we used to talk about applied systems we are using. We used to talk about heat recovery, right? So if you're cooling a space, what are you doing with the heat, where are you rejecting that too? We should try to recover that heat. We then move from there to like partial heat recovery, full heat recovery. Then we were talking about applied systems that were heat pumps. Again, we were using ambient to bring hot air into the space or rejecting heat from the inside the building to the outside. We then transitioned into simultaneous heating and cooling. You may have heard me refer to it as 4-pipe chillers. Where in a building, you often have the demand for both heating and cooling at the same time, how do you repurpose that so you could do it within one system. We're now to the point where we've taken that simultaneous heating and cooling and created thermal management systems out of it. And it's more than just the 4-pipe chiller. It's the controls, it's the other elements of the system that allow us to work in all geographical climates. So think about in a building, a hospital, I can give you an example after example where we get the call and they're like, "Oh, we need to replace our HVAC system." And we've been able to go in and say, "No, what you need to do is you need to combine your traditional boiler system with your traditional cooling system and create a thermal management system. And oh, by the way, when you do that, you'll no longer need fossil fuel to heat your space." And it's disruptive, and it's not normally that you see the incumbent with disruptive technology like we're implementing, but it is -- talking about decarbonization, talking about energy efficiency. This is totally different than we've ever been able to do before.

And so just building on that thought, what does that mean from a pricing perspective, a mix perspective, cost to manufacture these systems?

The combined system is a bit more expensive, okay, but the efficiency that you would get out of it, these systems, in many cases, have paybacks that are certainly less than 3 years in many cases, less than 2 years. If you think about a traditional combustion system, which would be a boiler, if you think about it, one unit comes in and made one unit comes out the other side, if you think about a vapor injection cycle, which is an HVAC system, 1 unit goes in and 4 units come out. So these are 4x more efficient than a conventional system by combining them. So the paybacks are very attractive. And the amount of carbon reduction is just -- it's phenomenal. HVAC represents 40% of all the energy to heat and cool a building, right? The majority of the carbon footprint is associated with heating, it represents 15% of all greenhouse gas. Again, the majority of that is heating, we're able to eliminate that into just a vapor compression cycle. So it's a dramatic impact to the -- to not only financially for the customer but also for the environment.

John, on pricing, we get a lot of questions, of course, around the commodity impacts and what do we see inflation, deflation going to next year. And that's certainly part of the formula as we think about price. But -- we don't want to discount the fact that when you have that much innovation, you're pricing for value as well. That is a componentry of why we've seen such strong price over the last several years, but certainly remain price cost positive in this inflationary environment. But it's that innovation as well that's going to be really strong on price as we think going forward.

Great. And maybe dovetailing off that, can you remind us just kind of what the price cost equation looks like? And what kind of the typical lead and lags are for that?

Sure. In a normal environment, we'd always be looking to get 20, 30 basis points of price over cost. Certainly in 2022, that's been a little bit more challenging just given the inflationary environment. But we have been very resilient in the last 7 quarters being price/cost positive on a dollar basis throughout that entire period of time. So I think that really is a credit back to our business operating system and much stronger in this cycle than we even saw in 2016, 2017 with the last inflationary environment where we were behind for several quarters. So we really like that improvement in the business operating system. Long-term target around incrementals is 25% plus. Maybe with some deflation we're seeing on Tier 1, that may be a positive outcome for next year. But I would also say we're watching things like wage inflation, energy inflation as well. We have to really bundle all that together. But I would say that's how we're kind of thinking about going into next year. But it's a multiple dynamic, but we are looking around the innovation as well that we've been driving in the business and making sure that's part of the price equation. There will be some positive price carryover with the price increases we've announced already as well.

Great. And I think in your last quarter slide, you highlighted some additional cost savings that you thought you'd be able to get out of the business. Can you maybe talk about that lever as well?

Sure. We announced back in -- well, just before March of 2020, when we launched the company that we were first targeting about $100 million of cost takeout from the separation of the industrial business. And through kind of all of our efforts, we came up with a $300 million plan of a cost takeout. We're in the second and last year of that journey. 2023 will be the final year of that program, and we remain well on track with that. But I would tell you as part of the business operating system, John, it's not going to necessarily stop in 2023. There's always room for improvement around lean. We're certainly seeing today the challenges of a constrained supply chain, the inefficiencies and the plans associated with that as well is costly. So we think there's still opportunities out there to continue to lean out the environment, drive for productivity. And certainly, as we wrap up 2023 and this $300 million program and say, close the books on that, we're always going to be looking for opportunities thereafter.

Great. And then maybe, David, I'd love to get kind of a view of how you're thinking about maybe the parts of your business that would be on the commercial side, driven by something like an ABI versus some other indicator, right? If you're going direct business.

Yes. If you think about Dodge or ABI, right, they tend to focus more on new construction. And if you think about in the Americas, think of our commercial HVAC business, about 60% of our total business, about half of that is in the services space. And then you got to remember that new construction versus retrofit is probably about maybe 30, 70 kind of split that could vary year-to-year. So you really have an impact there of the 10% to 15% on the enterprise, it is an important element that we look at, obviously, but it's -- the direct correlation is about -- think about it as 10% to 15% of the business.

Great. And then very topical, but maybe same line of questioning around residential and what kind of the trends are there that you're seeing?

Yes. Residential, again, it's about 20% of our business. Just so you're aware, I get about 80% of my questions for residential. But it is -- think of our business, it's 20% of the enterprise. About 20% of that is new construction. The other 80% is the retrofit space.

Great. And then obviously, at the industry level, lots of conversation around controls, digitalization. Could you talk a little bit more about what you guys are specifically doing around that?

Yes. Yes. I used to run our commercial HVAC business. I guess, it's 7 or 8 years ago. Now time flies. But I always used to tell people that I'm investing more in my control side than I am in the equipment side and no one really believed me. I used to tell them that we were behind in that space for a lot of reasons, and I don't really want to live the past, but I want to go forward, and I would always say, what are we going to do different with our solutions. And we really came down to 2 elements. One is, I said, look, I want to have a system that has open protocols. We don't want a proprietary system. We know our customers don't necessarily like that. We'll have an open protocol system. And the second is we need to be different. So we decided to really focus in on wireless technology. And today, the majority of our controlled BMS systems that we sell are wireless. And we created a meshing network where the repeatability is perfect. And we designed the battery use of the repeaters in a way that we guarantee them for the life of the product. So this is another innovative solution that really allows us to connect to our equipment in a wireless way. And if you think about that in a retrofit space that's very important. Now to your question on what are we doing with all the data and how we're utilizing it, that's -- you need to think of data as an asset. And sometimes I know we don't think of it that way, but it really is an asset and how do you utilize that. And what are the derivatives you could derive from that, whether it be on the efficiency of the building or in other ways where you can start to compare assets to other assets like buildings and campuses from an efficiency standpoint. We're doing a lot of work with AI on -- we implemented AI on a data center and I always like -- for those of you who know a lot about data centers, data centers tend to be the most efficient buildings that I know. They really are. That's the way they're designed. And someone had a conversation with us, said, we think we could get 20% energy savings in this data center. I'm like there's no way we're going to do that. We didn't quite get there, but we got pretty close, utilizing AI and algorithms and think about all the variables in the data center and how you can control them in different ways. And it's just really interesting as to what we're doing there. We started in that space with like digital twins with equipment, but it's quickly evolved now into a much vaster opportunity for us.

And maybe that's a good segue into data centers, right? So kind of what are you seeing in there? And how is the offering changing?

Growth, growth and growth, I'll start with that. Look, data centers, I can't say a lot about some of the solutions that we offer there because I signed documents that said we were not. But I would tell you that many of the large data center companies, you can imagine who they are. They all kind of have their own proprietary solutions that they believe gives them a competitive advantage versus their competition. We're a big part of that. We're a big part of helping them design those systems, and it's evolving, and so it's the technology. It's never staying still in the data centers. I like working with data center customers because I believe it pushes our application engineers even beyond what they may be thinking. And then obviously, there's a trickle on effect to that into the rest of the industry. And -- that's why we've been able -- one of the reasons why we've been able to come up with so many creative solutions for our customers outside of just the data center space.

Interesting. I guess thinking about IAQ, where do you think we are in that journey. And as we get further from the pandemic, does it changed conversations with customers?

Yes. I don't -- I think we're -- I think that IAQ, we've always been in indoor air quality. It's tended to be concentrated more in the health care vertical for obvious reasons. The pandemic certainly educated everyone as to how important the environment is in a building, okay, in a classroom. So everyone is not more cognizant of that. These systems for indoor air quality are built into our applied systems. So we don't see this stopping. I mean I can't imagine us going to an office building and not having a conversation around indoor air quality, the energy consumption and the carbon footprint in tomorrow's environment. It's just not going to happen. And -- but we're really good at taking those solutions and bundling them together into a system and being able to provide a comprehensive solution. Remember, early on with -- in the pandemic, right? You had everyone like, oh, the indoor air quality, they realized, how this is something that's important, and you had major cities saying, we want [ Happi ] filters in every single mall. Well, unfortunately, the systems aren't designed to take Happi filters, okay? They won't even fit. But people who have just all these misperceptions as to how they were going to increase the environmental safety of the space in which their employees were residing. And you had a lot of companies that were saying, "I want a lot more dilution", which is called fresh air exchanges. Sure, that's a great way. It's also -- there's also an energy tax on that, right? You're bringing air in from the outside, you have to condition that in, it takes energy to condition that air. So we've been able to help educate our customers as to there's a balance here, right? We always want to improve the indoor air quality, but there's also an energy consumption that you need to take into the equation. And like I said, these solutions are built into our applied systems. And explaining that to the customer, it's pretty easy concepts to understand.

It's really played into our results, too. Last year, we broke out the impact of indoor air quality. And in terms of top line revenue growth, and we said for the full year is around 2 points of growth. But as we got to the end of the year, to Dave's point, it just was more and more of a system solution. It was hard to break it out from a combination of an applied project to an IAQ to BMS system ultimately integrated. So we just see it right now is ultimately, it's just part of a reason why commercial HVAC is a multiple of GDP business. One of those solutions being indoor air quality helps contribute to that viewpoint.

Great. I want to go back to something you said earlier when we were talking about net zero and leading to find a way to scale. I'd just love to have you elaborate a little bit more on that? Is it manufacturing? Is it something in the industry?

It's education is really what it comes down to. Technology exists today where you no longer need fossil fuel for heating buildings. You just don't need it. This technology exists today, but we need to educate everyone that the technology exists. I'll give you a personal example. I'm building a new home, okay? So I'm very confident that when lumber was at an all-time high, I was by a [indiscernible] so I buy -- I'm building a home absolutely the worst time. But I told my builder. This guy works truly. He knows what I do for a living, okay? And I said, this is what I want for the HVAC system. And I said I want 20 CR heat pumps throughout the house. I want no fossil fuel in my home. And I'm going to put a solar array in the yard. I'm going to build it into the landscaping, blah, blah, blah. He calls me up, he goes, "Dave, you're making a big mistake." I said, why am I making a big mistake? He says, "You're going to be cold in the winter time." I live in North Carolina. It doesn't get that cold that you're going to be cold. I said, why are we going to be cold. He said, "Well, heat pumps don't always work when it's below 20 degrees F. I'm like what data are you looking at? What -- I mean that was the case in maybe 1990. That's not the case today. But how many other -- and he knows what I do and he's telling me this. How many other people is he telling that same story to. So it's going to become an education process. I used residential as an example, but it's more than that. It is in the commercial space. If you're in Europe and your boiler breaks, okay? Your building isn't being heated. Do you think you're going to call Trane Technologies to come fix your boiler? No, you're going to call this man or whoever is the manufacturer of your boiler. Do you think this man is going to say, "Hey, you need to call Dave at Trane Technologies because he'll be able to combine a thermal management system and eliminate the need for fossil fuel." That won't happen, right? So this education process as to what's possible, I mean, it will happen, okay? I'm not sure when the inflection point is, but it's going to happen over time. Our technology is disruptive. It really is. You do not need fossil fuel to heat a building. And just think about the carbon footprint is for the built environment. This is real. It exists now. It's not like carbon capture, where we could talk about when it's going to become efficient or economical. This is economical today. Sorry for...

No, that was great. That was great. Maybe we could pivot over to services. So obviously, I think in your opening remarks, you talked about some of the growth rates kind of you -- what's the trend there? And then kind of what are the levers that have kind of enabled that trend over time?

Yes. Our service business, again, it's about 1/3 of our business at the enterprise level. It's been growing. We did a study in the last 5 years, our service business has grown at a compound annual growth rate, compound annual growth rate of high single digits over a 5-year period. That includes the pandemic year, where our service business was flat. We didn't have access to many buildings, but our service was flat. This is a very resilient business that is growing that is very profitable for us. And we have lots of ways we invest in our service business. We have some of the best service technicians in the industry. They're all trained technologies, employees. They're all factory trained. When we have new products to the market, which is often, there's a process in place so they become educated on it. It's a great business. It's a global business and we really like our service footprint.

Great. Maybe pivoting to residential, we got to make sure we hit 80%. There's a SEER change, there's a refrigerant change. Kind of what does this mean for the industry from a pricing perspective or volume as well?

Yes, we'll start with the SEER change. It's happening, right? So we're a couple of weeks away from the date here. And I think I've been saying for a long time, we would not see a big pre-buy, and obviously, we have not seen that big pre-buy. From a pricing standpoint, there's a SEER up, so think of a 13 SEER becoming a 14 SEER. About 70% of the market is at minimum SEER. And think about half of that being impacted by the price change. And it's about 10% to 15% depending on the model, price change for the higher SEER, but obviously, not all of that will be in. You're not going to increase the price of the furnace if it's a split system because the condensing unit went up. So think about maybe 30% of the market is going to be impacted by that price, and it will be between 10% and 15% depending on the model. On refrigerant change, that may even be a bigger impact. The industry will be moving to an A2L, which is slightly flammable. It will be more expensive because these systems now are going to have to have different sensors in them because you're dealing with a refrigerant that is more volatile from a flammability standpoint. All of that's not yet baked into what that cost will really be, what the economies of scale will be there. We also have building codes that will be working through. So that's another variable there. But this is coming at us pretty fast -- so think of it as 2025, and you'll probably even see some 2024 action is around as a greener solution, which is a good thing. 410 will become outpaced by a different refrigerant that will have a dramatically reduced greenhouse gas impact.

And then do you think from an industry perspective, this changes a replacement or a repair decision for the customer?

For sure, it does because you have older refrigerants that are getting very expensive, and it would certainly -- it would be part of that equation. So for example, if you have a unit in your home and it's using R-22, which was the predominant refrigerant before R-410, to replace that unit or to fix that unit, you're going to be putting a very, very expensive refrigerant in it. Most of the time when you call your HVAC dealer and say, hey, my cooling is not working. A large percentage of the time, unfortunately, there was a small leak in the system and all your refrigerant has gone out into the atmosphere, which is not very good for the atmosphere. That's why this low GWP refrigerant is much better. But they have to recharge -- to fix -- find out where the leak is and then recharge the unit. And this refrigerant is very expensive. So it adds to the cost, which then you start getting into the equation. Well, should I just replace it then you have this new tailwind that's just been introduced called IRA, which will be a rebate if you -- and that's still being worked through exactly how that will happen, but it will be a tailwind where you're going to start to say, "Hey, maybe I should just go to a heat pump solution and eliminate this furnace that I have inside or come up with a hybrid system where you leave the furnace in place and still put a heat pump condensing unit on the outside."

Great. Maybe switching gears over to Thermo King. Maybe first question, kind of just remind us the mix of that business and then maybe we can talk through some of the trends that are impacting it right now?

Yes, sure. Yes. I'll start with the Americas. Think of that as truck trailer and APU about 2/3s of the business and then a very diversified portfolio. When you think about marine, bus, air and rail, making up the other 1/3 of the business. Great year in 2022, very confident in terms of our share gains, and this has been over a multiyear period of time, John, also driven by innovation in the marketplace as well. This is a place where you're seeing a strong shift to electrification of the portfolio, and that's in Europe as well as in the Americas. Both businesses winning in that environment. We launched a product called Advancer, about 2 years ago in Europe for single temp space and now just launched recently multi-temp space. 30% more fuel efficient than the previous unit in the marketplace, which is the Thermo King unit in the marketplace. So unfortunately, since then, we've seen fuel prices take off, of course, in Europe. And what was already a very strong payback for customers has only gotten stronger when you think about that fuel savings and a payback equation. So we really love the Thermo King business, driven by innovation and a diversity of products and ultimately, electrification is an area we've been investing in for many years, and we think that investment is going to continue.

Great. Maybe I'll see if anyone does have a question, feel free to raise their hand. You just have to wait for the microphone. But while we're seeing if there is one. Maybe we can talk a little bit about your opening remarks talking about where the backlog stands. So kind of what does that mean as we think about the trends in the industry? And how resilient is that backlog?

It's very resilient. So I know I get a lot of questions about can the backlog be canceled and -- yes, everything is possible, but I would tell you 90% of our backlog is in our commercial space, and that is not an area where we see a lot of cancellations, right? And that is not an area where we see a lot of cancellations, right? There's too much -- by the time we get an order, there's a lot of work that's already happened. So those projects are pretty solid. Could it cancel? Sure. Does it happen very often? No. So it's very real resilient backlog number one. The backlog gives us great visibility, right? I mean we haven't talked about supply chain, which is a good thing. But supply chain is improving, but I would tell you the more visibility you could give to your supply partners the better off they're going to be able to be to react. So it gives us a lot of visibility. And by the way, this backlog will normalize over time. So if things do slow down, and I'm not saying they are going to slow down, we have backlog that we need to burn through that is double what it normally is. And despite everyone saying it's going to stop, third quarter, our backlog, our book-to-bill was 103%. So we had 20% revenue growth, we had 8% order growth and our backlog went up 3%, right? So it's very, very strong.

Great. And then I think you touched on the IRA as we were talking about residential markets, but does that also have an impact for you on to the commercial markets and -- and what does that look like?

Absolutely. It's a little more confusing to work through there, but it has to do with efficiency per square foot. But we're really good at taking these policies. We've now had a track record here with lots of policies that have been implemented over the last 3-plus years and really making them simple. And that's the key, right? We don't want our customers having to work through how these policies will impact them or how they can take advantage of it. So a strength that we have is taking these complex policies and really making them very simple for our customers to understand. I mean I look at what the funding to make our school safe and more energy efficient. It's called ESSER funding, right? We were able to grow our education vertical so far this year by 40%, 4-0, right? Because we've been able to create road maps for our customers, help them apply for funding, help them just hit the easy button and make it work for them. We'll do exactly the same thing with IRA. It's different because it's going to be at the dealer levels for the residential space.

I'm just looking at the clock, and maybe that's a great note to end on. So what I'd like to do is, once again, thank Trane for being here and thank everyone for participating in the conference.

Yes. Thanks, John. I'm a little bit disappointed, he didn't come in, I thought he was going to come in -- well, I'm talking about [ Shaquille O'Neal ] for those of you online here. He's supposed to be of the next speaker. So anyway, thank you very much for your time today.

Thank you.