Trane Technologies plc (TT) Earnings Call Transcript & Summary

Next, so the next company that we have here at the conference is Trane Technologies. Really excited to have both Dave Regnery, Chairman and CEO; and Chris Kuehn, their CFO. Guys, thanks so much for being here today.

Glad to be here. Thanks for having us. Thanks.

And so we're just talking about my 16-year-old driving, and we'll take that offline. But Dave, why don't we chat a little bit more about Trane? And I'm going to start with a softball question for you because investors often give you guys credit as being like one of the highest quality multis within the space? Like what do you think really kind of sets you apart from the other HVAC OEMs? And what areas would you really point to?

Yes, thanks. That's a great question. And thanks, everyone, for joining us today. We're certainly glad to be here at the conference. Your team, Joe, does a nice job putting us together. And I certainly appreciate everyone's interest in Trane Technologies. Look, it's a system of things that makes Trane Technologies a great company. And I could point to our relentless investments in the company, right? We're not episodic. We invest in our business heavily year after year. It's our business operating system that allows us to take best ideas and share them on a global basis. It's our direct sales force. It's how we onboard our employees. It's how we train our service organization. It's about the breadth of our portfolio. All of that makes us a great company as Trane Technologies. But if I had to pick one, one thing that I believe differentiates us as Trane Technologies, I would go to our culture. And we have that uplifting culture. Our purpose is to challenge what's possible and innovate for a sustainable world. And I would tell you that all 40,000 of our employees realized that they work for a company that has a greater purpose, that is making this world a better place for the next generations that will live here, and it's evident in our culture. And I always tell people that our competitors can copy what we say, sometimes they do. They could certainly copy our products over time, they can even maybe copy our processes. What they will not be able to do is copy our culture. And that to me is really what stands Trane Technologies above the pack.

Good answer, Dave. And so...

I don't have any notes with me...

Yes. So last year, when we were sitting here, you were -- I think you were coming back from a sustainably -- sustainability forum in Europe, and you're all build up. New Year, different challenges. Just curious, is your outlook over the next 12 months changed much?

It really has. I think I was coming back from SMI over in the U.K., and I was with a group of CEOs and we were talking about the actions that we need to take as leaders of companies to make sure that this global warming that we're all facing could start to reverse. And it was just so refreshing for me. It was probably the first -- one of the first meetings I had been to with that group. And just to hear other CEOs share the same passion that I have around what we need to do to decarbonize was very refreshing. So to answer your question, yes, the megatrends around sustainability and decarbonization, they haven't changed, okay? In fact, they've intensified. Unfortunately, the world keeps getting warmer, and we need to take action. And we need to take action now, right? We have technologies that we could scale today that would dramatically reduce the carbon footprint of the built environment. And we need to scale this technology. I always get asked, you have this great technology, why can't you scale it faster? And I always say that the biggest hurdle is knowledge, knowledge about what's available today, right? We can combine heating and cooling into an electrified system that dramatically reduces the carbon footprint for the built environment, and it works in all climates. So we need to take action. We need to scale this. We need to go faster. [ 50% ] of all global warming, 15% is from heating and cooling of buildings. And the majority of that is from heating because it's using fossil fuel. We have solutions that can eliminate or significantly reduce the amount of fossil fuel that is used for heating. So we need to adopt those challenges. So I guess I'm still very passionate, and I think there's lots of opportunities out there. You think about it, there's 400 billion square feet of commercial real estate globally. 400 billion. It's hard to get your mind around that. And we need to take action on all of this to help decarbonize it to really make this world a better place for the next generation.

So the long term still sounds great. And you are very passionate about it. So it's great to see. The last 6 weeks did basically raise another wrinkle with all of the middle market financing that's occurring and credit tightening. And we had a company here earlier today, not seeing it in their business today, but certainly concerned about it going forward. How are you thinking about it across your portfolio?

We haven't seen it in our portfolio either, okay, in our business. We really haven't seen it. You see that with our first quarter results, which started out very strong, we're very happy with the results that we were able to put on the board in the first quarter. It gives us a lot of confidence in our full year guidance. We'll pay attention. I would tell you that the paybacks that we're seeing on a lot of our projects, especially on the applied space, are very, very accretive in a very short period of time. So if it does cost more to finance it, okay, does the payback go from 2.3 years to 2.4 years? That's still a very nice payback, and we'll see how it plays out. We haven't seen any kind of let up in demand.

If you were to start to see some of that let up, you guys have -- Chris, I'll bring you into this conversation as well. You've undergone an operational transformation, several cost synergies, $300 million in cost synergies. If you were to see a slowdown, how do you think about pulling back the toggle on cost for something that might be a near-term phenomenon versus what levers would you have available for you to pull to sustain margins going forward? How do you think about that dynamic?

Joe, we're on track to the -- delivering the $300 million of transformation savings by the end of this year. We use it for a couple of areas. One is to make sure we're investing back in the business. Two, to drive innovation and drive that market outgrowth on the top line. We're well on track with that program. But I would tell you one of the major opportunities we have going forward is around productivity, right? We've had higher cost to serve customers over the last 2 years with an inefficient supply chain. It's very expensive to be on the spot markets to buy chips and electronics. And we described the supply chain getting better gradually throughout the year. But you can see in parts of our business, even in the first quarter, especially Europe, a very challenged first quarter of a year ago. And as that productivity got better, as the supply chain got better, we saw that come through the margins in the first quarter. So that's a massive opportunity for us. You think about expediting freight. It wasn't very cheap to put components on an airplane to make sure it makes your factory in time, and you can keep your factory keep moving forward. So that's a massive opportunity for us. A, to get back to the basics, right? We love our lean thinking. We've had to spend more time leaning out the supply chain. Now we can shift back into the operations, and that's where we're describing more volume growth this year than we saw last year. I think there's a nice opportunity there.

Yes. One of the things, if I could add, Joe, is we do a lot of work. It's part of our operating system around scenario planning. So every year, we do very detailed if X happens, what do we do? And we do this at a strategic business unit level within a geography, within a particular country. And we look at broad macro as well as micro events, and we understand what we would do if we saw something happen. And we also are very clear on what we would not do if something happen. I know that may sound a little awkward, but it's just as important to understand what investments you would never cut because they're about the long term. So knee-jerk reactions, based on what happens in 6 weeks or what happens in 6 months, are always very poorly executed. And if you have a plan, though, you can execute to the plan. So we have very detailed plans. If there is a slowdown, trust me, I'm not talking ourselves into a slowdown here. If there is a slowdown, we'd be ready for it, and we're ready for it to say what we would stop doing. More importantly, what we will not stop doing. So we make sure we're continuing to invest for the future.

Great. You said you haven't seen a slowdown yet. I mean your recent trends. You're...

It sounds like it might be.

No. I know, I'm not trying to, actually. Like your 1Q backlog was up $400 million, 6% sequentially. That's a great sign. You talked about $6 billion being a floor in your backlog for the year. So maybe just kind of talk through what you're seeing in your -- maybe your front log or your pipeline that gives you confidence in those numbers?

Yes. We ended the first quarter with a backlog of $7.3 billion, okay, which is 2.5x what we would consider to be normal. We said that we would have a floor of $6 billion going into 2024. What that's code for is we're going to have a very strong backlog going into 2024. We think it will be north of that level. And by the way, in any particular year, we typically enter that year with about 20% of forward revenue in backlog. Well, if you do the math on the $6 billion, it would say we'd be at $30 billion. We're not going to be at $30 billion. So you don't write that in your report. But it just gives you a sense as to how strong our backlog is going to be going into 2024. And the megatrends around decarbonization, they're not stopping. The megatrends or the mega projects that we will be developing over the next 12 to 18 months, they're massive. The stimulus money that's flowing on a global basis is a stacking effect that's occurring. So it's continuing to create a lot of strong demand for our products and services.

Great. And one of the key themes that we saw come out of earnings this quarter was really just around supply chain easing, price costs, tailwinds. Maybe you can talk a little bit about the pricing that you're seeing come through your P&L today versus some of the pricing that might be even higher in your backlog? I don't want to put words in your mouth, but what's the pricing like in the backlog today versus what you're seeing in your P&L?

Yes. So Joe, I'd say we like the margins in the backlog. Our product management teams have done an outstanding job the last 2 years staying ahead of inflation. We feel like we've led the industry in price in 2021 and 2022. We started the first quarter with about 6.5 points of price at the enterprise level. We're looking at the full year revenue growth around 7% to 8% in our latest guide. We see more volume growth, though, on a full year basis. And we do price growth, price probably still in that 200 to 300 basis point range. But our teams have been leveraging the business operating system we devised in the company to make sure we're taking all the inputs on costs, the input on the total cost of ownership to a customer and making sure that we're pricing effectively. So -- we guided to 20 to 30 basis points of a price cost spread. We have a lot of confidence we're going to deliver on that in the full year. And we look at that across each of our three regions as well. They should be price cost positive on a dollar basis, margin basis. We saw that in the first quarter. We're expecting that for the second quarter and the full year.

Yes. And on supply chain, supply chain is improving. It continues to improve. It's not back to where it needs to be. So there will be several quarters of this improvement continuing in the future. It was funny, I had Head of Manufacturing [ came into ] my office the other day because I was on our earnings call. I said, yes, supply chain is getting good because [indiscernible] obviously, he said, Dave, you know that we still are working a lot to secure it. I said, I got it, I got it, I got it. But it is getting better and everyone should know that. We also still have elevated safety stock levels of inventory on a global basis. We think that's a prudent investment. And we'll burn that when we think the time is right, but this is not the right time. And through the course of the year, we'll reevaluate that as supply chain continues to improve.

Is there any particular end market or business where you're keeping more safety stock than others?

It's pretty universal. Certainly, anything that has to travel will keep more of. We're in region -- for a region from a manufacturing standpoint. Some of our components still do come from overseas in a particular region. So we'll double up on those. Certainly, on the electronic component side, we'll make sure we're well safety stock level in those areas. So it really depends. I mean Asia was a great example of where early on, we doubled down on our safety stock levels there and kind of saw what was going to happen with these lockdowns. And you saw us never missed a beat in Asia. We really didn't. I mean we had lockdowns in the second quarter last year was a little bit softer than others. But for the most part, I mean, we were able to execute and take care of our customers. So we're going to keep the safety stock in place. It's a bit elevated. But again, we believe it's a very prudent investment, and we'll burn it off over time.

So since we're talking inventory, can we talk about some of your -- some of the destocking comments? And I think your independent distribution was down mid-teens in resi, resi independent distribution. But your direct model was down, I think, closer to like high single digits. So maybe talk to us a little bit about the inventory levels that you're seeing across the channel?

Yes. I mean, first of all, our residential business, the way we're looking at that right now is sell-through, right, which is really the health of that business was flat year-over-year. We don't see that business falling off a cliff, so I'll answer that question now. As far as the inventory level goes in our independent wholesale distributors, and just to remind everyone, think about us as 50-50, 50% of that -- of our residential business goes through independent wholesale distributors, 50% were the independent wholesale distributors. At the end of the fourth quarter, I thought we were in good inventory position. And I said that on our call, we didn't -- it was a little bit lighter than we thought. So there's a little bit more destocking that happened in the first quarter. As I look at where we are today, I don't see anything alarming, but I do see that there could be some continued destocking through the second quarter. And -- but again, it's very early in the residential season. First quarter -- I wouldn't judge our residential business on the first quarter, and that's -- it's a seasonal business. So we'll see how the season picks up, the cooling season that is, and we'll be well equipped to handle it. This is a business that's a very solid business. We have a great leadership team there that's very experienced, and we have some great brands and channels and we believe we have this guided correctly for the year.

Great. Yes. And the commentary that I made with the numbers I threw out were more units, right?

It was a unit volume. Revenue in the residential business was down...

Mid-single.

Mid-singles, but unit volume was down. And -- but let's see how the cooling season plays out.

Can we transition maybe to the refrigerant change?

Sure.

So I'm curious just where does your portfolio stand in terms of making sure that you're ready for the transition that occurs next year? And are you continuing to make -- is that part of the investments that we're talking about that you'll continue to make to get there?

Yes. I mean, first of all, we've been dealing with refrigerant changes probably since I was running our commercial business back in 2012, not to date myself too much here. But we're very well equipped to handle any refrigerant change. In fact, we've led the industry with next-generation refrigerants. And Joe, you remember this, I was talking about moving to low GWP refrigerants. And I was getting questions, not from Joe, but from others saying, why is that important? And why do customers care? Now you could see it being regulated. So to answer your question specifically on the -- there is a phase out in 2025 of 410, okay? The majority of the industry will be migrating to a refrigerant called 454. And we're ready, okay? And yes, there is some cost, especially in our -- in the manufacturing locations. The 454 refrigerant is what they call an A2L. So it's slightly flammable, even though that may be a little bit of an oxymoron. So with that, you need certain different precautions about in your manufacturing locations as well as on the product side. So you'll have to have different sensors so that if there is any kind of a leak, it will be detected and the unit will protect itself.

I remember -- I remember the last refrigerant change. And I've been covering you guys since then.

Well, refrigerant changes, it's an opportunity for all of us, right? These are significantly less harmful chemicals for the environment. And the GWP of 410 versus the GWP, global warming potential of a new refrigerant is 60%, 70% less than the one it's replacing. And we have many refrigerants in our portfolio, especially on the commercial side, where the global warming potential is like, one, right? It's de minimis, right? That's what you want. You want a refrigerant that's very friendly to the environment and by the way, increases the efficiency of your product. And that's what we've been able to develop on our commercial business. So we look at refrigerant changes as opportunities, and I'm sure this will be an opportunity for us as well.