Trane Technologies plc (TT) Earnings Call Transcript & Summary

We started with Trane Technologies. I've covered Trane for about 18 years, and it's been really something to see the transformation in this company into one of the highest quality, most dependable companies out there. And it certainly wasn't that 18 years ago. So it's been wonderful to see this transformation. With us on stage is David Regnery, Chair and CEO of Trane and Chris Kuehn, EVP and CFO. So Dave, over to you and we'll go from there.

Thanks, Nigel, and thanks, everyone, for coming today. It's a great day here in New York, nice and sunny and I see a lot of blue jackets in the crowd here. So I was told I wasn't allowed to wear blue anymore from my wife. So look -- I still own a couple, but just to be fair. Look, our purpose at Trane Technologies 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 value for our shareholders. The mega trends around decarbonization and sustainability continue to intensify. Unfortunately, the world continues to get warmer and at Trane Technology, we are scaling technologies that exist today, and we can talk more about this, but they exist today that can dramatically reduce the carbon footprint of the built environment. And we're also relentlessly inventing for tomorrow. We had a very strong first quarter, which gives us a lot of confidence in our guide for the rest of the year. In the first quarter, we had organic revenue growth of 9%. We had EPS growth of 26% and we ended the first quarter with a backlog of $7.3 billion, which is more than 2.5x what we would consider to be a normal backlog. So we're very well positioned for not only 2023, we'll be very well positioned to 2024 and into the future. So with that, Nigel, I'll turn it over to you.

Yes, Dave. So I've got to mention there will be a chance to ask questions probably in 15 minutes or so. So put your hand in the air if you got any questions.

So Dave, your performance for the last 6 quarters or so has been pretty consistent, delivering your promises despite all the macro volatility. So maybe just talk about where we are today? What's sort of on your mind, top 2 or 3 kind of problem areas, key issues that you're working through right now and we'll get into the macro.

We always look at every problem as an opportunity, right? It's how you spin it. So look, I mean, our business is performing very, very well. I think the supply chain, we're still -- it's getting better and it continues to get better. And you see that obviously impacting our results in a positive way. The supply chain is not where I would call it's normal, and it has a ways to go to get back to that level. But we're continuing to work and our team continues to do a great job. I would tell everyone that we are carrying more inventory, working capital than we normally would. We believe that's a very prudent investment and we'll continue to do that to a time where we'll burn that off. I'm not concerned about burning it off. I'm more concerned about making sure we're able to have continuity in our manufacturing processes. It's very disruptive. If you have to take a product on and off the line to retest it, et cetera. So we want to make sure we have the right components. And it's also very, very disruptive to our customers when we don't deliver on time. So we're going to be on the conservative side here, and we'll leave in some layered inventory for a period until we can make sure that the supply chain becomes more robust.

And then with the inventory, are there any remaining bottlenecks, be it chips, filters?

Yes. I mean at the end of the day, our products over the last, I'll say, 5 years have become so much more intelligent that there are microprocessors that are built into the components are everywhere within the system. And we like to think about things at a system level, but that requires a lot of microprocessing. And when you start thinking about having a microprocessor in your -- not only in your fans but in your wire harnesses, you could kind of get a degree as to what we're talking about is the intelligence that are built into these systems. So what we've done there is we've actually redesigned a lot of our components to be able to accept many different kinds of chips. So think of it as a minimum of 2, and that gives a lot of built-in redundancy, which has helped us tremendously as we work through these supply chain issues.

Right? So you built backlog in 1Q. I was surprised that -- I mean, it's not unusual to build backlog in the first quarter, but of the kind of backlog you've got, that was quite impressive. What are you assuming over the next several quarters. Do we start eating into that backlog here? I mean now that the lead times are coming down, is it natural we should have seen backlog to kind of [ revert ]?

Do you want to -- sure go ahead.

Sure. So we ended the first quarter with $7.3 billion dollars in Q1, Nigel. We put a scenario out there, which would say we expect backlog if it were to be at the end of the year, $6 billion, okay, so down -- it would mean order rates were down 6% in the year. It was meant to be a scenario. And in the first quarter, we saw orders bookings down 1%. So we did better than that versus the scenario. And I would tell you that we fully expect the ending backlog in '23 going into '24 to be much stronger than $6 billion. Will the backlog ultimately come down over time as lead times improve? It should. It should absolutely normalize. We're seeing that in the residential space already for the last couple of quarters. Thermo King, that's a little bit lumpy in terms of when order rates have occurred just given when we've selectively opened up the backlog and the order bookings. But we should see that normalize over time. But right now, we're expecting to enter 2024 with a very strong backlog well in excess of $6 billion.

Okay. But not a [indiscernible], that -- not a [indiscernible] It'd be too...

Well, you'll see where the year kind of plays itself out. But remember, the majority of our backlog is sitting in nonresidential space, okay? So over 90% of the backlog is in commercial HVAC, in Thermo King. And of that, the vast majority of that is in commercial HVAC.

That's a great segue because -- so when you think about that backlog and you dissect it, how much of it do you think is due to structural secular factors where customers might be preemptively upgrading facilities to maybe reduce Scope 1, Scope 2. How much of it do you think is just lead time extension trying to get into the queue. How do you think about that?

Yes, it's a great question. I think lead time is certainly adding to it. If lead times have extended, obviously, customers are going to give us more visibility as to when they're going to need the order, when they're going to -- we're going to book that order, it's going to become part of our backlog. I would also tell you that innovation helps, if you're able to create solutions that are different in the marketplace, there's a lot of demand for those. And hopefully, you saw the results that we were able to demonstrate in our European business -- European commercial HVAC business with strong order demand, but also on the revenue side, our equipment business was up close to 40%, 40%. And that's really about innovation. You also have -- there are certain verticals that are really accelerating. Data centers has been strong for a while. You've probably heard me talk about the high-tech industrial vertical. It's kind of our own nomenclature for that. But think about EV battery plants, what's happening there, that's certainly adding to the backlog. Think about microprocessors. And I'm not talking about what's to come with the CHIPS and Science Act because I really do believe that that's in front of us. So a lot of different things that are growing the backlog. I would tell you, though, having a robust portfolio that's full of innovation, having a direct sales force on your commercial HVAC business. Being able to talk to end customers and all the different decision makers in an order process it all helps.

Clearly, more tailwinds than headwinds right now but...

The other thing, too, is that I didn't talk about it is the regulations that are out there, we -- in our industry, for the first time in a long time, we have the tailwinds of what I call policy stacking occurring. So it's not just one policy. It's many policies that are out there. It started with the whole think about ESR funding, we now have IRA that hasn't yet even impacted us. Think about what's happening with CHIPS and Science. You go over to Europe, there's other regulations that are really becoming tailwinds for our business.

And then there's a bunch of state and municipal codes as well. So there's a lot of tailwinds out there.

Yes. I mean the whole -- it really -- you think about the larger umbrella around the decarbonization of the built environment and it continues to intensify. And we're seeing it really on a global basis, but you're seeing a lot of codes being written around it. And municipalities, you have a local law. What's -- 97?

97, yes.

I always get it mixed up with what's out in Seattle. But again, it's a local law where it's at a municipality level. It's called New York City municipality. But it's really having an influence on what and how you're going to manage spaces in the future. And that's not just here in New York, okay? That's widespread. And if you go over to Europe, right, and you look at it by country level, I mean, you have many countries there that have said that if you're going to have a greenfield building, it will not use fossil fuel. So think about that, not use fossil fuel. So some of the solutions that we've been able to develop that -- our thermal management systems where we're able to eliminate or significantly reduce the need for fossil fuel. You can understand why our business in Europe is growing at the rate it is.

So more tailwinds and headwinds?

More tailwinds and headwinds.

But let's talk about the headwinds, the potential headwinds. And let's think about the regional...

I listened to Bloomberg in the morning, and there's one analyst on there that loves to go into the negative side. But go ahead Nigel. I won't mention...

We're like the groundhog, we see shadows. But thinking about the regional bank, lending stand is tightening. We're all freaked out about commercial construction. Are you seeing any pockets? I'm just wondering if maybe kind of like commercial rooftop units, are you seeing any pockets of weakness in that at all. Just in the front log perhaps?

I mean, we don't look at it necessarily at a product level. We look at it at a vertical level. And to be fair, on the regional banking side, we haven't seen an impact on that. But we've had -- it's been strong. I mean, it's been very strong. And there are some verticals that are less strong than others. I mean office certainly hasn't been as robust as, say, the high-tech industrial side. But the thing about our business is that with a direct sales force that's highly trained, we can pivot to different verticals very quickly. And we do. And that's -- we'll take advantage where the opportunities lie.

Okay. Moving to residential. I know you like to talk about the fact that this is a GDP plus industry, and I'm sure that's...

Over time.

Over time. But we are seeing a lot of noise right now with sell-through down double digits. Is this a weather issue? Is it a consumer issue? I mean how would you describe that?

First of all, in the first quarter, our sell-through was basically flat, which is a good way to look at the business is it really identifies the health of the business. Look, residential has been normalizing. I would say it's been normalizing for probably the last 3 quarters. And inventory's coming down in the channel. As I said on our earnings call at the end of the first quarter, how does the inventory look? It's probably a bit higher than it needs to be. So you'll see some more normalization that will occur in the second quarter. But understand, don't judge the residential business on the first quarter of the year, okay? It is the smallest portion of that business. And when the cooling season starts, demand will be there. And there's -- the other thing I would say about the residential business is, yes, it's -- our revenue number was down in the mid-single digits. Our volume was down in the teens. But we continue to invest heavily in that business. Because I know that this will come back, and I want to make sure we're ready for it. So we're doing a lot of work there with -- and I'm not just talking about the refrigerant change that's coming or a cold climate heat pump that they couldn't even stop our unit, okay? Literally, they had to shut it off. They were like, okay, you qualify. They couldn't fail the unit. But think about it at the digital side and what we're doing there and how we're helping our dealers be more successful with their customers. So those are the investments -- type of investments that we're making in the residential space. So yes, it's a business right now that's got some headwinds. It represents 20% of our business. So we don't see it falling off a cliff, but it will come back. And when it comes back, we're going to be more than ready.

But you think inventory will be rightsized by -- in the second quarter. Second half of the year, we should start see a cleaner...

Yes. We'll see how the year plays out, okay? A lot of it's going to have to do with the demand that we see as the heating season starts -- I'm sorry, the cooling season starts.

But should we -- any time, this week, next week?

Soon.

Soon.

Soon. I'm heading to Arizona after here, and I'm being told as I'm getting these e-mails that has already started there. So it's coming East.

Really sure Arizona -- if it's not warmer than this, I'd be very worried so...

I'd be nervous too.

Just thinking about the investment, you alluded to the refrigerant change. I mean, where is Trane on that curve of investment to get your residential and commercial products ready for the A2L?

Yes. We're more than ready. I mean, we've been we've been dealing with next-generation refrigerants since I was running our commercial business back in, I don't know, 2013 and there was always this myth out there that if you went to a low GWP refrigerant, you were going to sacrifice efficiency or performance of your equipment. Well, we broke that myth. And basically, we increased the efficiency of our product and the capacity of our product by going to a low GWP refrigerant. That was on the commercial side of our business. But -- and I was explaining to a group earlier that they're like, "how did you do that?" And I was like, it has to do with working across businesses. So you think about some of the major manufacturers of refrigerant. In the past, it was always like "this is ours, we're not going to share with you here, go try this gas and see how it works in your unit." That's a very ineffective way of developing next technology. But working together, and there's some relationships that have to be built to do that. We're able to come up with solutions that are better for the industry and better for the planet. And the speed to market now with next-generation refrigerants, is the reason why you see these things coming out so quickly. Right? Because we're working across the businesses to develop next technology. So we're more than ready. We welcome -- think about refrigerants. There's 3 aspects I always tell people to consider when you're thinking about refrigerant, right? One is, what's the greenhouse gas. That's the one that gets advertised. And the closer to 0 is better, right? And there's a point where it becomes de minimis at some level. The second is, what's the performance in your product, right? Did I increase the capacity or did I decrease it? So if I had a 500-ton chiller that now becomes a 300-ton chiller, that's a bad thing. Or did I increase it? Does the 500 now become 600? That's a good thing. The third element is safety. So don't forget safety because it's very, very important. And we're now talking about 2L refrigerants. I don't want to get too technical, but the oxymoron is they're slightly flammable I don't know how that could be. They're flammable, right? So you have to put different detection systems within your system to make sure if there is a leak, it can be detected. But we're well equipped to do this. We encourage, okay, the market to go to GWPs on refrigerants that are closer to 0, and we're helping to lead that.

Okay. So you'll be ready. Do you think your competitors will be? I mean where do you sense you are versus your comp...

I should ask you that question.

I think you've got a...