Trane Technologies plc (TT) Earnings Call Transcript & Summary

Thank you, everybody. Super excited to have Trane Technologies up here with us today. Dave Regnery, Chair and CEO; Chris Kuehn, CFO. Thank you guys for joining us.

Maybe starting off at a high level, if we look at commercial HVAC growth, it's bifurcated from global construction over the last couple of years, and no company has bifurcated more than Trane. Can you just talk about what's driving this?

Yes. Well, first of all, thanks, Chris, for having us here. And this conference is always one of my favorites. Maybe it has to do with the view outside of my room. I don't know. Actually not outside my room to be clear. I walk out here, I see it. But thanks, everyone, for joining us today, too. I really appreciate your interest in Trane Technologies, and we certainly had a very strong second quarter. Our organic revenue growth was up 13%. Orders were up 19%. EPS growth was 23%, and our backlog was -- remains extremely strong at $7.5 billion. To your question, like I always tell everyone that it's a system of things that makes Trane Technologies a great company. And I always start with our direct sales force and being able to talk to customers and being able to understand their needs today, and more importantly, anticipate what their needs are going to be tomorrow. I always talk about our service business, which is 1/3 of our company that represents just a fantastic business that we have. It's got a compound annual growth rate of high single digits over the last 6 years. I talk about innovation. And if you noticed, I didn't say product innovation because innovation to us is a much broader category, right? We invest in all aspects of our business and the relentless innovation is what maybe differentiates us from some of our competitors. I always get asked on earnings calls, why can't you leverage at a higher level, and I always tell people, we're not going to be the company that wins the leverage story, right? But we are going to be the company that wins the growth story because we're investing for the long term on a consistent basis. So I could talk about a lot of different things. I would tell you that the one thing that I always talk about that truly differentiates any company is its culture. And in Trane Technologies, we have an uplifting inclusive culture, and we don't look at problems. We look at what's the opportunity to solve that problem. And when you could solve that, that's when you become disruptive, that's where you have the real opportunity. And we believe that we can disrupt ourselves, and we've proven that we've been able to do that. So look, we've had a great run over the last several years and expect more in the future.

Yes. Do you think customers have a better appreciation of energy efficiency than they did 5 years ago? And if it's true, is it just because the paybacks are better or because there's a bigger focus on ESG targets and emissions.

I think the short answer is yes, okay. Certainly, the paybacks on our solutions today are very attractive. I think the education process, Chris, as you and I have discussed before, is certainly something that's a hurdle, right? We need to educate everyone on what's possible. And I think that many customers don't understand what's possible today. Even though I like to think they do because maybe I talk to myself in the mirror too much about it. At the end of the day, we need -- we still have a lot of work there. I can tell you a funny story, and I told the group this earlier today. So I was out buying home with my son, right? So he brought me along for moral support. He just told me it was banking support. But -- so anyways, I'm not buying -- and it's a national builder, they do not use Trane. And there's no way to convince a national builder unless you have the contract with them that they're going to make any substitutions in their home, right? So anyways, we go through the story, and I'm like, okay, just go down the road. And -- so I said to the person that's selling the home. I said, "Well, can we -- we sell the heat pump". And he says, "Oh, you can't use a heat pump in this house". I was like, this is in North Carolina, right? And I said, "Why can't you use the heat pump". He said, it's too big. House is too big, you never -- you could never heat it. I was like, really, I said, "Do you understand a heat pump?" And I start to get, and my wife said, hey, Dave, calm down, calm down. I'm like -- so I started talking about, well, you understand the efficiency levels and that really blew our way as soon as I said coefficient of performance. It was like, I wasn't going to get anywhere. Sorry. We leave. And in about 15 minutes, maybe 30 minutes later, like my son calls me he said, "Hey, Dad, she wants to know if I should get the 80% furnace or the 90% furnace"? And that triggered me. I was like, this is ridiculous. So I go in here, and I said, do you understand the question you just asked. And she goes, "You know what, I said an 80% furnace, 1 unit in equals 0.8, a 90% furnace, 1 unit in equals 0.9". Do you understand that a heat pump, 1 unit in equals 3.5. You understand the efficiency levels that we're talking about here with a heat pump. And she just looked at and she goes, look, we don't sell heat pumps. But it's one of those things where it's just -- it's a microcosm of the amount of education that we need to demonstrate and to bring to the industry. And I use residential as an example, but in commercial, the direct sales force helps us, right? Because we're able to educate our customers. We're able to take them on that journey that they need to be on that. These solutions exist today, right? You don't have to wait for something to be invented, right? We'll continue to innovate and we'll make ourselves even better tomorrow. But these solutions exist today. And getting that word out, 30% of all the energy in a building is wasted. I'm talking after the meter, right? I have to go up to San Francisco to speak at a conference next week, right? It's a Dreamforce, which is Salesforce's conference. The only reason why I'm going there is because I want to tell the world or at least the world that is in that space, how to use AI to solve real-world problems in a manufacturing environment, right? 30% of the energy after the meter is being wasted, right? That's the opportunity. There's goodness on the supply side and that will happen. Data centers. Yes, they're growing. It's a strong vertical, right? It's going to go from -- you pick a number, 4% of the energy consumed in the United States to some number that's double that in a very short period of time. Got it. The opportunity is in between what we call demand side management, solving the waste. That's where the opportunity is, and that's what we're doing at Trane Technologies.

I mean that 30% inefficiency is obviously a massive, massive number. What -- is that just because buildings have old systems? They have new systems that are maybe lower efficiency. They don't have the controls, like what's the biggest piece of that...

Yes, yes and yes. But when we say 30%, we've done hundreds of thousands of energy audits, okay? So this isn't a made-up number here. Most buildings operate a minimum 30% inefficient. That's based on how they were designed, right? So it's -- when you put new equipment and it gets better, right? So this is based on how it's designed, right? Is the asset performing the way it was designed to perform. I tell people our service business. We have a great service business, right? In today's world, right, an asset is not performing not only when it's not heating or cooling properly. It's not performing when it's using too much energy, right? And that's the mindset. It's just a shift, right, in our thought process. And we've been using what I'd call structured data for AI for over a decade, right? We've been connected to buildings. We've been connected to assets. Now when you take unstructured data and add it to your structured data, your intelligence, and how you operate a building and how you operate the sequence within your systems fundamentally changes for the better. This 30%, this is the opportunity. You need data centers, okay? You need that computing power to help solve this bigger problem, which is the 30% waste.

The company's direct sales force, I know is very important to you, as you talked about earlier. I think sometimes it does get underappreciated in the market. I guess it's always been a positive for the company allows you to pivot to where the growth is. Would you argue that the value add from that direct sales force has picked up in a world where energy efficiency and paybacks have kind of come to the forefront?

So, absolutely, it is a competitive advantage that we have. If you have a direct sales force, you're out talking to the customer, if you have a direct sales force and you're an innovative company, you're out educating the customer all the time on your newest innovations. And that's one of the advantages we have, marrying those two together is very, very powerful.

And then on that relentless reinvestment, I guess what do you see in the pipeline today? Obviously, thermal management has been a big deal for you guys, digitized service. And then ultimately, how does it come back through the P&L, whether it's pricing or gross margin as you guys are delivering these best-in-class.

I'll let you start, Chris.

Sure. I mean think about these investments, Chris, is a really wide umbrella. And we can talk about product, but I'm actually going to start with the front end of the business with our sales force, our direct sales force, making sure we're adding resources globally. This is not just an Americas comment. It's an EMEA comment. It's an Asia comment as well. It's also providing upgraded tools to the sales force. So how they connect with customers, track down leads. We talked in the second quarter, those front logs of our verticals continue to remain very robust. I want to make sure that our teams have got the right level of tools to go manage that. Let's move to service technicians. Service is 1/3 of the company revenues. We're always adding technicians but also the tools that they use, and that's where David was mentioning digitalized service, making sure we're connected to our equipment. So you're rolling a service technician when you know what the problem is, you detected a problem. You're not going out there trying to hunt for it. Now you can be very specific in how you solve for it. Now let's shift into capacity, which capacity give me in a lot of different areas, but if I focus on just physical capacity, we're focused and have been for a long time. We're a lean company. We want to make sure that we've got an existing line that we're continuing to get more throughput through. So think of that as factory automation. It could be adding lines in an existing facility and how do you reorganize the space in that facility to optimize it. So that's making sure that you've got a lean thinking. And then we're adding capacity where we think it makes the most sense. But it's really not starting with just let's add four walls. It's actually starting with what you have today and getting more throughput there. And I'll tell you, the investment base we -- our focus has been how much do you keep pulling in and advancing the investment and then still driving 25% or better incrementals over the long term.

Yes. A great example of that is in our Thermo King business. So our Thermo King business, if you follow Trane Technologies, knows that this is a business that's more cyclical than our Trane business. And it's in a down year. And next year, we could talk about what's going to happen, but it's in a down year. We're doubling down on investments in that business, right? And we're trying to disrupt ourselves in that business. And we have some really, really cool things that we're working on there that's going to fundamentally change how that industry works. So anyways, that's the advantage of a company that's constantly looking to recreate or disrupt themselves.

Maybe turning to the...

I can tell you more, but I can't say.

Yes. I look forward to learning more. The -- turning to the market, maybe commercial applied kind of company's strongest market, pretty incredible run. I think America is 90% on a 3-year stack, seems pretty good. Can you talk about the runway for growth?

Can it be 100.

Yes, yes. Can you talk about the runway for growth, both just in the market opportunities, but then also your guys' ability to continue to take share in our growth.

Well, look, I think this whole -- how you make buildings operate more efficiently is certainly part of it, okay? And I think you're going to hear a lot more -- you'll hear others start talking about demand side management and how that works. On the applied systems side, look, again, there's just opportunities in different verticals. And it's being able to understand where those opportunities are, pivot your sales force to the greatest opportunity. And right now, you're hearing a lot about data centers, and that vertical is very, very strong. And it will be very, very strong for the foreseeable future. We don't only sell to data centers. And I try to make that very clear to our investors that we play in 14 different verticals, at least in the Americas. And we have strength in all 14 and there's opportunities that exist in all 14. So look, we see this as a -- I always tell people that we've had certainly a great run for the last 4 years, but and my eyes are the best days are yet in front of us.

I mean, yes, 14 verticals. I think all or almost all of them were positive in Q2, if I...

We had a search for the 1 or 2 that weren't positive, and I think it was like or I think it was a retail and...

Retail, leisure and made in government.

Government.

Government. I mean when you look across these end markets, is there anywhere where you're seeing positive or negative rate of change?

Well, certainly, some of the high-growth verticals, they're certainly positive there. So I mean no deck. I've been saying for a while, the high-tech industrial has been very strong. Data centers have been very strong. Education has been very strong. Everyone thinks of education is just K-12. Think of higher ed as well, also very strong. We separate those two. Those are two separate verticals for us, two different focuses. So those continue to be very, very strong for us. And I don't see the -- I mean, there's lots of opportunities there. I mean if you've taken your child to college this year, does anyone taking their child to college this year? Nobody. A couple. Okay. They probably sold you on the fact of what they're doing to upgrade their facility, right, and how they've been able to take actions to make the learning environment more conducive to the student. And I'd tell you that we're all -- we're part of that whole solution for them.

Yes. I mean, obviously, the backlog is well above normalized levels, but it does include some longer-duration projects with data center. But when you look at the backlog and the orders that are coming in from customers, in general, do customers still want equipment sooner rather than later?

Go ahead, you can start.

Look, lead times are pretty much back to normal at this point. And as we phase out the backlog and timing, it's really when do customers need the equipment on site. We had $7.5 billion of backlog, as Dave said at the end of the second quarter, $2.8 billion of that was for 2025 and beyond. And really, that's majority commercial HVAC. And of that, it's really applied systems. Think of that, Chris, is usually 9 to 12 months out as a normal period of time for an applied system to be booked in advance of when it needs to be shipped. Data center probably gives us a little bit more visibility, it could be 15, it could be 18 months out. But think of it as when the customers need it, that's when we're making sure it's getting into the backlog and we're building a slot and executing to it. But we'll -- that $2.8 billion at the end of second quarter, that's normally what we would have at the end of the year to start the next year. So we'll build that level of backlog in the third and the fourth quarter. And our expectation is that it's going to remain elevated for a period of time here.

Yes. And remember, our backlog does not include service.

That's right, probably 1/3 of our business.

I know company serves 14 markets, not just data center, but that has become a very, very important one. And it does seem like when we look at the orders and the bifurcation does seem like you guys are winning more than your fair share in data center. What is the driver of that success? Is it the technology, they appreciate it? Is it the direct sales force?

Yes. I'm working directly with the data center customers, they're engineering teams, that's been happening for a long time. So that's not new to us. I always -- I was smiling because I was reading someone, not in this industry, okay? They were saying how we stood up a data center team. And I was like, you stood up a data center team, what were you doing before. We've had a team in place for a long time, right? But look, our teams are experts in this space and they're able to speak the language. They challenge data center customer. They challenge us. It's a great way to have innovative products. And the other thing I would tell you that is a little bit different is we look at everything at a system level. And it really goes back to our roots of being -- our strength in the applied world is a system. These are all bespoke systems and data centers fall into that. So we're always looking at the entire system, not just the, think of it as the terminal where the cooling is happening at the chip, but think about the air handling that's happening within the data center halls, think about the chillers that are outside that are actually removing the heat. So I mean, that's all part of the equation that we will look at.

How is the selling process to a data center? Is that like a Trane is working with the engineer of hyperscaler or X? How does that go?

Most of the hyperscalers will select their products and then they'll turn it over to someone else to do the build. And it's not something that's deviated. Like in a commercial building, you'll have an engineering team that will design a building, and sometime it's okay, you'll hear me -- you'll hear us say as well, basis of design. And sometimes that gets deviated from in a data center, it does not get deviated from. So the Hyperscale or if it's a hyperscaler, will select -- how they want their data center being built and then they'll contract with someone to actually do that building. It's not the -- you're not negotiating with the mechanical that's actually building it. You're talking direct to the hyperscaler. In hyperscaler world.

Can you talk about the service opportunity in data center? And is it any different than your kind of the typical service model elsewhere?

I would think, as you think about service just at a higher level, any time the product is more sophisticated, the more opportunity you have, and data center products, our systems are very, very sophisticated. So more sophisticated, higher the service content.

I guess maybe on service more broadly. I guess ex 2020 basically been a double-digit growth CAGR, still a very fragmented market. What is the runway for growth there on service broadly?

Look, it's a great business. We have an operating system that's built around our service business. Chris won't let me say this, this Chris, won't let me say, double-digit growth, he actually say high single-digit growth because that's what it has on a compound annual growth rate for the last 6 years. That includes the pandemic. And as our installed base grows, obviously, our service business is going to grow as we do combined heating and cooling with thermal management systems, our service business, maybe it's not doubled because it's not purely linear, but it's a function of what it was before, multiple function what it was before. So these are all opportunities for us that are really ahead. And when you start talking about the digital world and being connected and really going after this 30% of energy that's being wasted, that's an additional opportunity on top of where we are today.

Obviously, we're seeing tremendous growth in the installed base of Trane assets in the world. How -- on an applied project, when do they really start generating service revenue for you guys? Is there a period of lag before that starts to kick in?

Yes, think of it as a 1- or 2-year warranty, you'll have maintenance in those first couple of years, Chris, but it really starts to inflect up probably years 3 through 5 through 6 through 7, those first couple of years under warranty a little bit less. But look, we think the model is over the life of the equipment, service is bringing 8x to 10x the revenue from the original cost of the equipment over that period of time. So as the installed base grows, we have a lot of confidence that we're going to see the service business continue to grow. And maybe more recently, we've seen a lot of volume coming through equipment. So service is still right around about 1/3 of the company. But look, that installed base continues to grow. It's going to be a really nice opportunity for us going forward.

The other thing we do in our service business is that as our product is becoming more efficient, we've actually taken some of those efficiencies, and we bring it back into the installed base. What we call it our renewals, it's probably not a great name, but you kind of get the concept where we're able to make existing product that's already installed more efficient. So it's not just a linear line. Think of it as a, it could start like this, and then it could be linear as far as what you'd see for service growth. But then you have function changes as you upgrade that equipment in the field. In many cases, it doesn't make sense to take equipment that still has useful life and take it out, it makes more sense to upgrade that. Maybe you don't get 100% of the efficiency you'd have for a new product, but you'd get a high percentage of it.

I think the biggest pushback that we quite honestly got on Trane is, can things get much better than they are right now.

You asked me the same question a year ago, different conference. So you asked me a year ago.

And obviously, we kind of see demand still stays very good. Obviously, tough comps, particularly on orders into the back half of the year. Like what gives you confidence that things can continue to get better.

We have such a creative culture at Trane. And like I told you before, it's -- we don't look at things as problems. We look at what's the opportunity to solve the problem. And when you could develop that culture, and you have that momentum behind you and the amount that we're reinvesting in this business and the opportunities that we see in front of us. Look, I say with confidence our best days are in front of us. And if you think -- I mean, it makes sense, right? I mean if buildings are operating 30% inefficiently, and we live in buildings, right? We all live in buildings. So we really live in buildings as Trane, right? We love this space, right? And we look what we're doing there. In our Thermal King business, I told you we're reinventing how we're doing that. And think about it as -- I'll give you a hint here, as the trailer is going down the road, right, what's all the energy that's being wasted. That's not being harnessed. And when you could solve that and not put a drag on the tractor, but when you can solve that, that's where you're going to fundamentally change the diesel engine that exists in transport refrigeration. That is exciting.

On commercial HVAC, look, there's estimated to be 400 billion square feet of commercial real estate that needs to be decarbonized. And we believe we're very much in the very early innings of that process. And then the estimate on the residential side is, I think, 600 billion square feet. You got 1 trillion square feet of decarbonization opportunities. So a lot of companies have made pledges to openly decarbonize their facilities we're there with them over a multiyear journey. And I think it plays back in that direct sales force. These are long sales cycles, right? We're not here just to optimize one given quarter or one given contract. We want a customer for life. So it's making sure we've got that balance of blend.

Look at electrification to heating. That's another one on our Trane business, right? This started in Europe. You probably heard me talking in the past about thermal management systems. That entire portfolio has been replicated here in the Americas, right? So I could tell you that if you're building a new building, in fact, we were just with a one of the largest builders in the world in New York City yesterday. And we were talking about how all new construction is -- these buildings are 100% electric, right? We were talking about the solutions that we have. And it was funny back to the education comment. He's like, "Well, have you done that before"? And how can you show us like, yes, let's walk around the city block. I'll tell you where we've been, right? But it's -- I tell you there's tremendous opportunity in front of us, tremendous opportunity.

Maybe on commercial unitary, I think that market has hung in better than many expected 12 months ago. I guess why has that stayed resilient? And does commercial unitary get a lift from the strength that we're seeing on the applied side.

Yes. I always get asked about unitary versus applied, and I probably give an answer that nobody likes because I'm pretty vague. And there's a reason why I'm pretty vague is because look, we have a product portfolio and the breadth of our product portfolio is very vast, right? We sell solutions to customers right? The solution could have applied part of it. It could have unitary as part of it. It could have a mini split as part of it, right? We're agnostic to the product that's going to solve the solution for the customer. So yes, it could be an applied system also have a unitary, look at a hospital. That's a great example. Yes, they're applied systems. They are usually centrifugal chillers. They're going to be air-cooled chillers. They could also have rooftops in certain parts. You could have an annex that could have a mini split or a VRF system as part of it, right? Well, because of the breadth of our portfolio, we don't necessarily just focus on one aspect of the portfolio of the product portfolio. We're more interested in the solution and making sure the customer has the right solution the right efficiency within that solution. It's been -- like I said, in the second quarter, unitary was actually stronger than that applied. I think that got a lot of people's attention. I didn't mean it to. But -- and there's reasons there. But look, we have strengthened if you have strength in 12 of the 14 verticals that you're tracking and the two that were down, took us a while to find that they were actually down a little bit year-over-year, you're going to have strength just because of the different products that serve those verticals.

I appreciate that. Maybe moving over to resi, built some momentum in Q2, maybe better...

And if it was 2 years ago, I would have got resi the first question. I would get now the last question, wow, times have changed.

Q2 -- but there was some support from a visibility around the policy weather was pretty positive in Q2. Do you feel like that resi market is turning? And maybe also layered into there, what's the expectations with the refrigerant?

Yes, as I said in the second quarter, look, certainly second quarter was stronger than we thought for residential, three reasons, right? Clarification on the regulation certainly, inventory became normalized. And unfortunately, and I say this to the, unfortunately, was a very, very warm start to the season. In fact, it was another record this summer. I think I don't know if that's public yet, but it will be public. Another record of summer heat, which is something we should all not be proud of that record, right? We keep setting it year after year, which is a different problem. What was the other?

Refrigerant.

Oh, the refrigerant change, yes, sure, we've been doing refrigerant changes since 2013. And so this isn't new to us. And as I said before, we're ready. One of the things that we did that's a little bit different there is we did mix model lines. So it cost us more, but we're able to run 410 as well as 454 down the same line. Yes, we have to change what we call line of sight inventory, but we're able to do that. We believe that will be a great investment long term. Because remember, you're going to be able to make these components for a long time. You want to make sure your product can be serviced in the industry for the life of that product. So we'll have the capability of doing both. We've been saying for a long time, we don't expect a big pre-buy I think that's the case. We're probably one of the first to say that we don't expect to have a lot of 454B product being sold in 2024. I think that has played out. We still don't expect a lot. So, I hit all your questions?

Yes, you hit a lot. All right. Pretty good. Maybe moving over to Thermo King. I know a business near and dear to your heart, down market this year, ACT forecast a recovery. You guys are obviously investing. What do you see there over the next 12 months?

Yes, I'll start. Markets expect to be in kind of mid-teens for 2024. Our internal models, we're suggesting maybe it could be a little bit worse than that, especially in the second half of the year, Chris. Those models would suggest down 25%. We think it could be a little bit worse than that. We factor that into our guidance when we released at the end of July. So let's see how the rest of the year plays out. ACT released its forecast just this week on 2025 refrigerated trailer volumes. They took down 2025 a bit. I think it's just under 37,000 units right now. So if you believe 2024, it could be flat to up about mid-singles. The key there is making sure where does 2024 fall out. And to Dave's point, we continue to invest in that business. It's going through a cycle. But when this does recover, and it looks like maybe second half of 2025 will be the timing of that. we want the new products ready and available for that recovery to happen. So that's the key to our business.

Last one, international America has been incredibly strong. What do you guys see in the international market?

Yes. Europe was through the second quarter was certainly as we expected, which was a good thing. In Asia, think of the rest of Asia, pretty much as expected, China is a watch, China is a watch. And remember, before you get too excited, China represents about 4% of the enterprise revenue, but it's certainly a watch.

Well, we're up on the 30 minutes. Thank you guys both for coming.

Thanks, everyone, for coming. Appreciate it.

Thank you.