Trane Technologies plc (NYSE:TT) Q4 2023 Earnings Call Transcript

Trane Technologies plc (NYSE:TT) Q4 2023 Earnings Call Transcript February 1, 2024

Trane Technologies plc beats earnings expectations. Reported EPS is $2.17, expectations were $2.13. TT isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. Welcome to the Trane Technologies Q4 2023 Earnings Conference Call. My name is Julianne, and I will be your operator for the call. The call will begin in a few moments with the speaker remarks and the Q&A session. At this time, all participants are in a listen-only mode. [Operator Instructions] Thank you. I will now turn the call over to Zac Nagle, Vice President, Investor Relations.

Zac Nagle: Thanks, operator. Good morning and thank you for joining us for Trane Technologies fourth quarter 2023 earnings conference call. This call is being webcast on our website at tranetechnologies.com where you’ll find the accompanying presentation. We’re also recording and archiving this call on our website. Please go to Slide 2. Statements made in today’s call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause our actual results to differ materially from anticipated results. This presentation also includes non-GAAP measures, which are explained in the financial tables attached to our news release. Joining me on today’s call are Dave Regnery, Chair and CEO; and Chris Kuehn, Executive Vice President and CFO. With that, I’ll turn the call over to Dave. Dave?

Dave Regnery: Thanks, Zach and everyone, for joining today’s call. As we begin, I’d like to spend a few minutes on our purpose-driven strategy, which drives our differentiated financial results over time. Our strategy is aligned to powerful mega trends like energy efficiency, decarbonization, and digital transformation. These trends continue to intensify and increase the demand for our sustainable solutions. The year 2023 was recently confirmed as the warmest on record and caused many extreme weather events around the world. Urgent action is needed to reduce emissions and mitigate the effects of climate change on people’s lives. That’s where Trane Technologies is uniquely positioned to lead. We are the partner of choice to help our customers advance their own sustainability goals while driving broad impact through our Gigaton Challenge, a pledge to reduce customers’ emissions by 1 billion metric tons by 2030.

Our purpose-driven strategy, relentless innovation and proven business operating system, enable us to consistently deliver a superior growth profile, strong margins and powerful free cash flow. The end result is strong value creation across the board for our customers, our shareholders, our employees, and for the planet. Please turn to Slide number 4. We expect to deliver top quartile financial performance over the long-term, consistently and reliably on behalf of our shareholders. This is core to our culture and central to how we set our targets and execute our strategy across our global portfolio. I’m proud of how our global teams rose to the challenge in 2023 and met or exceeded our targets top to bottom. We track top quartile performance against our core peer group closely.

And while the results are not yet in, we believe we’ll hit top quartile on organic revenue growth up 9%, and adjusted EPS growth up 23%. We also delivered free cash flow of $2.2 billion or 103% free cash flow conversion, enabling us to make key strategic M&A investments while raising our dividend and returning significant cash to shareholders through share repurchases. Please turn to Slide number 5. Relentless investment in innovation and growth, people and culture and our business operating system are hallmarks of Trane Technologies. And over time, we see clear benefits accruing as evidenced by our strong track record. Since 2020, we have delivered a revenue compound annual growth rate of 12%, 260 basis points of EBITDA margin expansion and free cash flow conversion of approximately 100%, enabling us to execute a balanced capital deployment strategy.

We believe we’re well positioned to continue to drive strong performance for shareholders over the long-term. Please turn to Slide number 6. Q4 was another strong quarter. Despite challenges in our transport and residential businesses, we leveraged the strength of our diversified and resilient global portfolio in our best-in-class business operating system to deliver strong financial performance as an enterprise. In the Americas, we expected the residential markets to continue to normalize and for the transport refrigeration markets to move into a moderate down cycle in Q4. While the markets were down more than anticipated, each business delivered strong bookings growth in the quarter, strengthening our position entering 2024. Global commercial HVAC markets continue to be robust, and we’re leveraging the power of our direct sales force to identify and pivot to the highest growth opportunities.

We’re thriving in key verticals such as data centers and high-tech industrial, working alongside these highly sophisticated customers to solve their most pressing challenges with ultra-efficient bespoke solutions. This is one of the things that Trane Technologies does best, and our commercial HVAC bookings, backlog and revenue reflect our success. To put this into context, our Americas commercial HVAC bookings are up more than 50% on a three-year stack. Our applied bookings, where we estimate an 8 to 10x multiplier of higher-margin services for every dollar of equipment sold, are up over 100% on a three-year stack. As we look at our commercial HVAC end markets over the next several years, we see a strong pipeline of projects increasingly playing to our unique strengths.

We entered 2024 with a backlog of $6.9 billion, with the composition shifting increasingly towards commercial HVAC, including a large percentage of long-cycle applied systems. For 2023, backlog in commercial HVAC is up approximately $700 million. Over the past three years, our commercial HVAC backlog has nearly tripled. Turning to guidance. We expect another year of strong financial performance, with organic revenue growth of 6% to 7%, and adjusted EPS of $10 to $10.30. Chris will discuss some of the key dynamics later in the presentation. Please go to Slide number 7. Demand for our innovative products and services continues to be broad-based across our segments. During the fourth quarter, organic bookings were up 12%, led by our commercial HVAC businesses.

In the Americas segment, commercial HVAC bookings were up mid-teens and revenues were even stronger, up mid-20s. Revenues were up more than 30% in equipment, with particular strength in applied. Services growth was also outstanding, up mid-teens as our service business continues to compound at a rapid rate. Our residential business continues to normalize, as expected, but the market declined at a faster rate than anticipated entering the quarter. We expect the normalization process to continue in the near term but to return to a GDP plus growth over the medium to long-term. Bookings were healthy, up 8%. Our transport businesses was the tale of two halves. The first half of the year, revenues were up about 20% and the back half of the year down 20%.

Q4 marked the beginning of a modest market down cycle, which is expected to snap back in 2025. Our fourth quarter was down approximately 20% against a tough prior year growth comp of up 30%. For full year 2023, we modestly outperformed end markets, which were down 5%. Our EMEA segment delivered strong performance in the quarter. Commercial HVAC bookings were robust, up mid-teens. Revenues were up high single digits in Q4 and up more than 50% on a two-year stack. Transport bookings were flat as expected, and revenues were up mid-single digits for Q4. In 2023, revenues were up low single-digits, outperforming end markets, which were down mid-single digits. Our Asia-Pacific segment performed in line with our expectations. Revenues were flat in commercial HVAC due to a tough prior year comp, which was up low 20s.

China bookings were down low single digits but up high single-digits on a two-year stack. Revenues were down mid-single digits against and up low teens prior year comp. Now I’d like to turn the call over to Chris. Chris?

Chris Kuehn: Thanks, Dave. Please turn to Slide number 8. The scoreboard for the quarter highlights strong execution top to bottom. Organic revenues were up 6%, adjusted EBITDA and operating margins were up 150 basis points and 190 basis points, respectively, and adjusted EPS was up 19%. Q4 adjusted EPS includes a $0.03 headwind related to foreign exchange losses from the devaluation of the Argentine peso. At an enterprise level, we delivered strong organic revenue growth in both equipment and services, up low single-digits and low teens, respectively. Services growth continues to be a standout, representing about one-third of our enterprise revenues and making Trane Technologies more resilient, with higher recurring revenues and higher margins over time.

Over the past six years, our services business delivered a compound annual growth rate of high single-digits. 2023 services growth was even higher, up double digits. Last but not least, I want to thank our global teams for once again delivering strong free cash flow throughout the year, resulting in a 103% free cash flow conversion. Please turn to Slide number 9. At the enterprise level, we delivered robust volume growth with strong incrementals, positive price realization and productivity that more than offset inflation. In the Americas segment, we delivered about 4 points of volume and 3 points of price and 200 basis points of margin expansion. While volume growth was modestly higher than price growth at the segment level, it’s important to understand the dynamics below the segment level.

Robust volume growth of approximately 20 points in commercial HVAC accompanied by strong leverage more than offset volume declines in residential and transport. EMEA segment delivered strong incrementals and margin expansion, with organic revenues up high single-digits in the quarter made up of approximately 5 points of volume and 3 points of price. The segment also delivered approximately 6 points of M&A growth in the quarter. Organic incrementals were greater than 30%. The Asia segment delivered strong margin expansion and organic leverage on flattish revenues, with positive price and productivity in the quarter adding to margin expansion. As we’ve highlighted throughout the year, we reinvested heavily in our business and accelerated the timing of key projects across the enterprise in 2023.

We see a tight linkage between investments in innovation and market outgrowth, and we will continue to leverage opportunities to go further and faster. A few high-priority areas in 2023 and 2024 are sales and services excellence, digital, and factory automation. Now I’d like to turn the call back over to Dave. Dave?

Dave Regnery: Thanks, Chris. Please turn to Slide number 10. Looking at our segments and markets, we’re excited about excited the year ahead. We expect continued strength in our commercial HVAC businesses globally, which comprise about 65% of our revenues, supported by robust end markets, unprecedented backlog, our innovative portfolio and our world-class sales and services teams. We expect the strength of this business to more than offset softness we may see in other parts of the portfolio. We expect the residential markets, which comprise about 20% of our revenues to continue to normalize in the near term but to show significant improvement in 2024 versus 2023. We expect modest declines in our transport markets globally in 2024, which comprise about 15% of our revenues, with a snapback to growth in 2025.

Further, we see opportunities to outperform and further mitigate the market impact and to deleverage within gross margin rates. Now I’d like to turn the call back over to Chris. Chris?

Chris Kuehn: Thanks, Dave. Please turn to Slide number 11. Our guidance for 2024 reflects our optimism in key end markets and our ability to outperform. Embedded in our guidance is our philosophy around our value creation flywheel, which builds in continued investment in innovation, outgrowth across our end markets, healthy leverage and strong free cash flow. We’re guiding 2024 to 6% to 7% organic revenue growth and $10 to $10.30 in adjusted earnings per share or approximately 11% to 14% EPS growth. We’ve included approximately 1 point of growth from M&A in 2024, reflecting the carryover impact from bolt-on acquisitions completed in 2023. We’re targeting organic leverage of 25% plus for the year, which is consistent with our stated long-term target.

While we expect our recent M&A transactions to have a strong payout over the next several years, we’re expecting a modest headwind to operating income and to leverage in 2024 from M&A. Overall, we expect a negative impact of $30 million to operating income for the full year, primarily related to our technology acquisition Nuvolo, which carries non-cash accelerated intangibles amortization of approximately $25 million plus year one acquisition and integration related costs. We expect this acquisition to be EPS accretive by year three, consistent with our M&A. Turning to cash. We expect 2024 to be another year of free cash flow conversion of 100% or greater. We also wanted to provide some color on how we see the first quarter. We expect organic revenue growth of approximately 7%, led by continued strong commercial HVAC growth partially offset by softer residential and transport markets.

We expect adjusted EPS between $1.60 and $1.65, reflecting high levels of incremental business reinvestment we’ve discussed for 2024 and consistent with our historical Q1 adjusted earnings as a percentage of our full year earnings between 15% and 16%. Please go to Slide number 12. During 2023, we delivered an incremental $60 million of transformation savings. Over the last four years, we have successfully delivered $300 million of run rate savings from our business transformation program. The additional savings have allowed us to reinvest in our high performance flywheel, which ultimately drives consistent top quartile EPS growth. While this discrete program is complete as a lean based company with a world class business operating system, self-help, cost reduction programs, through productivity are part of our DNA.

This has been a strong lever for incremental margins historically and will continue to be in the future. Please go to Slide number 13. We remain committed to our balanced capital allocation strategy, focused on consistently deploying excess cash to opportunities with the highest returns for shareholders. First, we continue to strengthen our core business through relentless business reinvestment. Second, we’re committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve. Third, we expect to consistently deploy 100% of excess cash over time. Our balanced approach includes strategic M&A that further improves long-term shareholder returns and share repurchases as the stock trades below our calculated intrinsic value.

Please turn to Slide number 14 and I’ll provide an update on our capital deployment for 2023 and our outlook for 2024. During 2023 and including activity in January 2024, we deployed $2.4 billion in cash, including approximately $750 million to share repurchases, $684 million to dividends, and approximately $900 million on strategic M&A. We’re targeting $2.5 billion in capital deployment in 2024 and expect to deploy 100% of excess cash over time. We have significant dry powder with approximately $2.5 billion remaining under the current share repurchase authorization, and our shares remain attractive, trading below our calculated intrinsic value. Our strong free cash flow, liquidity and balance sheet continue to give us excellent capital allocation optionality.

Our M&A pipeline remains active, and in 2023 we made key strategic investments to accelerate our progress across energy services and digital solutions, industrial process cooling and precision temperature control technology. Now I’d like to turn the call back over to Dave. Dave?

Dave Regnery: Thanks, Chris. Please go to Slide number 16. In 2023, we delivered solid execution across our transport businesses globally and outperformed our end markets. Over the past three years, we’ve outgrown our end markets by roughly 30 percentage points. Globally in 2024, we’re expecting a relatively shallow down cycle and an Americas transport weighted average forecast of down 10% and an EMEA forecast of down low single digits. In the table on the page we’ve also included forecasts for the big three trailer, truck and APU for your reference. We expect to outperform the markets in both segments in 2024 and to delever within gross margin rates. This slide also includes some additional data points related to our transport businesses that you may find helpful.

Please turn to Slide number 17. We operate our transport businesses for the long-term and while we’re moving through a modest downturn in 2024, this is a great business with a bright future. ACT projects a strong trailer market rebound from 2024 to 2025, up 19% and projects continued growth through their forecast horizon in 2028. We have a diversified transport business globally with opportunities to grow across the portfolio. With leading innovation, strong execution through our business operating system and a world class dealer network, we’re well positioned to outperform in any market environment. Please go to Slide number 18. In summary, we are well positioned to drive significant value over time. We are proud to have been recently named to Corporate Knights 2024 Global 100 list.

Our uplifting culture and our talented team around the world help us fulfill our purpose every day. This focus on purpose, along with the strength of our business operating system and continued high levels of customer demand, enable us to consistently deliver strong financial performance while continuing to reinvest in our business. We believe we have the strategy, the innovation and the team to deliver strong performance in 2024 and differentiated shareholder returns over the long-term. And now, we’d be happy to take your questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Scott Davis from Melius Research. Please go ahead. Your line is open.

Scott Davis: Hey, good morning, guys, Dave and Chris and Zac.

Dave Regnery: Good morning.

Scott Davis: Feel like a broken record, but good quarter year, et cetera. You took looks like $60 million or something of cost out structurally. Just to clarify, is that to kind of reset the cost base into this downturn in transport and perhaps resi? Or is that more kind of structurally spread out?

Chris Kuehn: Hey, Scott, it’s Chris. The $60 million is, let’s say, the final year of that $300 million cost takeout program that we launched at the start of Trane Technologies. $300 million run rate savings now achieved by the end of 2023. So we did really just want to put a little bit of a bow around that program. However, I would tell you that the business operating system that we’ve had and we’ve built over, over a decade it’s really driven to drive strong productivity and cost savings over the long-term. So while that discrete program is behind us, I would say we’re very focused on the cost structure of the company and making sure we’re getting the right leverage over the long-term. And so we’ll always look at opportunities to lean out the structure in the organization.

Scott Davis: Okay. That’s helpful. And guys, you’ve got a high class problem and that you’re generating a lot of cash. You’ve delevered. Give us a sense, the M&A kind of possibles. Is there a pipeline? I know you have a competitor that seems like they’re going to be selling some assets. But is there an active pipeline that’s interesting and material enough to kind of help put capital to work? I mean, share buybacks obviously can always be an option. But walk us through kind of how you think about M&A at least? And whether there is kind of a higher or lower or some sort of a TAM associated with potentials out there that you guys think about.

Dave Regnery: Hey, Scott, how are you doing? This is Dave. Look, our M&A pipeline is strong, and I think we’ve been able to demonstrate, I think we actually closed five deals in 2023. We like technologies, we like products that we could put through our channels. And I think you see the success that we’ve had with those, whether it be MTA last year, AL-KO. We recently acquired Nuvolo, which we’re very excited about from think of it as augmenting our connected solutions. Very excited the more I learn about Nuvolo. So, look, we have a very active pipeline. We love the portfolio we have today. So I think you’ve heard me say in the past, we don’t need to do anything, but obviously, we’re always looking for opportunities where we can take a technology or a channel and expand what we do great today. So we’ll continue to be active in that area and expect more to come.

Scott Davis: Fair enough. Best of luck this year, guys.

Dave Regnery: All right. Hey, thanks, Scott.

Chris Kuehn: Thank you.

Operator: Our next question comes from Julian Mitchell from Barclays. Please go ahead. Your line is open.

Julian Mitchell: Hi. Good morning. Maybe just the first question around the organic growth framework for the year. So you have the 6% to 7% guide. When we’re thinking sort of by maybe end market vertical, let’s say, rather than your geographic segments, is it fair to assume that that growth rate you’re embedding sort of 9%, 10% in commercial HVAC, maybe flattish in resi and then down single digits in TK globally, is that roughly the right framework?

Dave Regnery: I think you’re pretty close there, so you’re spot on there, Julian.

Julian Mitchell: Okay. That’s helpful. Thank you. And then just my, I guess, quick follow up would be on the operating leverage point. The organic operating leverage of sort of 25% plus, you’ve got that that’s your normal run rate, but a step down from what was realized in 2023. The step down is that just – it’s early in the year, so no reason to diverge from the long-term framework. Or is there anything specific going on in terms of, say, a much smaller price cost tailwind, maybe something in mix or accelerating reinvestment spend, anything like that you’d call out when thinking about the organic leverage 2024 versus last year?

Chris Kuehn: Yes. Thanks, Julian. It’s Chris. Look, the 25% organic leverage 2024 versus last year?

Chris Kuehn: Yes. Thanks, Julian. It’s Chris. Look, the 25% organic leverage, or better, you’re right, it’s part of our long-term target within the company and our guide for 2024, it gives us a lot of optionality to invest back in our businesses at a steady rate and really drive market outgrowth. And I’ll tell you, we continue to see lots of opportunities to invest back into our businesses. We do expect 2024 to be a year of increased investments, just like 2023 was. And some of the examples we put out there. I mean, there’s the continued innovation investment. Think about the electrification of our portfolios and heating, cooling and transport products, self help around factory automation, and we’re always looking out three years to four years in terms of demand and making sure we’ve got the infrastructure to keep up with that demand.