2023-09-08 02:41:05 ET
Summary
- Trane Technologies has strong revenue growth prospects driven by a strong backlog, secular megatrends, stimulus funding, and M&As.
- The company's revenue in Q2 2023 increased 12% YoY, driven by robust demand in the commercial HVAC business.
- Trane Technologies is well-positioned to benefit from decarbonization, sustainability trends, and new product innovations.
Investment Thesis
Trane Technologies (TT) has good revenue growth prospects driven by a healthy backlog, secular tailwinds from megatrends such as decarbonization and sustainability, government stimulus funding, and strategic M&As.
On the margin front, the company should benefit from operating leverage, a mix shift towards high-efficiency products due to increased regulations, and easing supply chain challenges. Further, the company should also see gains from increasing productivity through cost-saving measures. Moreover, the valuation looks attractive when compared to historical averages. This, coupled with promising growth prospects, makes the company a good buy.
Revenue Analysis and Outlook
Trane Technology's stock has seen good growth in recent years. In the second quarter of 2023, TT's revenue growth benefited from robust demand in its commercial HVAC business in each region and the realization of inflation-based price increases. As a result, revenue increased 12% YoY or 11% YoY organically to $4.7 billion. The Americas segment reported a 9% YoY increase in revenue on a reported basis as well as organically to $3.69 billion, driven by strength in commercial HVAC and strong growth in the Americas transport refrigeration business, which more than offset the impact from continued normalization of the residential business. The EMEA segment's revenue stood at $617.6 million, up 18% YoY or 8% YoY organically, driven by 25% YoY growth in equipment and high single-digit growth in services. The Asia Pacific segment delivered an impressive 40% YoY and 41% YoY organic growth, reaching $394.6 million. This growth can be attributed to strong revenue growth in China due to easier comps, given the COVID-19 lockdowns in China last year.
TT's Historical Revenue Growth (Company Data, GS Analytics Research)
In the second quarter, the company booked orders worth $4.49 billion, down 3% YoY on a reported basis and 5% YoY organically due to the impact of the normalization of the residential HVAC business. Excluding residential HVAC booking declines, enterprise organic bookings increased by 1% YoY. The Americas segment's bookings were down 8% on a reported basis, as well as organically, at $3.4 billion. The bookings were down low-single digits excluding the residential HVAC bookings decline. In the EMEA segment, bookings were up 24% YoY on a reported basis and 14% YoY organically, reaching $610 million, driven by mid-single-digit growth in commercial HVAC bookings and a 25% YoY increase in transport refrigeration bookings. In the Asia Pacific segment, bookings were up 6% YoY on a reported basis and organically, at $461.9 million, driven by a 20% YoY increase in bookings in China.
TT's Historical Orders Growth (Company Data, GS Analytics Research)
Looking forward, while there has been some normalization in the order rates, I am not too worried about it. The underlying demand drivers for the company remain solid and I believe the reduction in order rate has more to do with supply chain constraints easing and the lead time becoming shorter. This means the customers don't need to order significantly in advance as was the case over the last couple of years.
Further, the company's backlog still remains elevated, giving a good visibility on near-term revenue growth despite normalizing order rates. According to management, the current backlog of over $7bn is still ~2.5x the normal levels despite seeing some easing last quarter. So, I am optimistic about the company's near-term growth prospects.
In the medium to long term, the company is well-placed to benefit from secular trends related to decarbonization and sustainability. The company's focus on energy-efficient HVAC/R products from its customers positions it well to benefit from it. Further, the broader reshoring trends as well as rising minimum efficiency requirements and the government policies supporting it like the CHIPS and Science Act, Inflation Reduction Act, ESSER funding for educational institutes, etc. all bode well for the company's growth. The recent SEER 2 requirement which raised minimum efficiency for HVAC systems in the US is one such example of government regulations which is benefitting the company's pricing as it can charge more for higher efficiency products. Further, management noted that it is seeing good demand from manufacturing projects related to the reshoring of manufacturing facilities like semiconductors fabrication units and increasing investments in the data centers in the U.S.
Management is also focused on new product innovations and in a recent UBS Global Industrials and Transportation Conference on June 7th, the company's chairman and CEO talked about the company's Thermal Management System offering which offers a combined heating and cooling solution which is 3x to 5x more efficient than the conventional systems and has a payback period of 2.5 years from the financial perspective. Below is the relevant excerpt from his commentary,
We developed what we call Thermal Management System in Europe. So let me just explain to you a little bit about what that is. So the conventional way in heating and cooling a building is you have a heating plant, we call that a boiler, and you have a cooling plant, we call that a chiller. These 2 plants operated independently. And what we did, because we like to think of things at a system level, we said, let's combine that into one system. And when we did that, we deployed 4 different technologies as part of that system. So the first is heat pump, right? So I think we all know what a heat pump is, but just to make sure, when you're heating a space, you're really removing heat from it and you usually take that heat and you put it out into the atmosphere. If you need heat, you go out outside to the ambient air and bring the heat in. So we took that technology. There's another technology called simultaneous heating and cooling. So in a building, oftentimes you have the need for both cooling and heating at the same time. If you ever went into a mechanical room, which I've done a lot, you'll find that the boiler is running the same time that the chiller is running. It's ludicrous, right? Because you're just rejecting the heat. Let's reuse that heat, so we call that simultaneous heating and cooling. Then you take that with a cascading system, and I would need more time to explain you what a cascading system is, but it basically allows you to operate in any climate on a global basis. So regardless of how cold it is outside, you could still extract enough heat to make this system work, right? And you take that and you wrap it around with sophisticated controls. And that's kind of where the secret sauce is, it's in the controls. You create a Thermal Management System. Thermal Management Systems are 3 to 5x more efficient than this conventional heating and cooling plant, 3 to 5x. If you look at it on the financial returns, if you come at it from the cooling side, like say, I need to replace my chiller plant, you could get a payback that's probably in the less than 3 years, probably in the 2.5-year range. Think about the financial returns, 2.5 years. These systems are so efficient that I was at a conference a couple of weeks ago, and the consensus was people won't pay for green. And I'm like, well, they pay for our green because, by the way, there is a financial return associated, it's green for green, right? And when you think about that concept, that's why we're able to take this technology and really scale it throughout Europe. And we're having a lot of success. And you can see that in our first quarter results. I mean, our Equipment business in Europe was up 40% in the first quarter, right? So this technology is being adopted."
I believe the company is well-placed to see good growth in both the near term as well as the long term driven by a healthy backlog, government stimulus and initiatives, and secular megatrends like decarbonization, energy efficiency, and sustainability. Further, the company is also focusing on tuck-in M&As which should complement the organic growth.
Margin Analysis and Outlook
During 2Q23, the company delivered a 100 bps YoY increase in adjusted EBITDA margin to 19.7%. The expansion in adjusted EBITDA margin was driven by volume leverage, effective price realization, and improved productivity which outweighed the inflationary costs and higher costs to serve customers.
TT's Adjusted EBITDA margin (Company Data, GS Analytics Research)
Looking forward, the company's margins should benefit from leverage from increasing sales and improving pricing/mix from a shift towards higher efficiency products. The improving supply chain situation should also continue to help the company's margins. Further, the company should also benefit from productivity improvements. Management has guided for ~$300mn of run-rate savings from the business transformation initiative by the end of this year and plans to invest a part of these savings to further fuel innovation, growth, and productivity.
Given the company's good margin performance in the first half of this year and the expectation of continued strength, management raised its organic incremental margin guidance to 30% from 25% prior, which is a good number for any industrial company. In addition, the company should also benefit from synergy cost savings from recent acquisitions. Overall, I am optimistic about the company's margin growth prospects.
Valuation and Conclusion
The company is currently trading at a forward P/E of 23.05x FY23 consensus estimate of $8.86 and a 21.20x FY24 consensus estimate of $9.63. Over the last 5-years, the company's stock has traded at an average forward P/E of 23.95x.
I believe the company possesses good near-term as well as long-term growth prospects. These growth prospects are supported by strong backlog levels, secular demand trends from decarbonization and sustainability, and government initiatives. Further, the strategic acquisitions should expand the company's service offerings across different markets. The company's margin growth outlook is also favorable with benefits from operational leverage, a mix shift towards high-margin products, and cost-saving measures. In addition, the company's valuation is attractive trading below its historical levels on a forward P/E basis. Hence, I have a buy rating on the stock.
For further details see:
Trane Technologies: A Good Buy At Current Levels