Trane Technologies plc (TT) Earnings Call Transcript & Summary

Yes. I don't know that it matters. I mean, yes, we know the number. Yes, we know what the price is over that. But it's really kind of [ straight to like the ] operating system, top line margin expansion work that we would do. And I'd come back to it. It's just not one of the top 20 things that I would be worried about or thinking about.

Yes. What's -- in the margin bridge, you guys used to give productivity and investments. What's kind of the rule of thumb for that equation now in your mind?

Yes, productivity pipeline to be 125% of what we think the nonmaterial inflation in the company to be. And so we manage the pipeline, manage the calendarization of that scheduling of those projects to make sure that we've got enough coverage because you get some breakage. Some projects don't work the way you want it. Some supply choices or VAV work may not be what we thought it would be. So we know that 125% in the pipeline calendarized out by quarter and month gives us coverage of all other inflation. So we like 20, 30 bps on price of material inflation. We like the total productivity to exceed other inflation. And we want volume to drop through at the right incrementals, which, in our view, should look something like gross margins. Mix will affect that a little bit, and reinvestment will affect it a little bit. This year, we'll do a little bit better, kind of 30%, for 2 reasons: one being, we've got a little better TK mix; the second being, we've got a tailwind with all the transformation work that's been going on for the last year.

So when we think about as commercial really starts to recover and TK and residential kind of flatten out, become a little less volatile, is that a bit of a drag on mix in kind of '22, '23, kind of looking beyond or you'd manage kind of around that to kind of drive to the high end of the 25 to 30? Or is that encapsulated in the 25 that you guided to?

I like the long-range plan we've got here, where I think even in res, you're going to have at least the 2023 efficiency change there. 2025, you'll likely have a refrigerant change to low-GWP refrigerant. Commercial, I like what's happening from IAQ, energy efficiency, greenhouse gas reduction. I like the uptake we're seeing around electrification of heat in places like the EU, China, California, potentially moving through the northern part of the U.S. That's a positive for our commercial business. TK, look, I think you could snap a line at 45,000 trailer units in North America, and plus or minus 10%, you'd be right in the next 3 years. It's only been 1 year lower than 40,000 units, which was last year. If you think about the prior 6 years, last year and in the next 3 years, 40,000 units, 9 out of 10 years isn't bad. It's 25% of TK. I think actually power units will have a big year. That's 10% of TK. We're still busy with air, bus, marine, rail. We're looking at some larger infrastructure projects using rail, as an example. So look, I think it was good diversity there. I know investors think about that being a choppy business. We actually don't think about it being a choppy business. Trailer got a little lumpy with order patterns in '18 and '19 and a little bit last year with the pandemic. But the balance of the business has been good. And as you get into straight truck and small truck refrigeration units, we're seeing nice, steady, solid growth around last-mile delivery. And we brought some technology from Europe to the U.S. here, recently announced it last week, to be able to really bolster an electric hybrid solution for last-mile delivery, which will be very popular, I think.

Well, I guess what I was talking about was more the mix impact of if TK and resi kind of flattened out a bit, not down, but flat to up kind of this low single-digit trend and commercial becomes the real growth driver. What does that do to mix on the margin?

Yes. The spread from an EBITDA basis isn't that horribly wide to create such a wide set of anomalies in mix. I mean, when TK is up 26% in 2021, yes, you got a little extra boost in mix there, right? But when you think about the biggest opportunity for margin expansion, it probably sits within our commercial business. And I think that, that's going to be a real opportunity over the next couple of years to continue to expand margins there. So no, to speak to your point, I don't see a particular onerous headwind there. Chris, any other -- what do you have on that?

I'm just going to add. On that 25% operating leverage, our plan, Steve, is that all of our business units would lever at 25% or better. So I'm just trying to give you some color. It's not like we're letting any fall above or a couple are really driving a higher mix or average there. So over that long term, we see that being the 25 points of leverage or 25% leverage for all of our business units.

That makes sense. On the commercial, you've made some commentary about this new product over in Europe. Kind of a commercial heat pump product, I guess, is what you're calling it. What -- I know it's been around. How long has it been around for? And what's the...

We're on our fifth generation of products. We sort of launched in 2015. We used to think it was a $1 billion opportunity. We think it might be closer to $2 billion just on what we're seeing in total opportunity. It's fun because even though we think we're in the HVAC business, we're really in the VAC business as it relates to Europe. So this was an opportunity incrementally to be in a business we weren't in. So we've got, we think, the leading position in this technology in Europe. We're not going to give specific shares of data for obvious reasons. But I think it's the fastest-growing part of the portfolio. And I think it's going to be particularly relevant in China and potentially parts of the Northern U.S. as well. And it's...

What's the brand name again?

Yes, Trane.

Is there a model name?

Sintesis would be what's used in Europe. Sintesis, yes.

Yes. Okay. I'm just making sure I was on the same page on that. And...

And it's really cool because it's a modularized system. We started it in 2015. What we tried to do was adapt so that from a modular perspective, every time we're addressing new technology introduction, we're changing the module in the larger sort of system application itself. So every year, we've been able to crank out a more efficient version of the machine. It's analogous to a variable refrigerant flow system. And this gets kind of geeky for the people maybe who aren't into this business, but it's a variable water flow system. And so we've got this now where you're actually using no- or low-GWP refrigerant. You're 300% to 400% more efficient than replacing a fossil fuel boiler with a fossil fuel boiler. And then the EU has a mandate on how much of the grid needs to be greened every year. If it's a green grid, you'll actually be in the market with net zero solutions. And so we've done entire district heating systems for cities at this point in time, which is really exciting. Again, we never would have been in that space 3, 4 years ago. By the way, we've been heavily influencing these codes and standards because of this technology and because it is just -- there's no downside to this, if you will. It's really a green solution across the board, checks all the boxes from an EU perspective.

You said you weren't going to kind of give market share numbers. But I mean, what are the advantages of your product versus other guys who would say, hey, I have a European heat pump, too, which they have said on commercial? So what are your kind of -- what are your advantages? And in what...

Sure. So the first thing is we've done it with HFOs, olefin-based refrigerants. So we're using low- or no-GWP refrigerants, global warming potential refrigerants, in the process. That's unique. We may have a competitor with one unit out of that variety, but the whole platforms that -- we do it in cooling only, heating while cooling, heating or cooling, heating while cooling -- or heating and cooling or any combination of that. That technology has eluded sort of our competition about how to use -- well, first of all, how to do that, what we've done is on this modular architecture to have us be able to swap out and like literally build these systems in a line and swap out the modular components to create really 5 different versions of this. And then the system efficiencies, right, because this isn't like the U.S. where it's a residential system, and everyone's going for a certain efficiency. It's a combination of mechanical, electrical controls and software that can deliver a certain efficiency. And we're delivering the best systems efficiency in the marketplace. So that systems efficiency, modular design, the cost structure allows us to be very competitive in the way we've done this because we're just swapping out sort of the guts of the system to give you the options that you want. And it is using zero global warming potential refrigerants. That's -- it's a home run. I mean it's been nothing short of that.

And the markets over there, I mean, in Europe, are they pretty stable in general?

Yes. Well, look, GWPs -- sorry. GDP has probably been 0 to flat. I think we've been 5, 6, 8 multiples of that over the last 5 years really by doing 2 things: reducing the energy intensity of buildings and transport refrigeration, making that hybrid electric, as an example; and taking really chlorine and fluorine refrigerants, replacing that with next-generation low-GWP refrigerants but doing that in a way that the efficiencies are actually lower than the chlorine- and fluorine-based refrigerants. That combination has been a knockout because it's no longer a false choice. Do I want to have lowest efficiencies or the greenest solution in the marketplace? You have the lowest efficiency, best efficiencies and zero GWP in the case of this electrification of a heat solution I'm talking about. It's been fantastic. We don't -- therefore, don't need a new green deal. We don't need European stimulus. We can get there all the way on our own, okay, by making it economically viable and checking the box around someone's own net zero plans and goals.

Right. When it comes to services, I mean, everybody is talking about attachment rate. How do you guys define attachment rate? And I guess, we'll just start there. And where...

Yes. So first of all, you have to think about what are you attaching to, right? We're not going to attach service to everything we do. We don't attach service to residential products, right? We attach parts. And then as you -- right? As you move up through the commercial line, right, you're not going to find us necessarily unless a customer really wants us to do that on top of a Home Depot, changing filters out on 25-ton HVAC systems, right? There's people with cost structures that do that. So for us, we think about applied and complex systems where it's some combination of equipment and controls, creating a system. And we look for and get 100% linkage on that, right? If a chiller is involved, it's 100% linkage on that solution. So that's been the case for several years. I don't know of an example where we don't do service on an applied system that we installed in the last 3 years. And part of that is because they've just become more complex to get these efficiencies. And like anything else, I mean, you always use -- Steve, I remember you said a car example. You buy a Mercedes-Benz, and the engine starts knocking. You're probably not pulling into Jiffy Lube, no offense to Jiffy Lube, for the diagnostic. You're probably going back to the people that know the diagnostics to figure out what happened. That's what's happening certainly in the HVAC OEM space for large complex applied systems.

How penetrated is your existing installed base?

Well, again, if it's something that's utilizing next-generation refrigerants, such as HFOs, thinking about 2015 forward, 100%. If it goes sort of somewhere back across 30 years, a little bit of a bell curve, right? The older these systems get, the more maintenance is required, and folks look for that sort of bootstrap guarantee to keep things running. So it's high. I mean, today, we think the Service business in Europe and North America is 50% of the mix. Well, if that mix includes unitary, it's a very high mix of Applied, right? It's like almost all of Applied. Yes.

Got it. How many units do you think the market ships a year in the U.S. applied total market?

Yes. It's a hard question because you said units, right? There's the air side of applied, and there's the water side of applied. Talking about the air side of applied, right, this is air handler units, custom air handler units, VAV boxes, multi-zone systems, right? If you go to the water side, right, it's going to be air cooled, water cooled, centrifugal, screw chillers. So it's in the millions and millions of pieces, right? Millions and millions of pieces.

Right. I guess on the chiller side then.

Well, again, air cooled, water cooled, centrifugal, massive. Massive.

Right, right, right. Okay. On...

And just -- I mean, yes, we have a number. We all have a number. We should have a number. All of us in HVAC land should have a number. But it's a big number, right? And by the way, you take this electrification of heat, essentially, right, it's a chiller. It's a chiller that we run in reverse. It's a variable water flow chiller that works as a boiler when you need to work like a boiler or in some combination. So think about all the units of electrification of heat that are actually chillers in the marketplace, and that's all going to have a very high attachment rate to it.

How is the evolution of -- what's your answer to OpenBlue and some of these other competitive products that are coming on the digital front? I know you guys have had Trane building advantage for a long time. What is -- are you guys -- obviously, things continue to evolve. Is there something in the pipeline that's going to come out as an update to that -- to those digital systems? How do you approach...

Are you talking about a marketing program, [ essentially ] a marketing program? I don't think so. I think that we like to think about these as a system of things. We like to sell them direct. We like to service them direct. It's the same way we do indoor air quality audits. We go in and start from the front end of the system, where air comes into a building, and we track it all the way through every mechanical, electrical and system component all the way out through exhausting out of a building. And that's the way we look at this thing. So when we talk about these sort of -- I don't know what you're talking about exactly, but if you're talking about point solutions for things, we really don't think that way. And frankly, we look for customers that don't think that way, that want to understand how systems work together. And so...

Well, I think it's the digital system that kind of pulls all the metrics from -- ranging from the building management system, various sensors and kind of pulls it all together and provides the dashboard for the building. Or I think -- whatever you want to call that, that's the system.

Yes. You're seeing that pre-COVID when you were down at our facilities when we talked about kind of what we do there. We've been huge proponents of open systems. We've been winning with open systems for a long period of time. I think you're seeing other companies getting on board with open systems. I mean we're in a world of open protocols today. And so the ability for us to work with hundreds, if not thousands, of companies that have something to bring to the party and do that in a seamless way is critically important. I mean we were able to adapt all of this IAQ sensor technology into our control algorithms using a standard open system connect between those to create this opportunity to sense pathogens and control systems from that sensing capability in a matter of weeks. And that's the advantage to open systems. That's always been our take on this. And I think you're seeing more companies that are talking about being open in terms of their architecture.

Right. Right. That makes a lot of sense. Within the Service business, how big is the rental business? And how fast has that grown?

Chris, I don't know if you've got a sort of an idea there or a number, but hundreds of millions, definitely, Steve.

Yes, that's probably ballpark and growing quite well. I think that's been a place where we've looked at investments that could be off-season where someone is looking for emergency replacements of products or even thinking about Europe, where they've got ice rinks, right? They need something in place for 2 months, 3 months, 4 months, another place where we're using and leveraging kind of the rental fleet. So we've had some M&A activity there in the past, and it's been a way for us to buttress the business as well.

So I assume, from a service perspective, you think about data centers or hospitals. We'll do an installation of an applied system or chiller system, and we'll pipe the outside of the building to be able to accept something on a skid, if, in fact, there would be a catastrophic failure. You're pulling up a skid. You're piping within, say, 3 or 4 hours, and you're back up and running. The ability to sort of price that into a service agreement to offer that kind of a backstop, think about health care, data centers, that sort of environment, that's been absolutely huge. Disaster recovery, that's been big. Vaccine distribution, seasonal ice rinks, winemaking, you name it, right? There's a whole world out there where people need this for 2 weeks at a time or a month at a time. And again, just the ability to backstop anybody with a critical operation, and we'll place assets right at where we need them nearby. And often, we'll set up a guarantee that within 4 hours or 8 hours, whatever it is that you have running in your building, we'll get you back up and running even if it's a catastrophic failure.

And utilization rates are high.

You obviously keep that stuff on your balance sheet. How do you provide that kind of coverage? Is it sitting at a distributor or like a cash flow?

Steve, cash flow -- well, no, so it's direct. We're in this business. These are all our assets, our service people, our capability. What's interesting, cash flow ROICs were 35% last year. They've been 26% over the last 3 years. They've been top quartile for the last 10 years. So it's not like it's draining the balance sheet. It's not like it's hurting somewhere. These assets pay for themselves in a very short period of time. And then we sell the assets when it's -- when it was time to come out of the fleet. Oftentimes, somebody will take on that asset when they have a failure, right? We'll let them buy the asset. So there's a rental life. There's a sort of a fixed life on a resale. There's a lot to this. There's maintenance on that.

How much did the Mitsubishi -- how did the Mitsubishi JV performed last year? And can you just remind us of how much of that is resi and how much of that is commercial?

Yes. It's probably 80-20 commercial. It's just been a home run. Whenever I talked to the Mitsubishi guys in Japan, they love it. We love it. It was a marriage of just a really strong technical channel, able to really apply the product and service it with really incredibly good, high-quality, full-product portfolio. So that combination has just created a leading position everywhere we work together. And it's a mature relationship. There's parts of the world where we work together like North America. There's parts of the world we compete. Like in Western Europe, we buy to and we sell to each other, just a way of a modern relationship in the space. But the JV has been phenomenal.

I think that's all we have time for. Mike and Chris, thank you so much for joining us, and best of luck into the summer selling season. We'll chat in April.

Looking forward to it, Steve. Thank you for having us.

Thank you. Thank you.