Trane Technologies Stock Valuation

Trane Technologies plc [NYSE: TT] is an American Irish-domiciled, diversified industrial manufacturing company. The firm, together with its subsidiaries designs, manufactures, sells, and services heating, ventilating and air conditioning (HVAC) systems, transport solutions, building management systems and controls.

The Company offers central heaters, air conditioners, auxiliary power units, air cleaners, chillers, humidifiers, hybrid and non-diesel transport refrigeration, ice energy storage solutions, and fluid handling products among others.

Trane Technologies markets and sells its products under a variety of brand, including:

• Thermo King,
• Trane,
• American Standard,
• Frigoblock, Ameristar,
• ICS Cool Energy,
• Nexia,
• Oxbox,
• Runtru and
• Thermocold.

The company was formerly known as Ingersoll-Rand Plc and changed its name to Trane Technologies plc in March 2020. Trane Technologies’ headquarters are in Swords, Ireland.

The Bull Case for Trane Technologies

Trane Technologies shares have been a good performer, gaining more than 30% over the past year. The company is well-managed, generates abundant free cash flow and continues to actively and successfully accomplish its broader growth objectives of augmenting its revenue stream and cash flow through gradual improvement in the quality of products and services it offers.

The company, riding on secular tailwinds such as rapid urbanization, resource scarceness, demographics, increasing environmental consciousness, digital connectedness, climate change and concerns related to indoor air quality to name a few, is expected to perform well in the coming years.

Moreover, Trane Technologies has been taking on a lot of initiatives in order to achieve sustained improvement in earnings, operating efficiencies and cash flow.  The company intends to save around $100 million in 2021 through various cost-cutting initiatives and hopes to treble its annualized savings to $300 million by 2023.

Trane Has Market Leading Brands

TT uses its Trane brand to compete in the commercial and residential HVAC market. It moves refrigerated food, medicines and other perishables around the world under the Thermo King brand. It offers premium heating and cooling systems and solutions for homeowners under its American Standard and Ameristar brand.  Other brands include, Thermocold, RunTru, OXBOX, and ICS.

It is worth noting that these are well-established brands with leading market positions that again attest to TT’s ability to bring sustainable, efficient climate solutions to buildings, homes and transportation.

Reports suggest that the HVAC market is expected to grow at a CAGR of 6.5% till 2025, that is from $202 billion now to $277 billion in 2025.

Analysts suggest that this spurt in demand could be attributed to heightened demand for energy-efficient solutions and smart buildings, with the commercial market accounting for the fastest growth rate. APAC region is predicted to account for a major share of the HVAC system market.

Management Supportive Of Shareholders

Trane Technologies is also a company known for embracing its shareholders (as opposed to some high tech firms that favor employee stock options at the cost of shareholder value). Additionally, Trane has been highly prudent with its capital management, which allows it to return excess at its disposal to shareholders in the form of dividends and share repurchases.

The company repurchased shares worth $250 million in 2020 and doled out $507.3 million in dividends. Likewise, the company had repurchased shares for $750.1 million and $900.2 million and paid out dividends totaling $15.8 and $41.4 million in 2019 and 2018, respectively.

These initiatives endear TT to its stakeholders, while also demonstrating the company’s confidence in its business. Also, both the return on equity and return on invested capital for TT are superb, which means the profits that the company reinvests are likely to compound at nice rates.

Well-managed capital also gives the company the leverage to carry out its acquisition activities, as well as survive periods of upheavals.

TT recently completed the acquisition of Farrar Scientific. The acquisition of 100% of Farrar Scientific’s assets, including its patented ultra-low temperature control technologies, will allow TT to meet fast-growing demands for ultra-low temperature processes in manufacturing and storage of medicines, vaccines and other life science products.

TT Financials: High Capital Allocation Optionality

TT so far has deployed $1.8 billion in cash, with approximately $1 billion for M&A and share repurchases, including $250 million for the Farrar Scientific life sciences acquisition.

The company paid $422 million in dividends and $425 million to pay down debt.

TT’s strong free cash flow, liquidity and balance sheet continues to give the company excellent capital allocation optionality, and the company is well on track to deploy at least $2.5 billion in excess cash in 2021.

The company recently reported the third-quarter of 2021 adjusted EPS of $1.8 which was below estimates, but increased 5% year over year. During the same quarter of the previous year, the company posted $1.72 EPS. The business generated $3.7 billion during the quarter, which was 2% below the consensus, but increased 6.4% as compared to the same quarter last year.

High ROIC Makes Trane Attractive

Trane is a well-managed business with high ROE (a company’s net income divided by its shareholders’ equity) and ROIC (amount of money after dividends a company makes). Both these ratios are used to determine a firm’s ability to generate returns on its capital.

High ROE and ROIC mean TT generates significant amounts of free cash flow, which the technology services provider returns to the shareholders as dividends, as well as uses the money for acquisitions and business growth.

The company is experiencing secular tailwinds such as the rise in HVAC and transportation demand, as well as concerns for indoor air quality – important factors that could up its revenue and profit.

TT has the potential to sustain the momentum in the near term, which means the future prospects look bright for the firm.

Its cost-cutting initiatives should improve margins, and a healthy balance sheet would allow it to indulge in M&A activities. The only issue seems to be its high valuation, which could tempt some investors to wait from the sidelines for the stock to pull back before investing in the company.

The Bear Case for Trane Technologies

Trane Technologies plc reported mixed third-quarter 2021 results.

Adjusted EPS of $1.8 came below expectations but increased 5% year over year. Revenues of $3.7 billion also fell short of the consensus mark, but increased 6% year over year. Bookings were up 22% year over year to $4.3 billion.

However, the real negatives to draw from Trane’s third-quarter results was that a few of its competitors performed better.

Also, it is expected that the company is likely to struggle to adequately fulfill the acceleration in demand in the short term as the supply environment remains challenging. Management accepted that the global supply chains, logistics systems and labor markets remain tight, and inflation continues to be a cause of concern.

Temporary supply chain delays on key materials had a negative impact on  few parts of the company’s product portfolio, which in turn shifted the timing of approximately $150 million or 4% of its revenue out of the third quarter and into future periods.

Labor and Supply Chain Shortages Threaten Growth

Residential orders remain strong, but near-term supply chain issues may make it hard for the company to fulfill that demand. Trane’s ThermoKing business has been doing well, but the orders fell as the major OEMs also struggle with shortages in semiconductors and other components. Also, truck fleet operators are having a hard time finding skilled workers to operate the trucks they have.

However, with the advent of a new virus variant, ThermoKing business is likely to gather speed as vaccines need to be kept at freezing temperatures (-94 degrees Fahrenheit for vaccine from Pfizer, and -4 degrees Fahrenheit for vaccine from Moderna), from where they are manufactured to where they are administered.

Thermo King, which is an industry leader in industrial-scale cold storage, is likely to emerge as a prime beneficiary of the heightened demand for refrigeration equipment. 

TT Valuation Is Sky High

All said and done, the primary cause of concern for Trane is its sky-high valuation.

Whether we take discounted cash flow or EV/EBITDA, they both suggest that TT is overvalued.

The demand for the company’s products remains strong, but the longer-term annualized return potential tends to dampen the spirit a bit when the stock’s price is taken into account.

Positives like stronger margins, heightened focus on indoor air quality, strong momentum in aging infrastructure, and expectations of above-average growth are already factored in the share price. It means that valuation-conscious investors are unlikely to chase this stock at its current valuations.

Trane Technologies Stock Forecast

12-month price forecasts for Trane Technologies PLC range from a high estimate of $230 to a low estimate of $160.00.

On an average, it is expected that Trane Technologies’ share price could reach $200 in the next twelve months. This suggests a possible upside of 3.4% from the stock’s current price.

Is Trane Technologies Stock a Buy?

Trane Tech stock has had an impressive run in the past year, notching up significant gains for the investors. With many factors working in their favor, strong HVAC names like Carrier, Daikin and Trane have continued to beat market expectations.

With the ominous threat looming from the highly mutated variant Omicron, experts believe that the air quality angle to the HVAC story will continue to play out stronger than before. Omicron has now been detected in at least 24 countries around the world, according to the World Health Organization (WHO).

HVAC is expected to register strong growth in the near future, and coupling that with rapid urbanization, indoor air quality demand, emphasis on energy efficiency, and the increasing pace of building automation are all long-term secular trends poised to strongly benefit Trane.

Mixed Bag Financials

Trane had a mixed Q3, as both EPS and revenue fell short of expectations, despite both registering an increase compared to the same quarter last year. 

Trane wasn’t the topper amongst its competitors, but Trane’s top line and operating lines remain in good shape, driven by strength across all three segments, namely, America, EMEA and the Asia Pacific.

Strong demand drove revenue, operating income and continuing EPS growth in improving end markets. Record third-quarter backlog of approximately $5 billion and record bookings position the company well for 2022.

Margin performance was sturdy, as gross margin improved 40bp, while segment operating income improved 5% with an 80bp improvement in margin. Overall operating income rose 6%. 

Bookings Continue To Impress

According to management “Bookings were once again exceptional in Q3, building on strong growth in both Q1 and Q2 and bringing our year-to-date organic bookings growth to over 25% for the enterprise.”

The company continues to see strong demand for its innovative products and services that help reduce energy intensity and greenhouse gas emissions for its customers. Overall organic order growth was an impressive 7%, particularly the 30%-plus growth delivered by Americas commercial HVAC business.

There seem to be quite a few drivers for the company on the horizon. One of the most important is the growth potential of the U.S.  residential construction market. The demand for housing is strongly fueled by ultra-low interest rates which makes buying a house a lot easier.

The growth potential on the non-residential side is huge as well. HVAC systems are responsible for more than 40% of energy consumption in commercial buildings, and as such upgrading and replacing energy-consuming equipment in buildings is strongly in focus.

The potential benefits presented by energy efficiency upgrades and retrofits in buildings has got investors excited across the board from the government to tenants who are increasingly demanding energy-efficient buildings.

Also, with the surge in mutant virus cases and tightening restrictions, indoor air quality is again under the spotlight, and this means another good business opportunity for Trane. 

Also, vaccine transportation demands supply chain cold storage issues, which again is beneficial for Trane’s Thermo King transport business.

Energy Efficiency Improvements: $279B Opportunity

As per reports, scaling building energy efficiency retrofits in the United States offers a $279 billion investment opportunity. The investment could yield over $1 trillion in savings in the next 10 years.

This is an incredibly strong long-term driver giving rise to expectations that the HVAC sector is in for some strong long-term growth. Moreover, long-term sustainability megatrends such as global urbanization, strong advocacy for clean technology, and increasing automation can continue to drive above-average growth for TT.

Within that bullish sector outlook, it is expected that Trane can generate mid-single-digit long-term revenue growth (4% to 5%), and modest improvement in FCF margins.

Is TT A Good Investment: The Bottom Line

Heightened focus on indoor air quality (a $15 billion market opportunity according to reports), increasing demand for energy efficiency upgrades and retrofits in buildings, global urbanization and fast pace of automation offers attractive business opportunities for Trane.

These factors coupled with strong margins and powerful free cash flow which the company efficiently deploys through its balanced capital allocation strategy makes Trane well poised to generate mid-single-digit long-term revenue growth.

Trane Technologies Investment Thesis Conclusion

The heating, ventilation and air conditioning (HVAC) industry is currently riding on some pretty interesting long-term sustainability megatrends that continue to intensify.

Fast-growing residential and commercial demand, the fast pace of urbanization, emphasis on energy efficiency, and longer-term opportunities in greener buildings and indoor air quality means that leading players in the industry like Trane are poised for substantial growth for many years to come.

A few important trends that Trane can benefit from are summarized as follows:

• Long-term sustainable megatrends including, global urbanization, fast-changing climatic conditions that are raising city temperatures, heightened focus on indoor air quality, and economically strengthening the middle class in the developing world demanding HVAC.
• Increasingly stringent regulatory requirements calling for carbon emissions reductions and the need to reduce carbon emissions. As the world decarbonizes, higher-quality HVAC providers like Trane possess the resources and the technology to efficiently take care of customers’ needs. Data suggests that buildings contribute around 40% of greenhouse gas emissions globally. Businesses operating in the HVAC industry as such have an added responsibility towards decarbonizing the world. Trane CEO Dave Regnery emphasized the same in the third-quarter conference call stating that “a quarter of the world’s emissions happen as a result of HVAC systems in buildings. Our aggressive goals and bold actions can dramatically reduce carbon emissions and accelerate the world’s progress. This is why we continue to set aggressive science-based emission reduction targets to push our innovation further and faster”.
• Also, the precipitous growth in Internet of Things (IoT) devices and rapid digitalization is going to benefit firms rolling out digital tools.

Moreover, , the Omicron variant has spread to about one-third of U.S. states, which in turn will again bring into strong focus the need for healthier, cleaner buildings – something that ‘ventilation’ in HVAC can help to support.

Moving onto the results, bookings were once again exceptional in Q3, building on strong growth in both Q1 and Q2 and bringing the company’s year-to-date organic bookings growth to over 25% for the enterprise. 

Trane as such is well-positioned to close out 2021 on a strong note and to enter 2022 with unprecedented levels of backlog as well.

Stumbling blocks like persistent inflation, supply chain issues, and logistics and labor markets problems have been well negated with Trane’s successful business transformation projects.

The company also seems to be on track to deliver a powerful free cash flow of equal to or greater than 100% of net earnings. This could provide it with strong optionality to deploy significant cash to opportunities now and in the future, including M&A and share repurchases.

Trane also remains upbeat about the future of transport refrigeration markets, where ACT and IHS are plotting a steady growth path forward in both 2022 and 2023.

Final thoughts

Trane has been doing well as demonstrated by its past three-quarters results. The company’s residential end markets remain strong. Trane is benefiting from increased demand across its K-12 customers with federal stimulus funds supporting both current and more importantly, future growth.

Green building retrofits, school upgrades, data center, emphasis on indoor air quality, concern for energy efficiency, data center prospects, increased automation, and pharma cold-chain build-outs are all major tailwinds for the company.

Trane has an attractive long-term growth outlook, and the overall consensus is for mid-single-digit revenue growth in the foreseeable future. The high valuation of Trane can keep a few value-conscious investors away though.

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