Trane Technologies Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 1, 2024

There are 14 speakers on the call.

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 and A session. At this time, all participants are in a listen only mode.

Operator

Thank you. I will now turn the call over to Zach Nagel, Vice President, Investor Relations.

Speaker 1

Thanks, operator. Good morning and thank you for joining us for Trane Technologies 4th quarter 2023 earnings conference call. This call is being webcast on our website at traintechnologies.com, where you'll find the accompanying presentation. We're also recording and archiving this call on our website. Please go to Slide 2.

Speaker 1

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 Regnary, Chair and CEO and Chris Kuhn, Executive Vice President and CFO. With that, I'll turn the call over to Dave.

Speaker 1

Dave?

Speaker 2

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 megatrends like energy efficiency, decarbonization and digital transformation. These trends continue to intensify and increase the demand for our sustainable solutions. The year 2020 was recently confirmed as the warmest on record and caused many extreme weather events around the world.

Speaker 2

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 1,000,000,000 metric tons by 2,030. Our purpose driven strategy, relentless innovation and proven business operating system enabled 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.

Speaker 2

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.

Speaker 2

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 $2,200,000,000 or 103% free cash flow conversion, enabling us to make key strategic M and 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.

Speaker 2

Since 2020, we have delivered a revenue compound annual growth rate of 12%, 2 60 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.

Speaker 2

In the Americas, we expected the residential markets to continue to normalize and for the transport refrigeration market 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 in our commercial HVAC bookings, backlog revenue reflect our success.

Speaker 2

To put this into context, our Americas commercial HVAC bookings are up more than 50% on a 3 year stack. Our applied bookings, where we estimate an 8 to 10 times multiplier of higher margin services for every dollar of equipment sold, are up over 100% on a 3 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 $6,900,000,000 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 $700,000,000 Over the past 3 years, our commercial HVAC backlog has nearly tripled.

Speaker 2

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 Q4, 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.

Speaker 2

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 2 halves.

Speaker 2

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 4th 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.

Speaker 2

Commercial HVAC bookings were robust, up mid teens. Revenues were up high single digits in Q4 and up more than 50% on a 2 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.

Speaker 2

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 2 year stack. Revenues were down mid single digits against an up low teens prior year comp. Now, I'd like to turn the call over to Chris. Chris?

Speaker 2

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.

Speaker 2

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 1 third of our enterprise revenues and making Trane Technologies more resilient with higher recurring revenues at higher margins over time. Over the past 6 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 once again delivering strong free cash flow throughout the year, resulting in 103% free cash flow conversion.

Speaker 2

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. 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.

Speaker 2

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 three points of price. The segment also delivered approximately 6 points of M and 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.

Speaker 2

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

Speaker 2

Please turn to slide number 10. Looking at our segments and markets, We're excited about 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 team. 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 market, which comprise about 20% of our revenues to continue to normalize in the near term, but to show significant improvement in 2024 versus 2023.

Speaker 2

We expect modest declines in our transport markets globally in 2024, which comprise about 15% of our revenues with a snap back 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? Thanks, Dave.

Speaker 2

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 included approximately 1 point of growth from M and A in 2024, reflecting the carryover impact from bolt on acquisitions completed in 2023.

Speaker 2

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 and 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 and A. Overall, We expect a negative impact of $30,000,000 to operating income for the full year, primarily related to our technology acquisition, Novolo, which carries non cash accelerated intangibles amortization of approximately $25,000,000 plus year 1 acquisition and integration related costs. We expect this acquisition to be EPS accretive by year 3, consistent with our M and A framework. Turning to cash, we expect 2024 to be in another year of free cash flow conversion of 100% or greater.

Speaker 2

We also wanted to provide some color on how we see the Q1. 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 $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% 16%. Please go to slide number 12. During 2023, we delivered an incremental $60,000,000 of transformation savings.

Speaker 2

Over the last 4 years, we have successfully delivered $300,000,000 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.

Speaker 2

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. 2nd, we're committed to maintaining a strong balance sheet that provides us with continued optionality as our markets evolve. 3rd, we expect to consistently deploy 100% of excess cash over time. Our balanced approach includes strategic M and A that further improves long term shareholder returns and share repurchases as the stock trades below our calculated intrinsic value.

Speaker 2

Please turn to Slide number 14, and I'll provide an update on our capital deployment for 2023 On our outlook for 2024. During 2023 and including activity in January 2024, we deployed $2,400,000,000 in cash, including approximately $750,000,000 to share repurchases, dollars 684,000,000 to dividends and approximately $900,000,000 on strategic M and A. We're targeting $2,500,000,000 in capital deployment in 2024 and expect to deploy 100% of excess cash over time. We have significant dry powder with approximately $2,500,000,000 remaining under 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.

Speaker 2

Our M and 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. I'd like to turn the call back over to Dave. Dave? Thanks, Chris. Please go to slide number 16.

Speaker 2

In 2023, we delivered solid execution across our transport businesses globally and outperformed our end markets. Over the past 3 years, we've outgrown our end markets by roughly 30 percentage points. Globally in 20 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.

Speaker 2

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.

Speaker 2

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 20 24 Global 100 list.

Speaker 2

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, enabled 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?

Operator

Our first question comes from Scott Davis from Melius Research. Please go ahead. Your line is open.

Speaker 3

Hey, good morning guys, Dave and Chris and Zach.

Speaker 2

Hey, Scott. Good morning.

Speaker 3

Feel like a broken record, but Good quarter, year, etcetera. Guys, you took looks like $60,000,000 or something of cost out structurally. Is that 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?

Speaker 2

Hey, Scott, it's Chris. The $60,000,000 is, let's say, the final year of that $300,000,000 cost takeout program that we launched at the start of Trane Technologies, dollars 300,000,000 run rate savings now achieved by the end of 2023. So we really just wanted to put a little bit of a bow around that program. However, I would tell you that the business operating system we've had and we've built 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.

Speaker 2

And so we'll always look at opportunities to lean out the structure in the organization.

Speaker 3

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 and A kind of Possibles. Is there a pipeline?

Speaker 3

I know you have a competitor that seems like they're going to be selling some assets. 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 what How you think about M and 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?

Speaker 2

Hey, Scott. How are you doing? This is Dave. Look, our M and A pipeline is strong, and I think we've been able to demonstrate I think we actually closed 5 deals in 2023. We like technologies.

Speaker 2

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 Alco, we recently acquired Novolo, 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.

Speaker 2

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.

Speaker 3

Fair enough. Best of luck this year, guys.

Speaker 2

All right. Hey, thanks, Scott. Thank you.

Operator

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

Speaker 4

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 Teekay globally. Is that roughly the right framework?

Speaker 2

You're pretty close there. So you're spot on there, Julie.

Speaker 4

Okay. That's helpful. Thank you. And then just My, I guess, quick follow-up would be on the operating leverage point. Yes, 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.

Speaker 4

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?

Speaker 2

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 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.

Speaker 2

We do Back 2024 to be a year of increased investments just like 2023 was.

Speaker 5

And some

Speaker 2

of the examples we put out there, I mean, there's 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 3 to 4 years in terms of demand and making sure we got The infrastructure to keep up with that demand, so factory automation is a big investment for us. We continue into 2024. Digital, think about digital services, digital controls, Dave just talked about the Nivolo acquisition. We're very excited about As we continued investment there, expanding digital twin opportunities, I can keep running down the list, but I'll end with sales and service investments. We really see that over now 6 years driving high single digit CAGR and services growth.

Speaker 2

We really like making investments in that space as well. It's about a third of our overall enterprise revenues. So the fact that we want to get started earlier in the year with those investments means that the payback will come sooner from that earlier start. So, those are some of the reasons that the guide is 25% plus. We want to make sure we're always relentlessly investing and frankly we don't want anyone to catch up to where our investments are today.

Speaker 2

It's a great question. We really like the model we have today with 25% plus. It gives us a lot of optionality. And As a CEO, you look at our results, right? And you look at the top line, you say, okay, we're going to have 9% growth for the year.

Speaker 2

I'm not sure that's going to be top quartile. We believe that we'll be able to see when everyone else reports. I look at the bottom line and I look at EPS growth of 23%, Pretty confident that will be top quartile. And by the way, that's the 3rd consecutive year that we've had 20% or greater EPS And then I look at the quality of our earnings, Julian, and I'll use free cash flow as a proxy to determine that and over a 3 year free cash flow 100%. So we're very happy with the model.

Speaker 2

And you take that and you wrap it around our culture, which is Uplifting and a can do culture that we have at Trane Technologies, we're very excited about the future. We're very happy with our performance in the past, but I always tell people our brightest days are still in front of us. So expect more investment, expect more growth and expect us to continue to innovate for the industry.

Speaker 4

That makes a lot of sense. I just had one tiny follow-up on the sales outlook, Dave. Transport down single digits. Any big divergence first half versus second half in terms of the year on year there? Or right now, it looks pretty sort of steady down through the year?

Speaker 2

No, I think the first half will be tougher than the second half, okay? A lot of that has to do with the comps. As I said in our prepared remarks, Think of the Americas weighted average will be down in the 10%. We'll do better than that. We'll outperform.

Speaker 2

EMEA is a little bit It's down low single digits. We'll do better than that as well. Look, our Thermal King business, it's a great in fact, actually, After right after this meeting, I'm going to be joining the Thermal King dealer network in the Americas. And It's a great business. We have such a great dealer network there.

Speaker 2

We've been through these slight downturns before. This will snap back. If you look at what ACT is projecting right now, it's down in 2024, a quick step back into 2025. And then they have growth through 2028. And we're very optimistic with a lot of the innovation that we've already launched and what's coming This is a great business not only today but well into the future.

Speaker 6

Great. Thank you.

Speaker 2

All right. Thanks, Julien.

Operator

Our next question comes from Chris Snyder from UBS. Please go ahead. Your line is open.

Speaker 7

Thank you. I wanted to ask about orders. In the back half of the year, orders have been incredibly strong and have really bifurcated when compared to any sort of industry Benchmark we look at or peers. Is there anything specific that's driving that pickup in orders that we've seen over the last 6 months? And anything you would comment on data center, because it feels like a lot of the ramp we've seen has kind of lined up with a lot of the investment that we're seeing in data center and specifically?

Speaker 7

Thank you.

Speaker 2

Yes. Chris, great question. And our team has just executed at a very high level. I'll start with that. You think about it, with the direct sales force, we're able to really pivot to where the opportunity is.

Speaker 2

And we track I'll use the Americas here, but we track 14 different verticals and there are some verticals that are very strong right now. Data centers, you just spoke about also in the high-tech, think of the semiconductor space, education is another, healthcare is another, very strong verticals. We're able to capture those opportunities with our direct sales force, very technical sales force and be able to really meet or exceed in many cases, exceed our customers' expectations. So, very happy with what we've seen from an order growth standpoint in the Americas, Very happy as well as in Europe. That team has continued to perform very well.

Speaker 2

And in Asia, I know there's a lot of we've heard a lot on the Different calls that have already occurred where people were talking about being down in Asia or our business in Asia with the leadership team we have there, We're doing very well in Asia. And our revenue growth in Asia last year was 10%. By the way, that's a 2 year stack, that's 20%. So the team performs very, very well there. And I'd be also the service business that we have, I could not be prouder of what our service business really on a global basis has been able to do.

Speaker 2

In 2023, our service business was up in the teens. On a compound annual growth rate over the last 6 years, our service business has been up in the high single digits. So, and it's as our installed base continues to increase in the applied space, you could see That tailwind really happening within service. So very happy with our results and very happy with the order book that we have going into 2024. It gives us a lot of visibility into 2024.

Speaker 7

I appreciate that. And then maybe just following up on data center. And I know we're in the very, very early innings on AI. But is there any way that you could frame Trane's positioning in that market, the opportunity that you see going forward just because it is very new, but it also does seem very significant? Thank you.

Speaker 2

Yes. I mean, it's not new to us. I mean, we've been in data For a long time, we're very strong in that vertical. There's a lot of public information out there that's trying to size the data center market, And it's somewhat difficult. You got a lot of variations in those reports just because by nature, the data center market is It's very confidential to data center providers, okay?

Speaker 2

They don't want a lot of that information out. But if you look at the reports and just kind of triangulate it, You get a global market anywhere between, I mean, it's a big range, but $6,500,000,000 to up to $10,000,000,000 I mean, it's a big range up. And if you look at growth rates, if you can take the most conservative growth rate, you're going to see high teens, maybe mid teens growth on a compound annual growth rate for the next 5 years. So this is a very strong vertical today. We do very, very well in it with our very technical sales team calling on data center customers and working with them.

Speaker 2

It's very strong today and anticipate it being strong well into the future.

Speaker 7

Appreciate that. Thank you.

Speaker 2

All right. Thanks, Chris. Have a great day.

Operator

Our next question comes from Gautam Khanna from TD Cowen. Please go ahead. Your line is open.

Speaker 2

Gotham. Operator, I think we might want to come back to Gotham.

Operator

Certainly. I'll move on to Joe Ritchie from Goldman Sachs. Your line is open.

Speaker 6

Hey, guys. Good morning and nice end to the year. Dave, look, the service business we've talked about now for several years, it's been great for you guys and yet continues to accelerate in 2023. The double digit growth number is pretty impressive. And just maybe could you maybe just like point out like what's allowing you to continue to accelerate that business here.

Speaker 6

Is there is it something around your digital offering connected, how much you're connecting, How much feet you're putting on the street? Like what is it that's kind of driving this acceleration and growth in that service business? And then and how do you see that playing out in the coming years?

Speaker 2

Yes. Hey, Joe. Thanks for the question. I think I'd say yes, yes and yes, okay. It's a system of things that makes our service business great.

Speaker 2

It starts with a great operating system around our service business. We track probably 30 different KPIs and if you went to one of our you'd see very detailed tracking on our service, which really leads to our success. So It's a great business, okay. I'll not disclose too much about our playbook, but we have a very detailed playbook And you see it in our results. And I would tell you that our service business is really built around our applied systems.

Speaker 2

And as our Applied Systems continue to populate at an increasing rate, you could see the tail that we're getting in our service business. Think about Applied Systems, I said this in our opening remarks, think about it as for every dollar of equipment, think about 8 to 10 times over the life our service business. And you could now start to see that flywheel that's being created in our service business. So great business today. As Chris said, it's about a third of the enterprise, Growing nicely and we're investing heavily in it because we know there's a lot of opportunities in the future as well.

Speaker 6

That's great to hear. And I guess, look, there's a lot of good news in this brand. I know that there's some investor concern around The health the healthiness of the office market in 2024 and ultimately, like whether that's going to be a drag On growth for a lot of companies, can you maybe just address that market specifically and how that's impacting your business or expected to in 2024?

Speaker 2

Yes. I mean, I'll speak of the Americas. And I think I said earlier, we track about 14 different verticals. Office is one of the weaker ones in 2023. 3.

Speaker 2

And right now, we're forecasting that weakness to continue in 2024. We do believe that at one point, office will come back and with our direct sales force, we'll pivot to that opportunity and capture that opportunity. Right now, it's going to be soft at least through 2024. We'll see we'll report back at the as the year progresses as to how that vertical is There's a lot in the news about it. So it's got some recovery to do, but it'll be soft in 2024.

Speaker 2

But that's all baked into our guide, Joe. So that's we've taken that into account. And I would tell you that the strength that we're And some other verticals are going to be more than compensate what we're seeing in the office vertical.

Speaker 5

Understood. Thank you. Sure.

Operator

Our next question comes from Steve Tusa from JPMorgan. Please go ahead. Your line is open.

Speaker 8

Hey, good morning and congrats on a very strong 23%.

Speaker 2

Thanks, Steve. Appreciate it.

Speaker 8

What are you guys embedding for price This year in general for the Americas, I mean, you said it was 3% in the quarter, I think. What are you embedding for your 2024 guide?

Speaker 2

Yes, Steve, it's Chris. Think about 2024 at the enterprise level around a point of price, it could be a little better than that. But as we've seen throughout 2023, the price contribution has started to level off as we move through the quarters. We had over 6 points of price in Q1 And we ended the 4th quarter with less than 3 points of price. So there'll be some carryover into 2024, But we're dialing in at the enterprise level probably around a point, could be a little bit better than that.

Speaker 8

Okay. And your inflation is kind of stable, I would assume?

Speaker 2

Yes, Tier 1 is fairly stable. I appreciate the notes you put out every weekend with updates on commodities. It's a close read. At Tier 2, that happens to be inflationary, right? As we're looking at wage inflation, refrigerants are a couple of examples in that space and we continue to work with our vendors on the demand we're putting through with our order growth.

Speaker 2

So Tier 2 is a bit inflationary. Freight could be a little bit inflationary going into 2024 with a very positive, at least for us in 2023 on the cost side. But overall, I would say, we're on track to get 20, 30 basis points price over costs in the year like we would normally target. But we remain flexible, right? We see things turn and we need to make another price adjustment.

Speaker 2

We've got the business operating system to do that.

Speaker 8

So I would sorry, just on a follow-up on the price. I would assume that the majority of that price is still coming in commercial. So when you talk about that flat revenue number for resi, Is that basically like what's the volume kind of price split that you're assuming in resi, I guess is the question.

Speaker 2

Yes, all in for resi, it's we're dialing in a flat year. Our guide would take into account a Plus or minus low single digits on full year revenues for resi. I'd expect price to be at that 1 or less kind of level for residential, Really it's going to depend on what we think for the volume in the year, but not a lot of price necessarily coming through at this point.

Speaker 8

And then for 2025, are you guys going to push through the A2L price like everybody else, the 10% 10% to 15%?

Speaker 2

Yes, we don't have a lot baked into 2024 on the conversion to 454B. If we think that Does have an impact, it's certainly second half of the year, maybe 4th quarter impact. We haven't dialed in the pricing saying exactly on that, we'll do that as we get ready to launch the products, but it's in the ballpark of what others have said around pricing. But we'll see how the year evolves. We'll see how the demand plays with the 410A product versus the 454B transition, and we'll update as we kind of go through the year.

Speaker 2

But to be specific, Steve, this is Dave. Yes, for sure, we'll see that in 2025.

Operator

Our next question comes from Andy Kaplowitz from Citigroup. Please go ahead. Your line is open.

Speaker 9

Hey, good morning, everyone.

Speaker 2

Hey, Andy. How are you? Good morning. Good.

Speaker 9

How are you? Dave, can you give us some more color on of your thermal management systems in EMEA and the progress you're making in bringing thermal management systems to the U. S, is it possible to quantify the business at this point or at least give us on how to think about how much of your growth it means coming from the management systems and where you are in terms of bringing it out here in the U. S?

Speaker 2

Yes. I mean, it's a great question. We continue to do very well in Europe, obviously, as you see in our results. Obviously, some of that has to do with thermal management which is really electrification and heating, some of it has to do with some key verticals that are very strong like data centers and electronics. Look, we're migrating that technology to different parts of the world.

Speaker 2

It's not just in the U. S. We're also bringing it to Asia. We think there's a tremendous opportunity to electrify heating and to significantly reduce the carbon footprint for buildings and help them decarbonize around the globe. We have already introduced several products in different regions.

Speaker 2

That trend will continue in 2024. And by the way, I don't want you to think that we've stopped innovating in Europe because that continues as well. I think we're on our Last time I was there, it was like our 4th or 5th generation of what's happening there. So this is an evolving market. We believe it's Tremendous opportunity, excuse me, for the future, but we have solutions that have such great paybacks for our customers That, I know a lot of people are I was getting asked the other day about some of the incentives around this.

Speaker 2

I'm like, yes, the incentives are great tailwinds, But these projects stand on their own. I mean, there's great paybacks. If you're able to increase the efficiency by 3, 4 times, These are fantastic opportunities for Trane Technologies and they're fantastic opportunities for our customers to really Help them decarbonize and actually save money as well in the process. So we're really excited about thermal management systems and expect to see more around the world.

Speaker 9

Very helpful. And then Dave, I wanted to double click on your comments around Asia and China in particular. As you said, China bookings barely down, I think, But as you mentioned, one of your peers had relatively sharp deterioration in bookings in China. You mentioned the strength of your team there. Maybe talk about the durability of growth that you see there and what you're doing to sustain that growth?

Speaker 2

Yes. I'm so proud of what our team has been able to do in Asia. In fact, Thursday morning, I have my 6:30 am call with the Asia team. And they're super excited about what they see moving forward. I think that Sometimes you get if you look at the headlines coming out of China specific, right, you're going to see GDP down And you see what's happening in the residential space there.

Speaker 2

I would tell you that the verticals that we're really strong in continue to be strong. And it is the pharmaceutical, it is semiconductor, it is data centers. We have great offerings there And we continue to win. So we're excited about the opportunities that exist in front of us there.

Speaker 9

Awesome. Keep up the good work.

Speaker 2

All right. Thanks, Andy. Talk to you soon. Thanks.

Operator

Our next question comes from Jeff Sprague from Vertical Research. Please go ahead. Your line is open.

Speaker 10

Hey, thanks. Good morning, everyone.

Speaker 2

Good morning, sir.

Speaker 10

Hey, morning. Sorry, I was on a few minutes late. I got kind of the end market kind of organic outlook within the 6% to 7%. How about geographically, did you address That how the 3 regions fit within the 6% to 7% guide?

Speaker 2

Yes. Hey, Jeff, it's Chris. What we really talked about was in the Americas and in EMEA for commercial HVAC, we can really see from our guide probably up high single digits for the year. In the Americas with resi, we're guiding that around flat, plus or minus LSD, but we're calling it flat. Teekay Americas markets are down around 10 points on a blended average basis.

Speaker 2

We'll outperform that. Think of that around mid single digits down in the Americas. And then if I go to transport in EMEA, markets also down low single digits and we'll outperform those markets. And One of the slides we really like putting into the materials is really just the history of market performance versus our performance within the transport businesses and gives us a lot of confidence with the investments we made over the years and we continue to make that we've got the ability to outperform markets again in 2024. But think of EMEA as if the market is down low singles, then we're flat to maybe a little bit better than that.

Speaker 2

And then Asia, to Dave's point, with a great team there, We're seeing somewhere in the mid singles kind of range. So hopefully that gives you a little bit of context. Julian got pretty close to it when he asked the question before, but I'll just to summarize it here. And just think about a lot of strength in our commercial HVAC globally.

Speaker 10

Yes. It sounds, Dave, that commercial HVAC price, I guess, is up a little bit more. Enterprise is up 1, resi is up 1 On price, maybe TK has got less with the volume pressures. I actually would have thought commercial price would be a little bit better than Maybe kind of the 1 plus implied. Can you just maybe kind of talk to that a little bit like the price in the backlog versus New things that you're trying to do on price just to kind of react to that Tier 2 inflation you were talking about?

Speaker 2

Yes, Jeff, it's Chris. I mean, look, it's early in the year. Resi on the comments, we're calling it flat on a full year basis. We'll see if we get Any price growth there, maybe a little bit. And even on our 1% guide for the full year, could it be better than that?

Speaker 2

Yes. We remain flexible as we move through the year and we'll look at the dynamics of cost. But right now, we've got positive spread in the guide like we would target any year, We'll be nimble to opportunities. So think of it as just the start of the year. We like putting out guidance that we can meet or exceed on a full year basis And we'll update you as we go through.

Speaker 10

Hey, maybe one just quick follow-up. Dave, a lot of your earlier comments on the call Kind of about making your own luck, right, with the sales force and everything. You may have heard one of your competitors sort of gave up on the IRA Your day like it'd be nice if something happens, but we don't see it. Like what's your view on really how some of the stimulus might work its way through the system and are you actually seeing any tangible benefits?

Speaker 2

Yes. I mean, we're still Holding out hope, okay? Look, we are seeing some of it in the commercial space with the 179 D tax credit. So that is driving Some tailwinds, okay. On the resi side, yes, that's been a little bit muted.

Speaker 2

We're still hopeful that, that could work through. We're still marketing to the customers about heat pumps and the importance of heat pumps and how we can help them. The key is going to be on Ira, and I've said this in the past, Jeff. You got to make it simple, right? So make it simple.

Speaker 2

It's complex. Don't let that complexity make its way to the customer because they won't understand it. So we've been really good with taking the complexity out of some of these more Intrigate policies and that's going to be the key to success. So the short answer is we still believe it's a tailwind. It's going to be a tailwind for both residential and for commercial.

Speaker 2

We just hope that the pipe starts opening in residential sooner versus later.

Speaker 5

Great. Thank you for that color. Appreciate it.

Speaker 2

Thanks, Joe. Thanks.

Operator

Our next question comes from Deane Dray from RBC Capital Markets.

Speaker 1

Thank you. Good morning, everyone.

Speaker 2

Hey, Dean. How are you? Good morning.

Speaker 1

I'm doing real well. Thank you.

Speaker 5

So what's that surprised you about the resi inventory normalization process and how long do you think it might

Speaker 2

What's maybe surprised me a little bit is the amount of time it's taken to burn off. I think you heard me at the in our Q3 call was we thought we'd be complete in Q4 and that's not the case. So This will burn off eventually. Right now, it's going to go in through at least the Q1, really the first half. But look, we're optimistic on residential.

Speaker 2

It's a great business. It will snap back. It is I've always said for a long time now, think of resi as a GDP plus business, that hasn't changed. And the inventory in the independent wholesale distributor channel will start to align to demand. It's the Q1, I remind you that.

Speaker 2

So we'll see what happens here as we get into peak season. So we'll give you an update as we get to our

Speaker 5

That's all good to hear. And then just data center has come up multiple times already And where the fastest growth is happening is Zen liquid cooling. And I know you all made what looks to be a great investment in liquid stack. The business is still really fragmented. And do you see opportunities where you can invest further there because that's where You're seeing a plus 30% growth for the next several years in that technology.

Speaker 5

And you would you have a right to be in that business and a right to win, but you'll have to invest. So just what are the expectations?

Speaker 2

Yes. I mean, Dean, I appreciate your insights In emerging cooling, I think you did a great piece on that. So appreciate that educating really the industry on the possibilities that we have with emerging cooling. Look, we're still very bullish. Our view hasn't changed.

Speaker 2

We're working through the technology, okay, really on the Fluid itself. So that's continuing to evolve. But we also believe it's a big opportunity. And if you think about it, right, I mean think about data centers. It's a Massive market today, think about the growth rates that's going to happen over the next 5 years.

Speaker 2

And whether you choose the high teens compound annual growth you're in the 20s, it's a large growth number. And the technology is going to continue to evolve. And I think that immersion cooling could be one of those technologies of the future. And we're certainly right in the middle of it, as you said, and we're going to continue We're being bullish on that.

Speaker 5

Great. Thank you.

Speaker 2

All right. Thanks, Dean. Our

Operator

Our next question comes from Nigel Coe from Wolfe Research. Please go ahead. Your line is open.

Speaker 11

Thanks. Good morning, guys. Thanks for the question. So today, you've been fielding a few questions on price. So let's have a couple more pricing questions.

Speaker 11

What's really kind of struck me is that Some of your competitors some of your larger competitors have actually gone out with very aggressive price increases and really guiding for pretty significant realized price increases. And your message is very, very different. So in your experience, have you seen situations where the market has this divergence on price? And Does it tend to lead to share shifts? It just feels like a sustainable, this gap here.

Speaker 11

So any thoughts? And then just kind of sub question to that would be The service fleets, you've got obviously a lot of labor inflation to deal with that. I mean, would you expect service pricing to be better than that 1%?

Speaker 12

Let me

Speaker 2

just start and I'm going to let Chris talk about price. Nigel, I think it's always important to look at the history on pricing. So if you remember, we were really early with pricing, right? And that's really because of our business operating system, we were able to see around that corner. So you really have to go back in history and kind of look at what we did early on versus maybe some of our competitors are catching up a little bit.

Speaker 2

So Chris, I'll let you answer the rest of the question. I think that's where it starts, Dave, right? 2021, 2022, even 2023, we really saw where we let on price there. So We're being strategic, Nigel, as we think about that. Again, the 1% guide for the year right now, it's early in the year.

Speaker 2

We'll see how we do as we move throughout the year. But services, what we would look at is we look at wage inflation, look at the demand out there in the marketplace and make sure we're pricing appropriately. We're also not there, and we've said this for many years, we're really not out there to try to gouge our customers, what we're trying to do is offset inflation a few years ago with price. We want customers for life. So we're going to think about that as we move through the process here, but we don't see pricing moving backwards here in the businesses, but Again, the 1% guide, it's just early in the year.

Speaker 2

We'll update you as we move throughout it.

Speaker 11

Okay. And it sounds obviously your guidance about $1,700,000,000 $1,800,000,000 Of capital deployment in 2024 consistent with what you did in 2023. Obviously, tough to know how much of that's going to be buybacks M and A, but as you do more M and A, the amort is going to be increasingly a burden to your GAAP EPS. I know I asked this question last year about a move to cash EPS, but is that something that's under consideration?

Speaker 12

We'll give it some thought as

Speaker 2

we move throughout. You're right on amortization. It's Really the main driver with the Novolo acquisition that we wanted to call out with higher amortization, Non cash accounting rule based shorter lived assets in terms of how you amortize those with a high technology business that's a youngish company. But yes, we'll watch it as we go forward. I really like our cash EPS In 2023, I calculated that after knowing your question was going to come up with 103% on cash and net income.

Speaker 2

I like our cash EPS. We have lots of opportunities still within our working capital, especially in inventory to make sure we have that level set And that will be a nice opportunity for us on cash going forward. But as we move out into future years, right, at some point, we're going to start comping against The Trane acquisition amortization, right? So as we move out into the future years, we may see some of that starting to roll off as well. Not so much here in 2024, but as we look out in the future, we could start seeing that being a tailwind, let's say, on operating income.

Speaker 2

But that's why we like also showing the EBITDA margins for investors, right? It takes out that noise on the amortization, and just gives another metric to look at.

Speaker 11

Right. Okay. Thanks for the details, Chris. Appreciate it.

Speaker 5

You're welcome. Thanks, Nigel.

Operator

Our next question comes from Andrew Obin from Bank of America.

Speaker 12

Just a question on TMS. I think you highlighted it to us back last year. And my understanding that it sort of qualifies, ICC, I think, was clarified back in November. And I think there are Or it's just more arrows in your quiver and just to work with your customers and to provide a good solution for them. Is that a game changer?

Speaker 12

That's the question, I guess.

Speaker 2

I certainly think it is a game changer when you start thinking about thermal management systems and electrification of heating and being able to significantly reduce the carbon footprint of a building and have a very, very efficient system versus a conventional system. So I think if you wrap all together, I'd say, sure, absolutely, it's a game changer. It's making its way around the world and as we launch it in different regions and continue to see more of that in the future.

Speaker 12

I guess I was referring to is the tax credit is a game changer. No, I know you're excited about the technology.

Speaker 2

I think any policy or tax Credit become tailwinds. I don't think they they're the only driver. I think the main driver of these systems is They're very, very efficient. They're very sustainable. And they have great paybacks with or without any kind of policy or tax credit.

Speaker 12

Got you.

Speaker 2

Tax rate will be a benefit to it, but it's not the only thing that's driving

Speaker 12

it. That makes sense. And then as we think about Inventory in the channel and the refrigerant change both on residential and light commercial, How do you see I think you addressed inventory on residential, but how do you see it playing out on light commercial and I know it's sort of hard to pin down what qualifies as live commercial. And then the second question, does it introduce Different seasonality first half versus second half for the unitary business? Thank you.

Speaker 2

Yes, I really don't. I think last year, the EPA came out and kind of clarified, so you can manufacture to the end of this year and then you have a complete Through 2025 to do the sell through, we see that as all that was a good ruling by the EPA. We support that. It gives the channel time to do proper sell through. So we see that all as positive.

Speaker 2

I don't see any different dynamic there On the light unitary, and I'm defining light unitary as less than 25 tons. So it will really be the same dynamic that we're seeing in res.

Speaker 12

How big is under 25 tons for you?

Speaker 2

It's a large portion of our unitary business, but we also have this great

Operator

Our last question today will come from Noah Kaye from Oppenheimer. Please go ahead. Your line is open.

Speaker 13

Appreciate it. Thanks. So you talked earlier about some of the digital investments you're making this year and you appointed a Chief Digital Officer in December, which Seemed like a pretty significant milestone.

Speaker 5

So just to

Speaker 13

help us understand, is there more of a digital transformation opportunity internally over the next few years? Or is this more about adding offerings to your quiver? Maybe you can Get a little bit deeper into some of the focus areas for those digital investments, cyber, digital twin, etcetera.

Speaker 2

Yes, I would tell you, we've been in the digital space for a long time, okay? So digital twins are not new to us. Connected solutions are not new to us. I think that bringing Riaz on board, which is he's just a fantastic talent and early days is just doing a great job. It's just creating a huge focus.

Speaker 2

And we believe that digitalization is a big part of our future, and Riaz is going to help us see the opportunities that exist. You take with Riaz, you take the Volo that we've added on, you think about what we're doing with Digital Twins, there's a lot of You think about the level that we're seeing in our service business today, the growth rates we're seeing, Just think of that even getting stronger with the digital application in the future.

Speaker 13

Appreciate that, Dave. Maybe the last question, I think around this time last year, you shared with us your view of where backlog would end. You said greater than $6,000,000,000 exiting $23,000,000 I think $6,900,000,000 So you clearly surpassed that. Can you share with us today where you see it ending 2024?

Speaker 2

Yes, I would just say that expect our backlog to remain elevated for several periods. Look, we're at $6,900,000,000 right now. It's the same level we were at when we entered 2023. So it's very strong. I think One thing I would say is the composition of the backlog is changing quite a bit.

Speaker 2

And as we went through 2023, it's now like 90% plus commercial HVAC and think of that as applied systems, which has that long service tail associated with it. So A lot of demand in those in the verticals, data centers, etcetera, that really require applied systems. So we're very happy with our performance.

Speaker 5

Appreciate that color. Thank you. Sure.

Operator

This concludes today's Q and A session. Would like to turn the call back over to Zach Nagel for closing remarks.

Speaker 1

Thanks, operator. I'd like to thank everyone for joining today's call. As always, we'll be around to answer any questions you have in the coming days weeks. We'll also be attending a number of the upcoming conferences as we enter The big conference season and we hope to have the opportunity to connect with many of you there soon. Have a great day and we'll talk to you soon.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.

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Earnings Conference Call
Trane Technologies Q4 2023
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