Trane Technologies plc

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Trane Technologies plc is a global climate innovator, creating efficient and sustainable solutions for buildings, homes, and transportation through its strategic brands: Trane® and Thermo King®.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Competitive Landscape Trane Technologies (TT) is a global climate innovator that generates revenue through several segments. It manufactures and sells climate control products under well-known brands such as Trane and Thermo King. Its end markets include commercial buildings, residential buildings, and transportation.

Commercial HVAC (Americas, EMEA, and Asia Pacific) is a substantial part of the business, which involves designing and manufacturing air conditioning, heating, and ventilation systems for non-residential customers like buildings, hospitals, and schools.
Residential HVAC (Americas, EMEA, and Asia Pacific), in contrast, focuses on the residential market, offering equipment for home heating and cooling.
Transport Refrigeration (Americas and Europe/Middle East) mainly sells transportation temperature-control products and services, such as refrigeration units for trucks, trailers, and railway cars.

The markets it serves are diverse geographically, with a big presence in North America, Europe, the Middle East, and the Asia-Pacific region.

Moat Assessment Trane Technologies’ moat is not as readily apparent as that of a brand-based company like Coca-Cola, and is likely to be a narrow moat. However, it’s not as bad as a company with no moat. Here’s why:

Distribution Networks and Services: TT benefits from its large distribution and service network, particularly in areas like HVAC. This network includes dealers and service providers, which help make it easier to meet customer needs across geographic regions. Because of the scale advantage of the company and the large distribution network, any new entrant would have a difficult time building a competitive and profitable network to directly compete with it.
Intangible Assets: The brands Trane and Thermo King have considerable brand recognition and are known for reliability and performance. This provides some intangible asset protection, although in industries with high competition, this does not guarantee long-term success.
Switching Costs Customers of Trane and Thermo King face switching costs, including the hassle of changing contractors, the cost of learning to operate new equipment, and the long-term relationships with service providers. These factors do make it less attractive to switch to an alternative vendor.

Therefore, while the moat is not as wide as some companies, the network of dealers and service providers, brands known for their reliability, and the switching costs associated with their products provide a competitive advantage.

Moat Rating: 3 / 5.

Legitimate Risks that Could Damage the Moat While TT does have a certain advantage, it’s not impermeable to external forces. Here are some risks that have a likelihood to hurt the moat:

Competition: The HVAC and refrigeration industries are highly competitive. New entrants or a large company with new technologies could challenge TT’s position by providing new products or better solutions. This may be through a variety of strategies including aggressive price wars, or by leveraging better manufacturing or technology processes.
Technological Disruption: As new technologies are developed and brought to the market, it is possible that they could disrupt TT’s offerings, including those in their established markets. This may be through a new type of cooling that doesn’t require ductwork, or more efficient refrigeration, or maybe through some new type of energy efficient or more sustainable type of product.
Economic Cycles: As the company operates heavily in the construction and industrial sectors, they are susceptible to major market downturns or business cycles, which can reduce sales and cash flow if investment in industrial and building segments reduces.
Regulation: Regulatory changes could increase expenses and have an effect on profitability. This particularly applies to their non-industrial businesses, where governments may act to make the industry more regulated to ensure better quality of service and pricing.
Supply Chain Issues and Increased Costs: In the earnings call in the quarter ended September 30, 2022, management said that they are increasing prices to combat inflation, however, there may be a time lag in reflecting the full scope of these costs. Furthermore, supply issues have had an effect on revenues and are a continuing risk.
Geopolitical Risks: Trane Technologies has significant operations in various regions around the world, and geopolitical events may have an effect on profitability and operating results. Trade wars or shifts in international relations may have an impact on its supply chain and ability to serve its international clients. Also, fluctuations in currency may effect profitability.
Customer Concentration: Although the company has a wide array of customers, some of these are large companies, which increases the risk of losing them or having to give discounts to maintain them.

Business Resilience Despite these risks, TT exhibits some resilience:

Recurring Revenue: A good portion of revenues are derived from recurring services and parts, as well as the replacements of systems that are already installed. This makes their revenues more resilient than those with one-time revenues.

Business Understandability: 2 / 5 While TT’s core business is relatively easy to understand (it’s a company that sells cooling, heating, and refrigeration products), the overall operations are difficult to follow due to its different segments and their geographic dispersion, which makes understanding all its revenue streams and cost structures very complex. The technicalities of the products, such as heat transfer and refrigeration cycles, add to the complexity, as well as accounting for lease obligations and goodwill from acquisitions. Therefore, the understandability rating is 2 / 5.

Financials in-depth:

Income Statement: Revenues and income fluctuate primarily with business cycles and seasonality. A review of quarterly statements highlights the dependence on construction and industrial sectors, where revenues tend to be quite uneven. However, the company does achieve some consistency through services for past customers, as well as selling products, parts, and replacements. Gross margins and operating margins have shown some upward progression over the years, but have been affected by rising material and energy costs. Therefore, they should be watched to see what impact they have on profits in the long run, given how the company is trying to pass on increased costs to consumers.
Balance Sheet: As previously stated, a significant portion of the value of the company is in its intangible assets, especially goodwill. These intangible assets have grown by several billions over the years through acquisitions. It’s worth keeping track of this, to ensure it’s not growing faster than profitability. As for hard assets, the company seems to have good control over its inventories, and over a decade or so it has been on a long-term trend of inventory reduction. The company also has a solid cash balance, but the short-term assets have fluctuated. Liabilities are mainly comprised of accounts payable, leases, and long-term debt, with little short-term debt. A more detailed analysis of liabilities shows that the company is highly leveraged, and will depend on it’s ability to refinance or repay them.
Cash Flow Statement: Cash flow from operations have generally been increasing over the years, but does occasionally go negative, typically in years with greater investment spending or major write-offs of the books. In those cases the cash is financed from debt. This highlights the importance of tracking their cash flow and the impact of those non-recurring costs.

Balance Sheet Health: 4 / 5 While the company is leveraged and thus has more risk that a less leveraged company, the cash flow from operations, and access to credit are reasonably strong, leading to a rating of 4 / 5. The company also needs to manage acquisitions effectively.

Recent Concerns and Management Statements The most recent earning calls have revealed a few issues, including:

Inflation: The biggest topic has been inflation in commodity prices, and the way that the company is passing on those costs. As per the last earnings call, increases were made, but there’s a delay in seeing their full effect. The management stated, however, that they are “confident in the pricing strategies in the long-term,” suggesting that they should be able to fully offset most of those cost increases.
Geopolitical Events: The conflict in Ukraine has had a negative effect on sales, but the company seems to have been resilient.
Supply Chain: There are some challenges in supply chains, although the company is responding to this issue.

All in all, management seems bullish about long-term prospects.

Conclusion While it is not a clear-cut wide-moat company, Trane Technologies’ moat provides a level of insulation from competition, although these are susceptible to certain challenges. The key lies in assessing how well the company is able to maintain its returns on invested capital and sustain growth. Investors must track future performance with that in mind and also assess the various risks laid out here in detail. For the sophisticated intelligent investor, a deeper dive into financial statements, reading 10k reports, reviewing multiple years of history to gauge the robustness of management, and checking past earning calls to analyze management thinking would all be of significant value in understanding the company.