Trane Technologies Offers A Multipart Puzzle Between Industry Drivers, Macro Risk, And Valuation

I described Trane's (NYSE:TT) valuation as "interesting" earlier this year, as the HVAC sector had weakened on a slowing outlook and what I believed to be sector rotation. While I wasn't fully comfortable with the valuation, I thought growth prospects were stronger in the near term than the Street was appreciating, and that has been borne out this year by the company's results.

The shares have appreciated close to 10% since that last article, outperforming not only the broader industrial space, but other HVAC and refrigeration companies like Carrier (CARR), Johnson Controls (JCI), and Lennox (LII). On the positive side, I like Trane's leverage to what I believe can be a multiyear trend of efficiency-driven upgrades, but on the negative side, I have some concerns about 2023 expectations and the valuation.

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Trane Technologies Offers A Multipart Puzzle Between Industry Drivers, Macro Risk, And Valuation

Apparently, It's Not So Hard To Stop A Trane

 

Okay, that title is admittedly a little harsh, particularly as there’s not really a core fundamental issue at Trane (TT), but if a company is going to use a marketing slogan like “It’s Hard To Stop A Trane”, it does invite a little ribbing when things turn down for the stock, and such has been the case at Trane, with the shares down around 20% since my last update. That decline is quite a bit steeper than the 4% decline in the industrial sector and the flattish performance of the S&P 500, but most of the peer group (Carrier (CARR), Lennox (LII), and Daikin (OTCPK:DKILY)) is clustered down there with Trane, while Johnson Controls (JCI) has outperformed.

I understand at least some of the concerns hitting the stock – current expectations are very much reliant on supply chain improvements in the back half of the year that will lead to better output and margins, and the North American residential replacement market is likely to see a reset down to the long-term replacement trend line after two strong years.

Still, I’m starting to think the reaction may be overdone, particularly with a healthy U.S. residential new-build market and ongoing opportunities to leverage global efficiency initiatives through the commercial HVAC business. My biggest concern now is no longer valuation but theme rotation and “fighting the tape”; owning yesterday’s hot thing can be a painful experience as seemingly cheap-looking stocks get even cheaper.

 

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Apparently, It's Not So Hard To Stop A Trane

Trane Technologies Needs Some Beat-And-Raise Quarters To Restoke Investor Enthusiasm

 

As I’ve written before, I think the global HVAC market (particularly the commercial/institutional market) is one of the more attractive markets today, as global ESG concerns are likely to put a premium on energy-efficient HVAC systems and controls, not to mention the recent pandemic driving more interest in indoor air quality systems. On top of that, the transportation refrigeration market looks poised for a strong rebound after some rough quarters.

Those positives aside, I’ve also written that I thought most HVAC stocks were ahead of where they should be on valuation, making them relatively less attractive. Since my last update on Trane Technologies (TT), the shares have continued to chug along well relative to the S&P 500 (basically tracking the S&P at 13% growth), but they’ve lagged the broader industrial space by a few percentage points. Trane has outperformed Carrier (CARR), Lennox (LII), and Daikin (OTCPK:DKILF) (OTCPK:DKILY). Meanwhile, Johnson Controls (JCI), which I did see as undervalued until relatively recently, is up more than a third over that time.

My view now is pretty much what it has been. I’m still pretty bullish on the near-term prospects for residential and transportation, but resi HVAC comps are going to get a lot more challenging in the second half. I’m not so bullish on the near-term commercial HVAC opportunity, but opportunities in indoor air quality are still relevant. Longer-term, I’m intrigued by management’s R&D and M&A focus on emerging technology. I’m still not excited about the share price/valuation today, though I could see some sources of upside across the business.

 

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Trane Technologies Needs Some Beat-And-Raise Quarters To Restoke Investor Enthusiasm