Trane’s (NYSE: TT) Q1:2025 organic revenue increased 11% and adjusted operating margins expanded 100 basis points (on the back of 28% incremental operating margins), helping to drive adjusted EPS growth of 26% from the same quarter in the prior year. Trane’s incremental operating margins in the quarter were above its long-term target of 25%.
Like Amphenol and GE Vernova (which were my other two newsletters so far this earnings season), Trane also reiterated its full-year 2025 guidance, but Trane chair and CEO Dave Regnery said the company “expects to perform towards the high-end of the range.” Importantly, it reaffirmed guidance despite an estimated $250 million to $275 million of incremental tariff costs (based on the tariffs in place as of April 30th) showcasing the agility and adaptability of their business operating system as well as the company’s pricing power.
As a reminder, Trane has historically increased prices annually and also has the ability to increase prices further during periods of higher inflation (ex: it increased prices 10% in 2022 and an additional 5% in 2023 to offset input cost inflation). Crucially, though, they are not trying to profit from the tariffs (in other words use tariffs as an excuse to jack up prices on customers to drive margins). Rather, they are first trying to mitigate the effects of tariffs through their supply chain, and the parts they can’t mitigate will be passed onto customers in the form of higher prices on a dollar-for-dollar basis (and no more).
Free cash flow (FCF) increased 31% to $230 million, which equates to a FCF margin of about 5% and a FCF conversion (on GAAP net income) of 38%. The first quarter is a seasonally low quarter for Trane FCF, and the company has maintained guidance to generate FCF conversion (on adjusted net income) of at least 100% in 2025. Trane generated a return on equity (ROE) of 38% (above its four-year average of 29%) and a return on invested capital (ROIC) of nearly 19% (above its four-year average of 14%). Trane has increased its ROE and ROIC for four consecutive years through 2024, and I think it’s on pace to increase returns further in 2025. Trane’s ROE is rising despite a declining debt-to-equity ratio. Its balance sheet is strong and getting stronger as seen by declining debt as a percentage of equity and total capital and also seen by rising interest coverage (EBIT/interest expense). Trane’s interest coverage has risen for four consecutive years and is now 15x (meaning one year of operating income could cover 15 years of interest expense).
Trane increased the dividend 12% back in February and “accelerated” share repurchases to opportunistically take advantage of the stock selloff. Trane’s management said it still believes Trane stock is “trading below our calculated intrinsic value” and the company has $5.6 billion remaining on its share repurchase authorization (equal to 6% of the current market cap). Year-to-date through April, Trane returned $860 million to shareholders, $210 million as dividends and $650 million via buybacks. For reference, during the same period of 2024 (YTD through April) Trane returned $621 million to shareholders ($190 million in dividends and $431 million in share buybacks). As a reminder, Trane is committed to consistently reinvesting into the business and to returning 100% of FCF to investors over time through a growing dividend and share repurchases.
Trane’s management reaffirmed 2025 guidance calling for organic revenue growth of 7% to 8% and for adjusted EPS growth to grow 13% to 15% to $12.70 to $12.90. But the press release did state that “The Company expects to perform towards the high-end of revenue and EPS guidance.”
Trane is IMO one of the highest quality industrial technology companies in the world and it’s getting better. I think it has a wide and durable moat based on its brand, global scale and distribution, highly trained direct commercial sales force with deep industry connections, and the industry leading software simulation platform used for HVAC system design and monitoring. Additionally, Trane is positioned to profitably grow from the long-duration secular growth tailwinds of energy efficiency, onshoring/near-shoring of manufacturing, and decarbonization. Regarding decarbonization, Trane has committed to reducing its customer’s carbon emissions by one gigaton by 2030 (see slide below). On the excellent Business Breakdown episode on Trane, Brett Larson (investor at NZS Capital) explained that one gigaton is equivalent to “one billion metric tons or 2% of world emissions.” Larson says, “There’s very few companies in the world that can have that type of impact and it speaks to an important growth driver.” One of the topics I discuss with my clients a lot is investing in companies with clear value propositions, and Trane is a perfect example. Its heavy commercial (applied) systems help its customers reduce carbon emissions and energy use so the payback (return on investment) to the client is very fast (measured in only a few years). To be clear, this isn’t about virtue signaling ESG. Rather, this is about one company that has the installed base, technology, and future demand that can have a real, measurable, and positive impact on the planet. (BTW other portfolio holdings with real sustainability characteristics include GE Vernova, Union Pacific, and Linde).
Its commercial HVAC segment (CHVAC) sells highly complicated and customized (applied) HVAC units into mega projects such as data centers, semiconductor foundries, medical facilities, universities, and skyscrapers. Yes, its data center business has been growing like a weed, but data centers are only one of 14 commercial verticals that it sells into. So, its commercial business is diversified by vertical and geography. Additionally, and important to the investment thesis, it has a large and growing installed base (in about 42,000 buildings) and these applied units are so complicated and customized that they provide a roughly 25-30-year lifetime of higher-margin service revenue that is equal to 8x – 10x the initial cost of the machine. This service revenue is higher-margin, predictable, and almost all of it is still in front of the company (has not been recognized yet). I believe the services business will provide Trane with durable growth and further transform the company into an even higher-margin, higher-ROIC business over the next 10-20 years. In other words, I think we are still in the early stages of a long-duration profit cycle at Trane that should drive a long runway of 10%-15% per-share growth.
Disclosure: John Rotonti is an investor in and the portfolio manager of the Bastion Industrials and Infrastructure Portfolio, which owns shares of Trane Technologies.
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