Trane Technologies

Trane Technologies released very strong second-quarter results with revenue increasing 9% organically to $6.4 billion and adjusted EPS increasing 11% to $4.31. The company saw broad-based strength across its portfolio including commercial and residential HVAC.

Why it matters: The solid print prompted management to once again increase their guidance for 2026. Organic growth has increased to 9% from 7% and adjusted EPS increased 3% at the midpoint to $15.20-$15.30. The company has a $12.1 billion backlog, providing excellent visibility for this year, and half the backlog hits in 2027 and beyond, increasing confidence in Trane’s growth outlook. The Americas grew 11% with tremendous commercial order growth. Margins compressed 30 basis points to 22.1%, but mainly weighed down by investments in capacity and innovation, which are good problems to have. EMEA decreased 4% due to issues in the Middle East but grew otherwise. APAC grew 10%.

Long view: While commercial HVAC is delivering tremendous growth rates, Trane also boosted its residential HVAC guidance to mid-single-digit growth, a stark contrast to results from peers Lennox and Watsco that reported yesterday. Market share in HVAC tends to be quite stable, so we will monitor this carefully.

The bottom line: We are increasing our fair value estimate for narrow-moat Trane to $422 per share from $402 on the better outlook for 2026 and increased conviction in the company’s operating leverage. Trane also called out a cyclical recovery for the ThermoKing business where operating performance has been subdued in recent years. Combined with recovery in residential HVAC, Trane’s portfolio could be firing on all cylinders in 2027 and beyond.

BLANK PAGEOverall, it was a good quarter for Trane, even with the residential HVAC and China headwinds. However, Trane's stock price dipped by a high-single-digit percentage in reaction to its earnings release. We think that's mostly due to investors recalibrating their long-term growth assumptions for Trane after second-quarter revenue narrowly missed the FactSet consensus estimate (the first sales miss in five quarters). However, if growth slows and/or margin expansion stagnates, we see significant downside for the stock as market expectations are further reset.

Our $422 per share fair value estimate equates to about 28 times our 2026 EPS, which is reasonable in historical context. Management faced headwinds in 2025, given weakness in residential construction in both North America and Europe, but the backlog growth, especially in commercial, is very robust and provides credibility for accelerating growth. Management is now targeting accelerating top-line growth of 9% and margin expansion in 2026, driven by low-single-digit underlying market growth, an improving product mix, and increased aftermarket/services penetration.

We model a 10% compound annual growth rate in revenue for Trane’s global climate business, with gradual margin improvement from 19% to 23% over the forecast horizon. These figures could prove conservative, especially given the company’s burgeoning opportunity in data centers. Our forecast margin expansion is consistent with Trane’s guidance and similar to its peer group. Based on past performance and assuming some recovery in residential HVAC and ThermoKing, Trane’s margin expansion could be closer to 100 basis points per year.

With modest capital-expenditure requirements at 2% of sales and research and development likely at similar levels, we anticipate Trane will generate healthy free cash flow and continue to improve shareholder returns.

Our Stage II forecast period incorporates an estimated investment rate of 35%, an earnings before interest growth rate of 7%, and perpetual growth of 3%. An 8.5% weighted average cost of capital is derived from the market average cost of equity and the firm’s current capital structure.

We assign Trane Technologies a Morningstar Economic Moat Rating of narrow, supported by intangible assets (brand and intellectual property/technical know-how) and customer switching costs. We estimate commercial HVAC accounts for approximately 65% of Trane’s sales. There are relatively few companies in the commercial buildings HVAC space, and the market for large, complex HVAC systems (known as applied HVAC systems) is the most consolidated, particularly in the United States. Four players—Trane, Johnson Controls, Carrier, and Daikin—control the US applied HVAC market. The US light commercial HVAC market is slightly more competitive than the applied market, but is still relatively consolidated; we estimate that Carrier, Trane, Bosch (which recently acquired Johnson Controls’ York brand), and Lennox control over two-thirds of the US light commercial market. Global commercial HVAC competition is intensifying, especially in Asian markets, where Daikin, Midea, and Gree are major competitors. However, all three firms focus more on ductless residential systems.

Trane's technological know-how and service capabilities are key differentiators in commercial HVAC, especially for large, complex projects. The company estimates its commercial market share is around 30%. Over the years, these differentiators have allowed the firm to build a large installed base, which can have long useful lives (up to 40 years for applied HVAC systems). An installed base of commercial HVAC systems is an important asset that can generate recurring revenue over the system's lifetime, as the relationship's lifetime value from services and support is several multiples of the original equipment sale. Given the mission-critical nature of commercial building systems, maintenance, service, and aftermarket parts are needed to avoid disruptive and costly system breakdowns.

New commercial HVAC systems require significant upfront investment and installation time but have long lifecycles. As such, we believe building operators would be reluctant to completely replace entire systems and instead prefer to retrofit existing systems to adapt to changing technology, regulatory standards, and user requirements. This is a favorable dynamic for Trane Technologies, which is well-positioned to capture incremental retrofit revenue in addition to unplanned service and routine maintenance revenue. That said, the ability to capture future service revenue from an installed base is not guaranteed, especially for less sophisticated systems. We believe third-party service companies can generally service many of Trane's products, and some customers have internal engineers who can service systems to a certain extent. However, third-party or internal service engineers would still need to purchase aftermarket parts from the incumbent manufacturer for many projects. While Trane is a leading player in the global commercial HVAC market, faces competition that keeps pricing power in check. While Trane, Carrier, and Johnson Controls have relative strengths and weaknesses, we don’t see significant differentiation among the three in the commercial HVAC space. As such, we believe a narrow economic moat rating is appropriate for Trane’s commercial HVAC business.

We estimate that residential HVAC represents approximately 20% of Trane’s sales. The US residential HVAC market is more competitive, and pricing power accrues to firms with strong brand recognition and quality ratings. On that front, Trane is a top performer. For example, based on industry data, the average cost of Trane-branded residential central air conditioning units and equipment is often 25% higher than the industry average. We believe the Trane brand has strong enough brand equity/pricing power to support a narrow moat for the firm’s residential HVAC business, which generates almost all its revenue in North America. The company estimates its market share is in the low to midteens.

We don't believe the switching-cost advantage in commercial HVAC extends to the residential HVAC market, as residential replacement costs are lower than those for commercial systems. Depending on the required repair (for example, compressor replacement), purchasing a new HVAC unit is often the better option, and there is no guarantee the homeowner will choose the same brand. Because the residential HVAC service market is third-party-owned and operated, OEMs have limited residential aftermarket service opportunities beyond replacement parts, which are not a material source of revenue.

Trane’s Transportation Refrigeration segment represents approximately 15% of sales. The company’s Thermo King-branded products have been serving the transportation refrigeration market since 1938. Thermo King, along with Carrier's Transicold brand, largely controls the US truck and trailer market. Thermo King has a long-standing reputation for dependability and continuous innovation, helping customers lower operating costs and prevent costly damage claims. For example, more energy-efficient and lighter trailer refrigeration units reduce fuel consumption and increase cargo capacity. Trane also offers customers service and maintenance programs through a network of hundreds of dealer locations nationwide, which can prevent downtime. In our view, using multiple suppliers for a trucking fleet would lead to inefficiencies in purchasing power and maintenance costs. We believe Trane enjoys long-standing relationships with trucking customers.

Despite a few competitors in the US truck and trailer refrigeration market, the industry is cyclical. Trane’s market opportunity is primarily for new trucks and trailers, and service revenue accrues mostly to third-party dealers. Furthermore, about one-third of transportation refrigeration business revenue comes from other applications, such as refrigerated marine containers, which we see as a more competitive market. As such, we believe a narrow economic moat is the appropriate rating for this business.

The company achieves more dominant share, especially in commercial solutions, widening its lead over Johnson Controls and Carrier.

Services/aftermarket attach rates grow above management’s double-digit target and further enhance returns.

The company establishes clear market leadership in cooling solutions to data centers.

Pricing power erodes due to insufficient product differentiation.

Independent third parties capture more of the aftermarket/service opportunity.

The company engages in value-destructive M&A.