Capacity Expansion And Aftermarket Strategy Fuel Future Growth Despite Market Challenges

Key Takeaways

• Capacity expansions and aftermarket growth strategies are set to enhance operational efficiency, revenue, and margins, contributing to Federal Signal's financial stability.
  
• Investments and acquisitions support sustainable growth, with strong order backlogs providing positive revenue prospects amid robust demand and infrastructure spending.
  
• Increased operating expenses and declining industrial orders, coupled with higher interest rates, could negatively impact revenue, margins, and overall earnings stability.

Catalysts

Designs, manufactures, and supplies a suite of products and integrated solutions for municipal, governmental, industrial, and commercial customers in the United States, Canada, Europe, and internationally.

• Federal Signal's ongoing build-more-trucks initiative and capacity expansions at major manufacturing sites are expected to increase production volumes, which can drive higher revenues and profitability through improved operational efficiency.
  
• The company's strategic focus on growing its aftermarket business, which has shown strong demand and double-digit growth, is anticipated to contribute significantly to future revenue and margin enhancement due to its higher margin nature.
  
• Investments in Federal Signal's Safety and Security Systems Group (SSG) over the past decade have structurally improved the segment, resulting in increased efficiencies and margin expansion, setting up the company for sustainable EBITDA growth.
  
• The acquisition of Standard Equipment is aligned with Federal Signal's aftermarket growth strategy and is expected to be accretive to both earnings and cash flow, enhancing revenue stability and reducing business cyclicality.
  
• Federal Signal's strong order backlog and visibility into demand, supported by public funding and infrastructure spending, provide a strong foundation for future revenue growth and set positive expectations for earnings continuation into 2025 and beyond.

Federal Signal Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Federal Signal's revenue will grow by 9.2% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 11.6% today to 11.2% in 3 years time.
• Analysts expect earnings to reach $268.1 million (and earnings per share of $4.31) by about November 2027, up from $212.7 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $233.8 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 28.1x on those 2027 earnings, up from 26.2x today. This future PE is greater than the current PE for the US Machinery industry at 23.8x.
• Analysts expect the number of shares outstanding to grow by 0.62% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.84%, as per the Simply Wall St company report.

Federal Signal Future Earnings Per Share Growth

Risks

• Increased corporate operating expenses were noted, with a significant portion due to adjustments and reserves, which could affect net margins negatively.
  
• Declining industrial orders, especially for high-priced products like safe digging equipment, suggest vulnerability to economic conditions, potentially impacting revenue and order intake.
  
• Higher interest rates have led customers to prioritize rentals or used equipment over new purchases, which may limit growth in new equipment sales revenue.
  
• The company’s reliance on aftermarket sales to mitigate cyclicality indicates potential vulnerability if demand for used or rental equipment decreases, possibly affecting overall earnings stability.
  
• The expectation of reduced chassis sales, perceived as a sales headwind, indicates potential challenges in passing through costs, impacting revenue and margins.

Valuation

• The analysts have a consensus price target of $99.6 for Federal Signal based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $115.0, and the most bearish reporting a price target of just $88.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $2.4 billion, earnings will come to $268.1 million, and it would be trading on a PE ratio of 28.1x, assuming you use a discount rate of 6.8%.
• Given the current share price of $91.35, the analyst's price target of $99.6 is 8.3% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.