Does Federal Signal (NYSE:FSS) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Federal Signal Corporation (NYSE:FSS) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Federal Signal

How Much Debt Does Federal Signal Carry?

You can click the graphic below for the historical numbers, but it shows that Federal Signal had US$298.1m of debt in December 2023, down from US$361.3m, one year before. However, because it has a cash reserve of US$61.0m, its net debt is less, at about US$237.1m.

A Look At Federal Signal's Liabilities

According to the last reported balance sheet, Federal Signal had liabilities of US$195.8m due within 12 months, and liabilities of US$422.8m due beyond 12 months. Offsetting these obligations, it had cash of US$61.0m as well as receivables valued at US$186.2m due within 12 months. So it has liabilities totalling US$371.4m more than its cash and near-term receivables, combined.

Since publicly traded Federal Signal shares are worth a total of US$5.08b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Federal Signal's net debt is only 0.83 times its EBITDA. And its EBIT covers its interest expense a whopping 11.4 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Federal Signal has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Federal Signal's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Federal Signal's free cash flow amounted to 48% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Federal Signal's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its interest cover also supports that impression! Looking at the bigger picture, we think Federal Signal's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. We'd be motivated to research the stock further if we found out that Federal Signal insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.