Federal Signal (NYSE:FSS) Could Easily Take On More Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Federal Signal Corporation (NYSE:FSS) does use debt in its business. But is this debt a concern to shareholders?

We check all companies for important risks. See what we found for Federal Signal in our free report.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Federal Signal Carry?

As you can see below, Federal Signal had US$276.0m of debt, at March 2025, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$57.5m in cash offsetting this, leading to net debt of about US$218.5m.

How Healthy Is Federal Signal's Balance Sheet?

According to the last reported balance sheet, Federal Signal had liabilities of US$278.4m due within 12 months, and liabilities of US$398.6m due beyond 12 months. Offsetting these obligations, it had cash of US$57.5m as well as receivables valued at US$223.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$396.3m.

Given Federal Signal has a market capitalization of US$5.83b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

View our latest analysis for Federal Signal

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Federal Signal has a low net debt to EBITDA ratio of only 0.60. And its EBIT easily covers its interest expense, being 23.9 times the size. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Federal Signal has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Federal Signal can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Federal Signal produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Federal Signal's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Federal Signal seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. We'd be very excited to see if Federal Signal insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.