What Investors Should Know About Federal Signal Corporation’s (NYSE:FSS) Financial Strength

Investors are always looking for growth in small-cap stocks like Federal Signal Corporation (NYSE:FSS), with a market cap of US$1.4b. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. However, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into FSS here.

How much cash does FSS generate through its operations?

Over the past year, FSS has reduced its debt from US$283m to US$222m , which includes long-term debt. With this reduction in debt, FSS’s cash and short-term investments stands at US$35m for investing into the business. Moreover, FSS has produced US$93m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 42%, signalling that FSS’s operating cash is sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In FSS’s case, it is able to generate 0.42x cash from its debt capital.

Can FSS meet its short-term obligations with the cash in hand?

Looking at FSS’s US$155m in current liabilities, it appears that the company has been able to meet these obligations given the level of current assets of US$314m, with a current ratio of 2.03x. For Machinery companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

NYSE:FSS Historical Debt December 5th 18
NYSE:FSS Historical Debt December 5th 18

Is FSS’s debt level acceptable?

FSS is a relatively highly levered company with a debt-to-equity of 43%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can check to see whether FSS is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In FSS’s, case, the ratio of 11.28x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving FSS ample headroom to grow its debt facilities.

Next Steps:

FSS’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around FSS’s liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven’t considered other factors such as how FSS has been performing in the past. I recommend you continue to research Federal Signal to get a more holistic view of the small-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for FSS’s future growth? Take a look at our free research report of analyst consensus for FSS’s outlook.
  2. Valuation: What is FSS worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether FSS is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.