TRN - Federal Signal Corp.: No Buy Signal Yet

Summary

• Federal Signal Corporation has had a fairly solid operating history, despite some volatility over the years.
• Long term, the company will likely do just fine and will probably add value for investors down the road.
• But the stock is not all that affordable in the grand scheme of things.

Perhaps I'm odd, but when it comes to investing, some of the most mundane companies are some of the most interesting. One of the companies that falls under this description is a firm called Federal Signal Corporation ( FSS ). In short, the company focuses on designing, producing, and selling a variety of products and integrated services to both government and private customers. For the most part, the company's financial picture has been fairly positive in recent years. Although cash flows have been a bit lumpy, the general trend for revenue has been encouraging. Shares are not ridiculously priced by any means. On the other hand, they definitely don't fall into the value territory. All things considered, I would say that this combination of facts makes the enterprise a solid 'hold' prospect at this time, a rating that is indicative of a company that should generate upside or downside more in line with what the broader market should experience.

A niche prospect to consider

According to the management team at Federal Signal Corporation, the company produces and supplies a variety of goods and services to customers that include municipal, governmental, industrial, and commercial parties. Specific products that it sells include, but are not limited to, sewer cleaners, industrial vacuum loaders, vacuum excavation trucks, hydro excavation trucks, street sweepers, road-marking and line-removal equipment, water blasting equipment, dump truck bodies, trailers, safety and security systems, and more. On top of this, the company also provides services such as service and repair work, and equipment rental work, and it even sells various parts of the products that it sells to its customers when said parts need to be replaced. The company achieves all of this through the 20 manufacturing facilities that it has spread across the globe.

All of the company's primary operations fall under two distinct operating segments. The first of these is the Environmental Solutions Group, which focuses on many of the primary products I already mentioned. Using data from its 2021 fiscal year, which is the most recent year for which total annual data has been provided, 82.8% of its revenue and 78.7% of its profits came from this segment. The other segment is referred to as the Safety and Security Systems Group. Through this unit, the company produces systems for community alerting, emergency vehicles, first responder interoperable communications and industrial communications, and more. Examples of products produced include public safety equipment like vehicle light bars and sirens, industrial signaling equipment, public warning systems, general alarm and public address systems, and more. This is the smaller of the two segments, accounting for only 17.2% of revenue but also responsible for 21.3% of profits.

The general financial trajectory for the company has been positive over the past few years. Revenue rose from $898.5 million in 2017 to $1.22 billion in 2019. In 2020, thanks to the COVID-19 pandemic, sales dropped down to $1.13 billion before rebounding some to $1.21 billion in 2021. Along the way, the company benefited tremendously from an increase in orders and a corresponding rise in backlog. For instance, in 2020, orders totaled only $1.05 billion. But in 2021, this number came in at $1.54 billion. That was enough to push backlog for the company up from $303.9 million to what was then an all-time high of $628.9 million.

This increase in revenue over the years has brought with it, for the most part, increased profitability. From 2017 through 2019, net income almost doubled from $61.6 million to $108.5 million. Profits fell to $96.2 million in 2020 before climbing to $100.6 million in 2021. Operating cash flow rose from 2017 through 2020, climbing from $72.8 million to $136.2 million. But then, in 2021, the metric dropped to $101.8 million. Though, if we adjust for changes in working capital, it actually would have risen from $148.7 million in 2020 to $155.4 million in 2021. And finally, we have EBITDA. After peaking at $191.7 million in 2019, it began a steady descent, eventually hitting $180.5 million in 2021.

When it comes to the 2022 fiscal year, management reported sales in the first nine months of $1.04 billion. That's comfortably higher than the $911.8 million reported the same time one year earlier. This came as orders for the company continued to increase, totaling $1.25 billion in the first nine months of the year compared to just under $1.10 billion the same time one year earlier. Backlog still managed to grow year over year, jumping from $487 million to $824 million. With the rise in revenue also came improved net income. Profits inched up from $81.1 million to $85.8 million. This is not to say that every profitability metric fared better. Operating cash flow actually dropped from $55.1 million to $32.4 million. But if we adjust for changes in working capital, it would have risen from $116.1 million to $134.3 million, while EBITDA rose from $140.5 million to $153.9 million.

For 2022 in its entirety, management said that revenue should be between $1.41 billion and $1.44 billion. Earnings per share, meanwhile, should come in at between $1.91 and $2 per share. Using the midpoint figures for this, we would get net income of $119.3 million. If we then annualize results achieved for the other cash flow metrics, we would get adjusted operating cash flow of $184.3 million and EBITDA of $214.1 million. Based on these numbers, the company is trading at a forward price to earnings multiple of 25.9, a forward price to adjusted operating cash flow multiple of 16.8, and a forward EV to EBITDA multiple of 15.8. As you can see in the chart above, this pricing is more favorable than if we were to use data from the 2021 fiscal year. As part of my analysis, I also compared the company with five similar firms. On a price-to-earnings basis, these companies ranged from a low of 8.4 to a high of 21.4. In this case, Federal Signal Corporation was the most expensive of the group. Using the price to operating cash flow approach, the range would be from 7.1 to 417.6. In this scenario, only one of the five companies was cheaper than our target. And finally, using the EV to EBITDA approach, the range was from 7 to 14.1. In this case, just as was the case with the price-to-earnings approach, Federal Signal Corporation was the most expensive of the group.

Takeaway

Operationally speaking, I find Federal Signal Corporation to be an intriguing company because of the space in which it operates and the vast portfolio of products it provides its customers. Long term, I suspect the firm would do just well for itself and its shareholders. But this doesn't make it an ideal stock to buy now. Given how shares are priced at the moment, I think the stock is much closer to fair value. Yes, the growing backlog and strong orders that led to it are definitely promising. But that's not enough on its own to make it encouraging enough for me. As such, I've decided to rate the company a 'hold' for now.

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