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Are Federal Signal Corporation's (NYSE:FSS) Interest Costs Too High?

Simply Wall St

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Federal Signal Corporation (NYSE:FSS) is a small-cap stock with a market capitalization of US$1.7b. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Understanding the company's financial health becomes crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. However, this is not a comprehensive overview, so I suggest you dig deeper yourself into FSS here.

FSS’s Debt (And Cash Flows)

FSS's debt levels have fallen from US$267m to US$245m over the last 12 months , which also accounts for long term debt. With this reduction in debt, FSS currently has US$23m remaining in cash and short-term investments , ready to be used for running the business. Moreover, FSS has produced cash from operations of US$74m over the same time period, resulting in an operating cash to total debt ratio of 30%, meaning that FSS’s operating cash is sufficient to cover its debt.

Can FSS pay its short-term liabilities?

With current liabilities at US$164m, it seems that the business has been able to meet these obligations given the level of current assets of US$340m, with a current ratio of 2.08x. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Machinery companies, this is a reasonable ratio as there's enough of a cash buffer without holding too much capital in low return investments.

NYSE:FSS Historical Debt, May 6th 2019

Does FSS face the risk of succumbing to its debt-load?

With a debt-to-equity ratio of 45%, FSS can be considered as an above-average leveraged company. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. 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 14.65x suggests that interest is comfortably covered, which means that lenders may be willing to lend out more funding as FSS’s high interest coverage is seen as responsible and safe practice.

Next Steps:

Although FSS’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Keep in mind I haven't considered other factors such as how FSS has been performing in the past. You should continue to research Federal Signal to get a better picture 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.