By: Michael
Reardon, AIM student at Marquette University
Summary
• Federal Signal Corporation. (NYSE:FSS) designs and manufactures
products and integrated solutions for municipal, governmental, industrial, and
commercial customers. The business operates in two segments: Environmental
Solutions (ESG) and Safety and Security Systems (SSG). ESG manufactures vacuum
trucks, sewer cleaners, and street sweepers, as well as operates rental centers
for such products. SSG manufactures lights and sirens used on emergency
vehicles and mass warning products such as warning lights and alarms used in
industrial settings.
• Strategic review and recent
M&A provides catalysts to profitable growth.
• Joe Johnson Equipment will
greatly expand geographic reach and provide a platform that FSS can leverage to
drive operational efficiency and earnings• Management has laid out a capital allocation policy that should focus on better utilizing the balance sheet to satisfy shareholders through organic growth, M&A, and dividends.
• These drivers could give FSS the boost it needs to head back to its November high of $17.13
Key
points: Federal Signal Corporation is in the midst of an
M&A-fueled overhaul of the business. For several quarters, FSS has
expressed a desire to pursue acquisitions as a path to profitable growth and
the company has indicated it would like to add at least $250 million in revenue
from M&A over the next three years. For a mature industrial company with
$768 million in 2015 revenue, this has the potential to be transformational.
The search for acquisition
targets started with a strategic review, which identified the Bronto Skylift
business as non-core and not important to long-term strategy. This unit was
largely unprofitable with limited growth opportunities. Despite this, FSS sold
Bronto for $88 million and quickly redeployed this capital into other growth
opportunities that better fit the new strategic plan.
This strategic plan involved
realigning the portfolio into market-leading businesses with recurring revenue,
solid operating margins, and complementary product/service offerings. Joe
Johnson Equipment fit the bill, and FSS inked a deal to buy JJE for $93 million
less than three months after dumping Bronto. JJE brings to the table C$162 in
annual revenue from selling and renting vacuum trucks and sewer equipment in
Canada. The business offers a great platform to distribute existing
complementary products in new geographic markets and nearly doubles service
center locations. JJE should also be accretive to earnings by year end and
provide margin upside to the current business as shared infrastructure costs
are stripped out and the business scales.
Source: FSS Investor
Presentation
Management has
begun to position the business to be more flexible and nimble in reacting to
potential M&A opportunities, including signing a new $325 million credit
facility. Addtionally, continued product innovation in the legacy industrial
business should provide further upside as new products enter the municipal
market over the next year.
What
has the stock done lately?
FSS flirted with $17 last
December following the announced sale of Bronto; however, the stock responded
poorly to the news of the JJE acquisition, but is up 17% since then. The stock
is within 1.3% of its 100 day moving average and the successful integration of
JJE should provide a positive catalyst for the stock.
Past
Year Performance:
FSS is down 16.5% in the last
year, with valuation being hurt by exposure to the Oil & Gas industry. The
merger news pressured the stock further. A return to the 10-year average P/E
multiple would imply a 24.0% upside from the current stock price of $13.88.
Management’s recent recommitment to provide a competitive dividend should also
drive value (2.0% yield at current run-rate).
Source: FactSet
My
Takeaway
Federal Signal Corporation has a
clear plan to acquire accretive businesses that have the potential to expand
geographic reach and add complementary products to FSS’ current offerings. Joe
Johnson Equipment fits the bill, and should provide a great platform upon which
to grow the business across North America. The strategic review that led to
this decision has given management a focus and clear set of objectives to
improve the business, and JJE is an indication that management can execute on
this strategic plan. JJE and further M&A should provide FSS with just the
boost they need to regain investor confidence and drive the stock’s performance
over the next 52 weeks.
Source: FactSet
