Friday, April 29, 2016

61st AIM Equity Update by Michael Reardon. Federal Signal Corporation (FSS): “Acquisitions a Signal of Firm's Plans for Future Growth”

 Federal Signal Corporation (FSS, $13.88): “Strategic M&A Provides Signal of Future Growth”
By: Michael Reardon, AIM student at Marquette University

 Image result for Federal Signal Corporation
Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

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