CLS:CC - Celestica: Uncovering A Hidden Gem In The Tech Industry

2023-11-19 04:17:27 ET

Summary

• Celestica Inc. specializes in design, manufacturing, and supply chain solutions for innovative companies across various sectors.
• The company has impressive financials, recently exceeding revenue expectations and demonstrating significant growth in its Advanced Technology Solutions segment.
• Celestica's strategic initiatives in artificial intelligence and data center infrastructure and undervalued market valuation make it an attractive investment opportunity.

Investment Thesis

Despite the competitive landscape, Celestica Inc. (CLS) has broad service offerings and a strategic focus on lifecycle solutions, positioning it as a crucial partner for businesses aiming for growth and innovation. Recently, Celestica reported impressive third-quarter earnings, where the company not only exceeded revenue expectations but also demonstrated significant growth in its Advanced Technology Solutions segment. There is great emphasis on the company's optimistic guidance for the upcoming fourth quarter and the upward revision of its full-year forecasts, reflecting strong business performance and a positive outlook.

I believe Celestica has long-term growth with its strategic initiatives in artificial intelligence and the development of advanced data center infrastructure, highlighted by the launch of the 800G Power Switch. Celestica also has a solid balance sheet, great liquidity, and a planned share repurchase program, which illustrates a commitment to enhancing shareholder value (Q3 earnings transcript).

Moreover, the company market valuation appears to be undervalued in light of its growth trajectory and market position. Celestica is also successfully navigating through current supply chain challenges, cementing its status as an attractive investment opportunity with a forward-looking approach.

Introduction

Celestica specializes in comprehensive design, manufacturing, and supply chain solutions for innovative companies across various sectors, including aerospace, defense, healthtech, and industrial markets. It operates through two main segments: Advanced Technology Solutions and Connectivity & Cloud Solutions, with a significant global footprint of 42 locations. Celestica's ideal clients range from large enterprises to technology firms seeking advanced manufacturing and supply chain optimization. The company faces stiff competition from other industry leaders like Plexus, Jabil, Foxconn, and Sanmina.

Financials

In the third quarter, Celestica posted revenue of $2.04 billion, exceeding the high end of its guidance range of $1.90 billion to $2.05 billion. The strong 6% year-over-year revenue growth was driven by the company's Advanced Technology Solutions ((ATS)) segment, which saw a 12% increase, and its Connectivity & Cloud Solutions ((CCS)) segment, which grew 2% versus the prior year period.

The ATS segment revenue growth was led by strong demand in Celestica's industrial, aerospace and defense, and health tech businesses. Meanwhile, the CCS segment continued to benefit from robust customer investments in artificial intelligence infrastructure, offsetting anticipated softness in its communications business (Q3 earnings transcript).

In addition to the top line beat, Celestica delivered non-International Financial Reporting Standards (non-IFRS) adjusted earnings per share of $0.65, handily surpassing the high end of its guidance range of $0.56 to $0.62 (Q3 earnings release). The combination of higher revenues and solid cost management drove substantial margin expansion in the quarter.

Specifically, Celestica's non-IFRS operating margin came in at 5.7%, up 60 basis points compared to 5.1% in the year-ago period (Q3 earnings release). The company has now delivered 15 consecutive quarters of year-over-year non-IFRS operating margin expansion, highlighting its consistent execution.

Upbeat Forward Guidance

Along with the strong third quarter results, Celestica also issued upbeat guidance for the fourth quarter of 2023. The company expects Q4 revenue in the range of $2.0 billion to $2.15 billion, which would represent a slight increase versus the prior year period at the mid-point of the range (Q3 earnings release).

Celestica also guided for Q4 non-IFRS adjusted EPS of $0.65 to $0.71, reflecting approximately 23% growth year-over-year at the mid-point (Q3 earnings release). This demonstrates continued momentum heading into the final quarter of the year, which is a very positive note.

Furthermore, management raised its full year 2023 outlook based on the strong year-to-date performance. Celestica now expects revenue of $7.9 billion (up from at least $7.85 billion previously) and non-IFRS adjusted EPS of $2.36 (up from $2.25 previously), which personally makes my confidence soar when a company hikes its guidance estimates (Q3 earnings release).

The company also boosted its 2023 non-IFRS adjusted free cash flow guidance to $150 million, up from its prior outlook of $125 million (Q3 earnings release). The increased free cash flow projection reflects growing cash generation capabilities, yet another favorable detail.

My Unique Perspective Of Patterned Growth And Innovation

Diving deeper than the typical earnings analysis, my investigation into Celestica's financial standing post Q3 earnings reveals the robust growth of the ATS and the consistent contributions from the CCS segment, illuminating a business model that is not only diversified but strategically aligned with market demand. It is estimated that as of the beginning of 2023, Celestica held approximately 9.41% of the market share relative to its competitors within the Technology Sector.

Celestica's financial discipline is highlighted in its operating margin trends over 15 quarters, showcasing a company that doesn't merely grow but does so with increasing profitability. Such an extended period of margin expansion underscores a strategic mastery over cost management and operational efficiency that is often neglected in less detailed evaluations. Also, the company's share repurchase initiatives offer investors a clear indication of the tangible benefits of the company's financial strategies, particularly as it pertains to shareholder value.

Furthermore, Celestica's strategic initiatives, such as the introduction of the innovative 800G Power Switch, illustrate the backdrop of heightened market demand for sophisticated data center solutions. This move by Celestica, who’s customers include IBM, Intel, HP and over a hundred more, is presented not just as a product launch but as a leap to capture market share in the high-growth of AI and machine learning (Q3 earnings transcript).

CEO and President of Celestica, Rob Mionis, added:

“Market observers have suggested that we may be in the early days of this long-term secular trend accompanied by a major hardware upgrade cycle to support artificial intelligence applications and the resulting increase in data center traffic. We believe that the different stages of this investment cycle will be synergistic and support demand for our entire suite of data center offerings at various times throughout the entire cycle.” - Q3 Earnings Transcript

Long-Term Growth Drivers

Celestica continues to see strong tailwinds driven by new program ramps and ongoing investments in key secular growth areas like artificial intelligence, advanced data center infrastructure, and 5G network upgrades.

In particular, Celestica noted that it is seeing tremendous momentum with its hyperscale customers, reflected in 31% year-over-year revenue growth in its enterprise end market in Q3 (Q3 earnings transcript). The company remains very bullish on multi-year growth from hyperscalers as they build out capacity to support artificial intelligence workloads.

Celestica also recently announced its 800G Power Switch, which provides next-generation high-density and high-performance solutions to meet increasing data center networking requirements. The new 800G platform highlights Celestica's capabilities in developing cutting-edge infrastructure for artificial intelligence and machine learning applications.

Market observers believe it is still in the early stages of a long-term upgrade cycle driven by cloud and enterprise investments to support surging data traffic and AI adoption (Q3 earnings transcript). Overall, Celestica is well-positioned to benefit from these strong secular tailwinds.

Capital Return Potential

Celestica maintains a strong balance sheet, ending Q3 2023 with a net debt position of $260 million and liquidity of approximately $1 billion. The company's gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio improved to a very healthy 1.1x as of Q3 2023 (Q3 earnings transcript).

The robust cash flows and pristine balance sheet give Celestica considerable financial flexibility. Management stated that the company intends to launch a new Normal Course Issuer Bid (NCIB) in the fourth quarter to repurchase shares, demonstrating its commitment to return capital to shareholders (Q3 earnings release).

Mandeep Chawla, CFO of Celestica, reiterated:

"We do, however, intend to continue to be opportunistic on share repurchases under our current NCIB for the remainder of the year and intend on renewing our NCIB program in December.” - Q3 Earnings Transcript

Celestica aims to repurchase up to 10% of its outstanding public shares over the next year, pending approval from the Toronto Stock Exchange. The program, set to follow the expiration of the current one in December 2023, underscores the company's confidence in its financial health. If sanctioned, the purchases will be executed through public market transactions on both the TSX and the NYSE within the stipulated guidelines (Q3 earnings transcripts). Meanwhile, these continued buybacks funded through free cash flow provide great upside to EPS growth.

Risks

Although Celestica has delivered strong results recently, several risks remain that could derail the stock's robust 140% surge year-to-date. Firstly, such a parabolic rise in a short period of time increases the risk of a pullback as investors book profits. Furthermore, the company relies heavily on a few large customers like Cisco (CSCO) and IBM (IBM), so loss of business from any major client could impact sales and profitability. With Celestica ramping up multiple new programs, this presents execution risk if faced with manufacturing issues or delayed timelines, therefore, possibly causing a pull back in the stock. While Celestica's growth outlook appears positive, its concentrated customer base and newer innovations could interrupt its current business momentum. Investors should monitor how effectively Celestica manages these risks going forward.

Deep Value

Despite the strong results and outlook, CLS stock trades at a very attractive 0.41x forward price-to-sales, which can be viewed in the table below. This represents a 83% difference to its 5-year average of 0.22x. The company's leading market share in high-growth end markets combined with consistent execution supports a reason for upward growth. While supply chain constraints and component shortages pose near-term headwinds, Celestica has proven to navigate these challenges over the past year without material impacts.

With the stock trading at 11.43x forward non-GAAP P/E (half of what the sector median is trading at), rewarding shareholders through buybacks, and anticipated EPS growth, Celestica appears attractively positioned at current levels for long-term investors (Seeking Alpha Valuation Metrics). Celestica stands out among its peers Plexus (PLXS) and Sanmina ( SANM ) with its strong quarter-on-quarter performance, significant year-over-year revenue growth, a robust balance sheet, and a focused strategy on shareholder value through a buyback program??????. In contrast, Plexus, while favored by the community and institutional investors, shows lower profitability compared to Celestica????. Sanmina faces more significant challenges, with declining revenue and EPS, a negative market reaction, and a diluted focus due to its diversification strategy. Overall, Celestica's growth, return on equity, and financial health give it a comparative advantage over Plexus and Sanmina.

Conclusion

Ultimately, Celestica's strong financial results, bullish management commentary, and attractive valuation make the stock a buy. The company is successfully capitalizing on multi-year growth trends in areas like artificial intelligence, data center infrastructure, and 5G networks. With Q4 revenue projections signaling steady growth and an EPS growth rate that could put a spring in the step of any investor, Celestica is demonstrating great momentum that is attractive to investors. The company's robust balance sheet and strategic capital return initiatives further its position as a compelling value proposition in the tech sector. Trading at a forward P/E that suggests a deep discount to sector median’s, Celestica's stock offers a rare blend of value, growth potential, and resilience. In a world where data is king, Celestica's pivotal role in powering AI and data center infrastructure positions it for steady growth; a “buy” nonetheless.

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