2023-08-03 16:07:10 ET
Summary
- Celestica Inc. (CLS) is a $2.5-billion market cap company based in Toronto, Canada, that offers supply chain solutions across North America, Europe, and Asia.
- The end market in which the company operates - Hyperscale Cloud Platforms - is expected to grow at a CAGR of 37.8% over the next few years.
- CLS's commitment to shareholder value was demonstrated through share repurchases, with the company purchasing ~1.4 million shares during the 2nd quarter.
- Most of CLS's valuation multiples are 50-80% lower than those of the IT sector.
- Aside from a possible multiple expansion, the stock has a chance to grow at a CAGR of ~17% over the next 2 years, so I recommend you take this opportunity.
The Company
Celestica Inc. ( CLS ) ( CLS:CA ) is a $2.5-billion market cap company based in Toronto, Canada, that offers supply chain solutions across North America, Europe, and Asia. According to the latest quarterly 6-K filing , CLS operates through 2 segments:
- Advanced Technology Solutions [ATS] - 44% of total revenue - delivers innovative supply chain solutions to customers in Aerospace and Defense (A&D), Industrial, HealthTech, and Capital Equipment industries;
- Connectivity & Cloud Solutions [CCS] - 56% of total revenue - focuses on providing supply chain solutions to customers in the communication and enterprise sectors, particularly those related to servers and storage.
In other words, the company provides a wide range of product manufacturing and supply chain services, including design, engineering, component sourcing, electronics manufacturing, testing, logistics, and after-market repair. They also offer hardware platform solutions and management services for various industries, such as aerospace, defense, HealthTech, capital equipment, and communication and enterprise markets.
CLS reported strong financial results in Q2, with revenue of $1.94 billion, exceeding expectations , and a record non-IFRS operating margin of 5.5%. The company's focus on operational excellence and diversified portfolio contributed to its success, according to the management's commentary during the earnings call , with solid growth in the Connectivity & Cloud Solutions segment driven by hyperscaler business. The key margins and ROIC expanded quite meaningfully QoQ and YoY this quarter:
In addition to the above strong financials from the income statement, Celestica's focus on cash flow generation was evident in their non-IFRS adjusted free cash flow of $67 million, the highest quarterly result in over three years. In GAAP terms, the FCFF amounted to $94.9 million, according to Seeking Alpha data - that's a YoY growth of 15.6%. I'm impressed with Celestica's approach to generating its FCF, as it stems from its effective management of working capital.
As I can see from the filings, Celestica's cash balance amounted to $361 million by the end of Q2, down $5 million YoY but up $42 million sequentially. They had total liquidity of ~$1 billion, including borrowing capacity. The gross debt was $618 million, down $5 million QoQ, resulting in a net debt position of $257 million [IFRS data]. The company's gross debt to non-IFRS trailing 12-month adjusted EBITDA leverage ratio was 1.2 turns, indicating reduced leverage compared to the previous year.
Leaning on the above strong results, Celestica's management raised its FY2023 outlook, expecting revenue of at least $7.85 billion, and non-IFRS adjusted EPS of $2.25, reflecting continued growth and market opportunities:
And I believe such management projections are justified if we recall the reasons for the company's recent growth (including the Q2 data). The end market in which the company operates - Hyperscale Cloud Platforms - is expected to grow at a CAGR of 37.8% over the next few years, according to a recent Fortune Business Insight report :
The opportunities for CLS here are tremendous. If we examine the recent quarters, the revenue from Hyperscalers has shown steady growth with a CAGR of ~51%. This suggests that the company is not only focused on maintaining its current market share but also aims to expand it.
Furthermore, CLS's commitment to shareholder value was demonstrated through share repurchases, with the company purchasing ~1.4 million shares during the quarter.
That is, while the company continues to enjoy the rapid expansion of the market, generating a return on investment of over 20%, it does not forget to share the fruits of its labor with its shareholders - this is very important for any growth story, in my view.
Overall, I like the financial position CLS has achieved in recent quarters and the outlook for the foreseeable future. But apparently, I'm not the only one who likes it - CLS stock has doubled in the last year:
Further growth is likely to depend on whether the valuation of the company is still attractive today. Let's tackle that together.
The Valuation
CLS has a strong "A" rating under the Seeking Alpha Quant System because most of its valuation multiples are 50-80% lower than those of the IT sector :
Looking at next year's EV/EBITDA, we see that the current multiple is slightly below the long-term average, and the 2-year EBITDA growth forecast looks too low when we consider how fast the addressable CLS market is growing and the prospects for gross margin expansion next year (on a TTM basis, CLS has only generated ~9% gross margin, which is extremely low and should continue to grow, in my view).
So let's assume that the company's revenue actually increases to $7.85 billion in FY2023 (as guided) and only increases by 5% year-over-year in FY2024. If we then assume a further EBITDA margin expansion up to 6.5% (from the current TTM of 5.55%), we will achieve an EBITDA of $536 million in FY2024. At an EV/EBITDA of 7x, we should have an enterprise value of ~$3.75bn, which equates to an equity value of ~$3.49bn after adjusting for net debt. This is 37% higher than today's value. And I am not talking about multiple expansion here, which would be absolutely normal in the case of the CLS, which is trading at such large discounts to the market as it is now.
The Bottom Line
There are certainly some risks to my thesis. First , I am confused by the persistently low margins of Celestica's business. A fluctuation in its end markets and a possible decline in business could hit the bottom line hard, making CLS much riskier than many other companies in terms of operational sustainability. Second , if home markets are forecast to grow 30-40% annually in the future, that will attract a large number of firms who want "their piece of the growth pie" - competition promises to be fierce, and CLS will have to work hard to cope with it.
Despite the risks, CLS looks like an attractive long-term investment in my opinion, as the company has good prospects for expanding its profit margin and market share in the fast-growing end-market and is also favorably valued today.
Aside from a possible multiple expansion, the stock has a chance to grow at a CAGR of ~17% over the next 2 years, so I recommend you take this opportunity.
Thank you for reading!
For further details see:
Celestica: A Top-Rated Stock To Keep An Eye On