Celestica: Why I’m Buying This Stock (NYSE:CLS)

Investment Thesis

Celestica (NYSE:CLS) delivered Q4 results that were slightly better than I expected. But as I’ve stated throughout, as an inflection investor, it’s much more important to understand and gauge what investors are pricing in, rather than simply picking out high-growth stocks.

That being said, I am pleasantly surprised by the strength of Celestica’s Q1 2024 outlook. Even though management has not put out particularly bullish guidance for 2024, I believe that management is simply being prudent this early into 2024.

I estimate that Celestica is priced at approximately 21x this year’s free cash flow, a figure that I believe is most attractive for a business that’s growing at 12% CAGR this year.

My price target of $45 per share by summer of 2025.

Celestica’s Frame of Reference

As you’ll see throughout, I believe that management has been super conservative with its guidance. As a point of reference, Celestica’s Q1 2024 already points towards its EPS growing by 60% y/y, clearly massively beating my previous estimate for 15% CAGR in 2024. At the current run rate, I believe that Celestica could easily deliver +$3.00 of EPS in 2024, a 23% y/y CAGR rather than the 15% CAGR I was previously expecting.

All in all, there’s a lot to like here.

Why Celestica? Why Now?

Celestica provides design, manufacturing, and supply chain services to various industries, including technology, healthcare, and aerospace. Acting as a partner for businesses, Celestica supports clients in bringing their products to market by offering services like product development and supply chain management. The company’s optimistic guidance for the fourth quarter of 2023 suggests promising near-term prospects.

Celestica has 2 main segments, Advanced Technology Solutions (“ATS”) and Connectivity & Cloud Solutions (“CCS”).

Robust growth in the CCS, driven by data center capacity investments, positions Celestica for a solid 2024.

However, once again, Celestica notes that it faces challenges in the capital equipment sector, where there is ongoing market softness. The broader wafer fab equipment market is also affected by soft demand in the semiconductor industry. But I hope this will soon improve.

Given this context, let’s discuss its financials.

Revenue Growth Rates Should be +12% in 2024

Celestica put out guidance that it could deliver 18% growth at the high end in Q1 2024. Even if this is all, there is for Celestica in Q1, given that the comparables with the prior year were toughest in Q1, this naturally implies that the remainder of 2024 should be growing by at least 15% CAGR.

I recognize that this is different from what Celestica guides for when it guides for at least 8% y/y (or $8.50 billion in 2024). But context matters. Celestica wouldn’t want to give out all the good news together with its Q4 2023 results and have nothing to deliver throughout the year.

After all, what investors love is a steady drip of positive news. And what investors hate is a company that overpromise and underdeliver. Given the strong Q4 results that Celestica put out where they beat the high end of their Q4 revenue guidance by 300 basis points, there’s no need for it to promise too much at this juncture.

Therefore, I’m reassured that Celestica should deliver around 12% CAGR in 2024. I know that this doesn’t sound like much of an increase from the 10% that I previously expected, but again, we are talking about a slow growth business. These small changes can have a dramatic impact on the valuation that investors will be willing to pay.

Essentially, I would say this is the core of what I buy into: stocks that are going to inflect higher, but expectations are still muted.

Given this background, let’s discuss Celestica’s valuation.

CLS Stock Valuation – 21x Free Cash Flow

Celestica holds a net debt position of $240 million. This is down from the $260 million reported in the previous quarter, Q3 2023.

Next, consider the graphic that follows.

What you see here is that Celestica raised its free cash flow outlook so that it will deliver at least $200 million of free cash flow. Of course, it’s still early in the year, and I would hope this free cash flow will ultimately reach closer to $220 million by year-end. A figure that strikes me as being within Celestica’s reach.

Therefore, taking my estimate of $220 million of free cash flow at face value, this leaves Celestica priced at 21x forward free cash flow, a figure that I believe is most reasonable for a business growing at approximately 12% CAGR in 2024.

On top of this, management has stated that it will return to shareholders a portion of its free cash flows. But given that in Q4 these repurchases amounted to less than 1% of its total shares outstanding, I’ve not put any weight on future share repurchases going forward.

Celestica may indeed repurchase some of its shares in 2024, but this will not be a needle-mover for my thesis.

The Bottom Line

In conclusion, my recommendation and investment in Celestica is strategically focused on its role as a low-growth yet undervalued stock, providing diversification in my portfolio.

The company’s recent Q4 results and optimistic Q1 2024 outlook align with my expectations.

One key factor that reinforces my confidence in Celestica is its valuation at approximately 21x free cash flow. Despite being a slow-growth business, this valuation appears attractive, especially considering the projected 12% CAGR in 2024.

The company’s commitment to returning a portion of its free cash flows to shareholders further supports its appeal. Therefore, maintaining my price target of $45 per share by the summer of 2025, I believe Celestica’s undervalued position and solid financial outlook make it a compelling investment for the long term.