Is Celestica Still Worth Buying after 139% Gain YTD
Celestica’s (NYSE:CLS) stock has been on a strong uptrend in the past year, reaching a 52-week high of $28.39 on November 15, 2023. The stock has gained 139 % since the beginning of 2023, outperforming the S&P 500 index, which has gained 26% in the same period. As the price has risen quickly, investors have grown skeptical and wonder if it is overvalued, overbought, still worth buying, or ready for a drop.
Even though short-term corrections are anticipated, we remain confident in the stock, with a price target of $63, which means more than 100% rise from the current levels. Celestica’s unique value proposition, strong financial results, and involvement in high-growth markets such as AI will continue to drive its growth and profitability in the future.
In this article, we will focus on the CCS segment of Celestica, which we see as the key growth and profitability engine for the company because of its unique value proposition in the industry. We will converse why Celestica has become the preferred partner for Hyperscalers, and what differentiates Celestica CCS solutions from its competitors. We will also perform a valuation based on its growth projection and market potential.
Celestica – An Innovative EMS Company with a Global Supply Chain
Celestica is a Canadian EMS company that offers design, manufacturing, and supply chain solutions for various industries, such as aerospace, defense, communications, healthcare, and industrial. It has a diverse business portfolio and operates in high-growth markets that are being driven by secular trends such as AI, cloud, smart buildings, electric vehicles, industrial automation, surgical robots, health devices, drones, satellites etc.
The company operates an impressive global supply chain network which consists of 40 sites in 16 countries. The regionalization of its business is a big competitive advantage as it strengthens its supply chain resiliency and business agility. This distributed model can quickly reply to changing customer demands, business disruptions, or regulations in local markets which is a very important requirement for big multi-national customers. These Tier-1 customers look for reliable supply chain partners that can design, manufacture, and uphold their products across the globe with efficiency, high quality and business continuity.
Celestica has two business segments: Advanced Technology Solutions (ATS) and Connectivity & Cloud Solutions (CCS). Th ATS Segment is 43% of the business and has been growing at a 17% CAGR last three years. Company is targeting 10% annual growth for its ATS business on the long term.
The CCS Segment: Growing in a Slowing-Market
The CCS Segment, which covers the Communications and Enterprise sectors, makes up 57% of Celestica’s revenue and has been expanding at a 7% CAGR since 2020. Despite the global economic slowdown in the communications and enterprise sectors, Celestica’s CCS Segment continues to grow, outperforming its peers who are experiencing business declines. The driving force behind the CCS segment growth are the Hyperscalers.
Why Do Hyperscalers Prefer Celestica?
Hyperscalers are the mega-scale cloud service providers that necessitate massive amounts of datacenter hardware to power their platforms. Due to their unique requirements, Hyperscalers are pivoting from off-the-shelf hardware to custom solutions can be optimized for their special workloads. They are increasingly looking for custom silicon’s for their platforms and creating their own custom compute, storage and networking solutions. For example, Google has created custom Cloud TPUs for AI workloads, Microsoft just announced their custom designed Azure CPU and GPUs. Amazon has its own AI chips, Trainium and Inferentia and its CPU Graviton. These custom silicon systems necessitate very special kind of rack, form-factor, power, cooling and packaging systems which is what Celestica is specialized at.
Celestica has a strong relationship with these Hyperscalers. Due to its many years of custom solution expertise (building products for OEMs) and advanced engineering capabilities, Celestica is in a very unique position to offer tailored solutions to face their specific needs. On top of it, Celestica provides product lifecycle services, such as testing, validation, certification, and uphold which are all very high-value services (which equals to high-margins).
Also, Celestica’s global supply chain network provides Hyperscalers with additional advantages. It enables Celestica to deliver products to Hyperscalers with speed, flexibility, and cost-efficiency. It uses its global network of facilities, suppliers, and logistics partners to improve its sourcing, manufacturing, and distribution processes for Hyperscaler companies. These are very key solution capabilities which are not easy to replicate or build from a competition point of view.
You can see below, how important the Hyperscaler business is for Celestica. It constitutes 35% of the overall business and has the highest margins across the segments. It’s remarkable to see that the Hyperscaler revenue has been growing at 48% CAGR, representing a significant growth opportunity for the company.
Celestica is the only EMS provider of this special Hyperscaler category and by serving this niche market, Celestica is differentiating itself from its competitors and capturing the growth opportunities in the segment.
Expansion Opportunity to the Enterprise
Celestica’s HPS portfolio of AI compute, high-end networking and storage solutions are designed to face the high-performance and quality needs of the Hyperscalers. A great market expansion opportunity for Celestica is to position their HPS portfolio to the broader enterprise segment as the AI trend continues to grow into industries. Celestica can offer the Hyperscaler value propositions to the enterprise customers and this would enable Celestica to tap into a larger and more diverse market, and encourage enhance its revenue and profitability.
What we grasp from the company’s virtual Investor meeting is that Celestica is working on this expansion opportunity and building industry specific GTMs around its HPS solutions (see below)
Operational Excellence Driving Margin Expansion
Margin expansion is very key to Celestica’s market valuation. We think it’s the most important financial driver of the company’s shareholder value, as it indicates its competitive advantage and profitability. Celestica is driving operational excellence and margin expansion, as it implements its
Celestica Operating System (COS). The COS is an operational framework that aligns the company’s strategy, with consistent processes and best practices to deliver superior customer value and financial performance. Through the COS, Celestica is improving its productivity, efficiency, and profitability, while generating strong cash flow to invest in growth and return capital to shareholders.
Over the past few years Celestica has shown great operational excellence with consistent improvement in its operating margins (see below). The company expects this trajectory to continue.
Long Term Financial Outlook
Celestica is having a strong performance in 2023, and guiding revenue of $7.9 billion, a 9% enhance over 2022, and adjusted EPS of $2.36, a 24% enhance over 2022. The FY23 operating margin is expected to be 5.5% which is an 12% enhance YoY.
For the long term, Celestica is aiming to grow its revenue at around 7% CAGR and its EPS at 13% CAGR (see below). We think the revenue and EPS projections are quite conservative and expect Celestica to grow minimum at the high-end of their guidance.
Valuation
During the virtual investor meeting, Celestica presented a valuation model that showed its share price as undervalued relative to its EMS peers on a P/E basis (see below). Based on its $2.7 EPS guidance for 2024, Celestica has a forward P/E multiple of 10.3. The average forward P/E multiple of Celestica’s industry peers is 12.2. which implies that Celestica is undervalued by ~20% compared to its peers.
Note: Its EMS peers are Jabil (JBL), Sanmina (SANM), Flex (FLEX), Plexus (PLXS) and Benchmark Electronics (BHE).
The company’s valuation seems to be conservative as it does not capture its potential we think, given its strong business performance and its exclusive Hyperscaler advantages. Besides, Celestica is the only company among its peers that will be growing in 2024, so it deserves a higher multiple.
We want to do a DCF analysis to calculate the fair value of Celestica. We use 10.5% WACC to discount the future cash flows. We take the company guidance of 7% long term revenue growth rate and keep it flat at 7% for 10 years. We apply a 5% terminal growth rate after the 10-year period. Our model starts with 1.9% FCF margin for 2023 and assumes a 10% annual enhance, consistent with the company’s FCF growth guidance (see below).
Our DCF model estimates that Celestica business has a value of $7.5B, with a price target of $63, implying a 130% rise from the current price (see below). We think that Celestica is considerably undervalued at the current price levels.
Risks
We see the following risks for Celestica’s valuation:
- Macro Uncertainties: Celestica is a global company and is exposed to macroeconomic uncertainties, geopolitical conflicts and trade disputes that may affect its customer demand and operational efficiency.
- Competition: The company faces strong competition in a cyclical industry. It has to contend with leading ECMs, ODMs and in some cases OEMs which that may impact its market share.
Conclusion
Celestica is a special company in the EMS industry, with a differentiated portfolio of end markets, a focus on high-value segments, and a strong innovation capability. The company has been delivering solid financial performance and has attractive growth prospects. The stock’s valuation is appealing compared to its peers, and is supported by its growth potential, solid margin expansion and its shareholder returns.
Our DCF valuation estimates that Celestica has an intrinsic value of $63. Despite the recent surge in its stock price, we believe that it has significant upside based on our valuation metrics.
We rate Celestica as a Buy.