Description

Celestica Inc. (CLS) 

Summary 

We focus on smaller companies with “Ft. Knox” balance sheets and large & sustainable free cash flow yields and we are typically seeking a double-digit FCF yield or higher on an unleveraged basis. The objective is for the sustainable FCF to eventually drive up the share price to a more reasonable valuation through share buybacks, debt reductions, dividends, or accretive acquisitions. Obviously, it is important we have a management team that cares about shareholder value. We focus on small-cap stocks because there is a much better chance to find an attractive investment opportunity which is under-followed or undiscovered. 

Celestica Inc. (CLS) provides hardware platform and supply chain solutions in North America, Europe, and Asia. It operates through two segments, Advanced Technology Solutions (ATS), and Connectivity & Cloud Solutions (CCS). The Company offers a range of product manufacturing and related supply chain services, including design and development, engineering, supply chain management, new product introduction, component sourcing, electronics manufacturing, and assembly, and more. It also provides enterprise-level data communications and information processing infrastructure products, such as routers, switches, data center interconnects, edge solutions, and more. The Company serves aerospace and defense, industrial, energy, health-tech, capital equipment, original equipment manufacturers, cloud-based, and other service providers. Celestica, Inc. was incorporated in 1994 and is headquartered in Toronto, Canada. 

CLS has several characteristics that we like including: (1) a highly resilient business model with deep customer relationships, (2) a highly cash-generative business with low capital expenditure needs, (3) a strong focus on higher value-added services with longer-term and “stickier” customer relationships, (4) an attractive valuation trading at 4.5x adjusted EBITDA, (5) a focus on industries that are sustainably growing over the long term, (6) a record of strong sales growth - both organic and inorganic, (7) a disciplined management team focused on accretive acquisitions, (8) a “Ft. Knox” balance sheet with net debt at under 1x adjusted EBITDA, (9) a powerful global footprint, (10) a long-term strategy to grow sales and EBITDA, and (12) a high-ROIC business model with limited capital requirements.

Over the past 5 years, CLS has shifted its business model to much higher value-added relationships with customers with higher margins and longer contract periods.  CLS focused on highly engineered and design solutions to deeply integrate into its customers.  CLS also focused on specific markets and verticals and industries which had strong long-term growth potential.  CLS eliminated lower-margin work and removed some large revenue contracts and relationships with lower margin profiles.  CLS is an industry leader in product and platform solutions across higher value market based on the following goals: 1) grow Lifecycle Solutions revenue by leveraging their leadership position in targeted industries, 2) invest in differentiated capabilities to capitalize on current and future secular tailwinds, 3) drive operational excellence enabled by Celestica Operating System and peer-leading supply chain resiliency. CLS has a solid foundation for growth as demonstrated by their transformation over the last several years in the chart below.

The primary driver of CLS improved growth and financial results has been its Lifecycle Solutions strategy, which is summarized below.  Lifecycle Solutions represent higher value-added and stickier and longer-term relationships with customers and have steadily grown as a percentage of total sales.  Lifecycle Solutions represented about 66% of total sales for CLS in 2022.  We expect Lifecycle Solutions to continue to increase its share of total sales for CLS in the future and drive improved growth and profitability.

CLS has an attractive valuation, especially given its recent growth profile, driven by its Lifecycle Solution strategy.  In 2022, which included the PCI Ltd. acquisition completed in November 2021, CLS grew revenues 29% and adjusted EBITDA 38% and adjusted EPS by 46%.  CLS has 125m shares outstanding trading at about $13.50 per share for a market cap of about $1.65b.  CLS has net debt at 12/31/22 of about $411m.  CLS has an enterprise value of about $2.1b which compares to 2022 adjusted EBITDA of about $465m, or about 4.5x LTM adjusted EBITDA.  Further, CLS earned adjusted EPS of about $1.70 per share in 2022 which compares to its current price of about $13.50 per share or about 8x.  

We believe these multiples are depressed and remain extremely attractive given CLS strong growth in revenue and adjusted EBITDA and adjusted EPS over the past few years.  We believe the market has not recognized CLS more resilient and predictable business model which it developed over the past 5 years and its strong revenue and profit growth in the last couple years.  As CLS continues to execute and grow both organically and inorganically, we believe the market will eventually recognize CLS with more appropriate earnings multiples.

We believe CLS can continue its strong growth trend over the last few years in revenues, adjusted EBITDA, and adjusted EPS.  CLS originally projected adjusted EPS of about $2 per share in 2025 but due to strong recent organic and inorganic growth, CLS expects to achieve close to $2 per share in adjusted EPS in 2023.  We believe CLS can achieve adjusted EPS of $2.50 per share or more by 2025 and trade for a modest 10x multiple of adjusted EPS which would result in a stock price of about $25 per share, as compared to the current $13.50 per share price.  On an EBITDA basis, we believe CLS could grow adjusted EBITDA from $465m in 2022 to $500m or more by 2025 and trade for a modest 6x adjusted EBITDA with net debt close to zero.  Based on 125m shares outstanding, this would result in a share price of about $24 per share.  Further, we believe CLS strategic and diversified manufacturing platform and long-term customer relationships could be attractive to either a strategic or financial purchaser.

Business Description

Celestica, Inc. (CLS) is a small cap stock which is a global leader in innovative end-to-end product lifecycle solutions. It operates through two segments, Advanced Technology Solutions (ATS), and Connectivity & Cloud Solutions (CCS). The Company offers a range of product manufacturing and related supply chain services. The Company serves the Aerospace and Defense, Industrial, Energy, Health-Tech, Capital Equipment industries, among others.

Celestica is focused on enabling the world’s technology brands. The Company is tailoring customer-centric solutions for the markets it serves and operating a global network of sites with specialized Centers of Excellence. 

Celestica is an electronics contract manufacturer based in Toronto, Canada. The Company provides Electronics Manufacturing Services (EMS) and they also provide higher value services, like joint engineering and product development. The Company delivers innovative supply chain solutions globally to customers in its ATS and CCS segments.

The ATS segment is comprised of Aerospace &Defense (A&D), Industrial, Energy, Health-Tech, and Capital Equipment businesses. The Capital Equipment business is comprised of semiconductor, display, and power & signal distribution equipment businesses. 

The CCS segment consists of Communications and Enterprise end markets. The Enterprise end market is comprised of servers and storage businesses. CLS customers include original equipment manufacturers (OEMs), cloud-based, and other service providers, including hyper-scalers, and other companies in a wide range of industries. 

The Company operates a network of sites strategically located in North America, Europe, and Asia, with specialized end-to-end supply chain capabilities tailored to meet specific market and customer product lifecycle requirements. 

CLS offers a comprehensive range of product manufacturing and related supply chain services to customers in both segments, including design and development, new product introduction, engineering services, component sourcing, electronics manufacturing, and assembly, and more. Within design and development, Hardware Platform Solutions (HPS) offering includes the development of hardware platforms and design solutions in collaboration with customers, as well as management of the program’s design and aspects of the supply chain, manufacturing, and off-market support. 

CLS solutions and services create value for customers by enabling their strategies, while accelerating their time-to-market, and by providing higher quality, lower cost, and reduced cycle times in the customers’ supply chains. CLS believes this results in lower total cost of ownership, greater flexibility, higher return on invested capital, and improved competitive advantages for their customers in their respective markets.

Aerospace and Defense

Aerospace and Defense is a leading A&D electronics manufacturing services provider with capabilities to deliver end-to-end solutions. Commercial aerospace has begun its recovery since its pre-pandemic levels and expected to be an ongoing significant driver of growth. CLS designs and produces components, subsystems and systems used in virtually all commercial aircraft in service today. The path to grow includes commercial air traffic increasing and new wins and logos anticipated in Defense, Space, and UAV markets. 

Industrial 

CLS expertise in high volume automated manufacturing and complex product enablement. One of the largest business segments after acquisition of PCI with total revenues of $1.05 billion in 2021. CLS is focused on driving increase share in high growth markets. The PCI acquisition, completed in November 2021, is seeing commercial cross selling synergies bear fruit. 

Capital Equipment 

CLS provides highly specialized solutions for capital equipment industries with a focus on building effective, efficient supply chains to customize growth. The capital equipment industry is constantly evolving to stay ahead of the latest technology innovations. CLS is the largest end-to-end capital equipment manufacturer in the industry with a highly strategic footprint with a focus on high-demand geographies. 

Health Tech 

CLS is partnering with leading healthcare companies to bring critical medical devices to market. The markets CLS serves in the health tech space include surgical instruments, monitoring, imaging, diagnostics, and more as listed in the chart below. CLS plans to expand into high growth markets of renal dialysis, neurostimulation, and dental radiology. 

Hardware Platform Solutions 

Hardware Platform Solutions (HPS) is a leading hardware platform solutions provider for datacenter and network infrastructure markets. The anticipated data center growth is strong over several years and continues to be a growth engine for Lifecycle Solutions. Key capabilities are listed in the chart below including tailor-made network in high-demand geographies, robust design process (500+ engineers and 280+ patents), and leading-edge, customizable hardware portfolio. 

HPS has differentiated itself from its ODM and EMS competitors including a diversified portfolio, diversified global network, customer engagement, and supplier ecosystem. Further information regarding HPS differentiation from its ODM and EMS competitors is outlined in the chart below. 

Additionally, secular growth expected to continue while new demands on data centers further bolster growth. There are various growth drivers that will act as catalysts such as hyper-scalers announcing significant data center capex, aging data centers beginning refresh cycles, AI and machine learning changing data center architecture requirements, and increased investment in modular datacenter and connectivity. CLS has a leadership position in networking, with extensive expertise in niche, high-value storage and compute. 

Highly Resilient Business Model 

CLS has a highly resilient business model with deep customer relationships.  Over the past 5 years, CLS has shifted its strategy towards growing its Lifecycle Solutions revenue to about 66% of total revenue in 2022.  These long-term, design and engineering-driven, higher value-added relationships with customers are much “stickier” and resilient in response to adverse macroeconomic trends.  CLS has become more of a strategic partner to its customers over the last 5 years.  CLS business is more predictable given the stronger and deeper relationships with customers.

Attractive Valuation

CLS has an attractive valuation, especially given its recent growth profile, driven by its Lifecycle Solution strategy.

CLS has 125m shares outstanding trading at about $13.50 per share for a market cap of about $1.65b.  CLS has net debt at 12/31/22 of about $411m.  CLS has an enterprise value of about $2.1b which compares to 2022 adjusted EBITDA of about $465m, or about 4.5x LTM adjusted EBITDA.  Further, CLS earned adjusted EPS of about $1.70 per share in 2022 which compares to its current price of about $13.50 per share or about 8x.  

We believe these multiples are depressed and remain extremely attractive given CLS strong growth in revenue and adjusted EBITDA and adjusted EPS over the past few years.  We believe the market has not yet recognized CLS more resilient and predictable business model which it developed over the past 5 years.  As CLS continues to execute and grow both organically and inorganically, we believe the market will eventually recognize CLS with more appropriate earnings multiples.

Highly Cash Generative Business with Low Capital Expenditure Needs

CLS is a highly cash generative business with low capital expenditure needs. The Company has an attractive unleveraged FCF yield in the high single-digit range. The Company targets $100m or more of annual free cash flow. They have generated almost $1.1b of cumulative cash from operations over the past 4 years, or close to 2/3 of the current market cap.  Also, CLS has modest capital expenditure requirements (1% to 2% of revenues per year).  CLS has completed multiple successful strategic acquisitions with its strong free cash flow, most recently the PCI acquisition in November 2021.  These strategic acquisitions have enabled CLS to significantly strengthen its business model and its resiliency. Due to strong performance, CLS has been able to deleverage its balance sheet after the PCI acquisition and is well-positioned for additional accretive M&A opportunities.  CLS has repurchased substantial shares over time, over 14% of total shares outstanding in the last five years, and over 32% of total shares in the last 10 years. 

Strong Growth in Revenues, Adjusted EBITDA, and Adjusted EPS

Over the past few years, CLS has shown strong growth in revenues, adjusted EBITDA, and adjusted EPS.  In 2022, which included the PCI Ltd. acquisition completed in November 2021, CLS grew revenues 29% and adjusted EBITDA 38% and adjusted EPS by 46%.  While we expect growth to moderate in 2023 as CLS comps these strong results, we believe CLS can continue to grow over time as it executes its Lifecycle Solutions growth strategy and these revenues become an increasingly large share of total revenues.

“Ft. Knox” Balance Sheet

CLS has a “Ft. Knox” balance sheet with $375 million in cash and $411m net debt as of 12/31/22. Net debt to adjusted EBITDA is less than 1x LTM adjusted EBITDA.  CLS has reduced leverage after the successful acquisition of PCI Limited in November 2021.  We believe CLS is well-positioned to make further accretive acquisitions like PCI Limited and drive additional shareholder value.  Its “Ft. Knox” balance sheet reduces risk and enables CLS to take advantage of strategic opportunities. 

Focus on Industries and Segments that are Sustainably Growing Over the Long-Term

The Lifecycle Solutions segment has been the CLS growth driver. Lifecycle Solutions are higher value-added and longer-term and “stickier” customer relationships. The growing Lifecycle Solutions revenue concentration has enabled long-term profitable growth.  Life Cycle Solutions has become a progressively larger share of total revenue. Lifecycle Solutions revenue consists of combined ATS segment and HPS business revenues. HPS business revenues are in CLS’ CCS segment and primarily represent revenues related to datacenters and hyper-scaler customers, an area of strong growth in recent years and expected to continue into the future.  Additional industries with strong long-term growth profiles in Lifecycle Solutions are aerospace and defense (A&S), industrial, health-tech, and capital equipment.  Growth in Lifecycle Solutions business increases diversification and exposure to markets with “stickier” customer relationships, faster growth, and accretive margins. Lifecycle Solutions represented about 66% of CLS’s revenue in 2022. Additionally, Lifecycle Solutions has had a 10% growth CAGR since 2017 with 10%+ annual revenue growth objective through 2025. 

Disciplined Management Team Focused on Accretive Acquisitions

We have observed the management team of CLS for several years, including the last 5 years where they developed their Lifecycle Solutions strategy to drive resilient and reliable growth into the future.  We believe they are highly disciplined with a strong focus on resiliency and profitability and return on invested capital.  They have executed multiple highly successful and accretive acquisitions, most recently with PCI Limited in November 2021.  They have paid down net debt after the PCI acquisition to position themselves for additional accretive M&A opportunities.  We believe they have executed well during the supply chain problems and Covid pandemic issues.  

When supply chain issues drove customers to request CLS to hold larger inventories to provide safety stock to make sure their orders could be filled, CLS required these customers to post large cash deposits against these increased inventories.  In this way, CLS was able to hold larger inventories and protect customer sales orders and relationships while requiring the customers to finance the increased inventories.  This allowed CLS to maintain a high return on invested capital as higher inventories were offset by higher cash deposits.  This is just one example of management highly disciplined approach to capital allocation and both organic and inorganic investments.

Focus on Higher Value-Added Services with Stickier Relationships with Customers 

CLS has adopted its Lifecycle Solutions strategy over the past 5 years and these relationships are higher-value added, higher-margin, and more resilient with customers.  Lifecycle Solutions has a strong focus on engineering and design services which are specific to customers and often designed into their manufacturing programs far in advance.  These sales relationships are more deeply integrated with CLS as a strategic partner to customers rather than a supplier of commodity good and services.  The result has been more stable and predictable revenues, profits, and cash flows as the Lifecycle Solutions programs have become a progressively larger share of total revenues, representing about 66% of total revenues in 2022.  The market continues to not recognize this major shift in CLS business model to a higher margin, more resilient and strategic relationship with customers and a more recurring revenue base.

Powerful Global Footprint 

CLS has a powerful global footprint with over 40 sites in CLS network, spread across 15 countries, a diversified footprint is key to CLS success. Not only is CLS able to serve customer needs across the globe, whether that is high-touch design or low-cost manufacturing, diversification has helped partially mitigate geopolitical concerns and Covid impact over the few years. 50% of capacity is in Southeast Asia, a highly sought-after geography. CLS has a strong presence in North America and Europe to capitalize on increasing levels of regionalization. Operational excellence is not just about having the right number of sites in the right locations, you need a system for ensuring consistent execution and continuous improvement of safety, quality, cost, and delivery. CLS operating system was deployed to drive global standards in operations while at the same time empowering local leaders to drive results. 

Catalysts

• Highly cash-generative business model.
• Low valuation at 4.5x adjusted EBITDA and 7x adjusted EPS est. 2023
• Attractive free cash flow yield in high single digits.
• Continued steady growth of revenues, adjusted EBITDA, and adjusted EPS.
• Business model is resilient, not recognized in market valuation.
• Long-term and deeply integrated customer relationships are significant barriers to entry.
• Excellent management team focused on shareholder value.
• Strong track record of highly accretive acquisitions.
• “Ft. Knox” balance sheet.
• Further accretive acquisitions like PCI Limited in November 2021.

Risks

• Severe downturn in U.S. and global economies
• Business segments are less resilient than expected – e.g., Capital Equipment segment in ATS is expected to be down in 2023
• Poor acquisition which hurts shareholder value

Catalyst

See above