Expecting Upside in Celestica Following Earnings

Several firms comment on Celestica (NYSE:CLS) after the company released its Q2 results last night:

- Citigroup notes Celestica’s June results and outlook were better than expectations. The stock was up +3.5% in after hours trading (after trading down 4% during market hours) as some investors had expected a large miss this quarter, but instead the company showed slow and steady progress.

Firm says CLS saw q/q growth in most of its end markets, including telecom, server, industrial/defense/aerospace, & consumer/auto/medical; Also closed 3 additional Mexico inventory warehouses bringing its number in this location from 7 in March to 4 in June; & decreased inventories in Mexico by 45%; Inventory work down of -11.6% or -$126m compares favorably to SeptQ sales outlook of +3-16% q/q.

On the negative side, despite significant restructuring & employee reductions Celestica's profitability has not improved much — operating margins at 1.1% (up from 0.3% last quarter) remained below EMS average of 2.3%; Mexico operations continue to disappoint and are a quarter behind management’s expectations.

Firm maintains Hold rating and $7.50 tgt representing 31.6% upside.

- Banc of America notes they believe management is making progress streamlining operations despite continued challenges in Mexico and Europe. 2Q07 revenue of $1.94B was in-line with our/consensus view, while EPS of $0.02 (ex-items and pre-options) beat by one cent on a slightly better-than-expected operating margin of 1.1% (versus BAC's 0.9% estimate and 0.3% in 1Q).

Celestica guided to 3Q07 revenue/EPS of guidance of $2.1B/$0.08 (midpoints) compared to BAC's $2.05B/$0.04 and consensus of $2.06B/$0.06. Management confidently stated that the company would deliver Q/Q improvement through year-end, even in Mexico, and seems unconcerned about losing business with top ten customers. They watch for further improvement. Firm's 2007/2008 EPS estimates increase to $0.17/$0.60 from $0.09/$0.46 (pre-options) on lower operating expenses. Tgt is upped to $6.50 from $6.

Notablecalls: Looks like CLS managed to squeeze out results that were better than expected. The stock has taken a bad beating and I think that at least some shorts were caught off guard.

While I acknowledge the lack of improvement in Mexico and Europe, I think CLS may be in the early stages of margin recovery. They are closing down warehouses and cutting inventory. Management sounded optimistic regarding Q3, saying they hope to realize some relief in Mexico during Q3/07 due to benefits from programs that have been shifted to Asia, higher consumer revenue from existing programs and the elimination of several million dollars in Q2 customer disengagement costs.

I expect to see upside on CLS today. Note that CLS's tangible book value is $5.20. Tangible book value has historically represented a trough valuation during challenging times.