Celestica: Positives Are Priced In Despite Encouraging Q2 Revenue Growth

Summary

• Celestica delivered decent revenue growth in Q2 after many quarters lacking growth.
• Operating profit and the bottom line did not benefit from growth as restructuring and other charges continued.
• Celestica is priced fairly at best under the assumption of better margins and significantly higher bottom line in 2019.

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Celestica (NYSE:CLS) finally delivered some revenue growth in Q2 after a very long period. Unfortunately, operating margin and the bottom line did not benefit from this due to continuing restructuring and transition charges. Though we expect Celestica to continue growing its more profitable ATS business, it is unlikely to create meaningful improvement in its bottom line in 2018. Furthermore, the stock seems to have priced in the possible margin and bottom line improvements which will take place in 2019.

Financial Overview

Let us quickly go over Celestica's long-term financial performance:

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Over the 3-year period from 2014 to 2017, Celestica failed investors with a cumulative revenue growth of only 8.5% from $5631M to $6111M. During this period, gross margin hovered between 6.7% and 7.0% while operating margin averaged 2.4%. Due to plenty of restructuring and other "one-off" costs, Celestica's net margin remained under pressure with an average of 1.8%. Net income remained almost flat at $105M over the 3-year period. In summary, Celestica has been running a low-margin business and delivered no real growth over the past few years.

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Let us review the company's Q2 18 earnings:

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Celestica achieved a surprising revenue growth of 8.8% yoy with revenues rising from $1559M in Q2 17 to $1695M in Q2 18. However, gross profit declined by 4.8% yoy and gross margin contracted by 80 bps with respect to last year and came down to 6.0%. Gross margin has been on a consistent downtrend over the same period. Similarly, operating margin shrunk to 1.5% from 2.6% a year ago with an operating income of $26M. Finally, the company ended with $16.1M net income with a net margin of only 0.9%. Over the last three quarters, Celestica has been operating with a steady operating margin around 1.5% and a net margin of 0.9%. Until there is some material improvement in profitability, investors would do well to assume that the current tight margins will persist.

According to company management, lower yoy net earnings were driven by lower gross profit and higher other charges, including higher restructuring, Toronto transition, and acquisition-related costs. Most of these charges will persist at least through the end of the year.

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On the flip side, Celestica still has no net debt and sits on a net cash position of $51M as of Q2 18. More importantly, Celestica has been growing its more profitable ATS segment both organically and inorganically. Once restructuring and other charges are done with, the company that emerges could end up with a portfolio that generates higher margins and bottom line. This is what management aims for.

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Management Guidance

Management guided for $1650M-1750M in revenues for Q3 during the earnings call which indicates that the decent growth will continue into next quarter. Though management uses adjusted figures, we assume a 20 bps sequential improvement in operating & net margins for the next quarter. This would take Q3 18 net earnings to roughly $19M with similar restructuring costs. Management affirmed that Celestica will continue its efficiency program into the first half of 2019. This means over the next four quarters, $25-50M in restructuring expenses will be realized.

Valuation Not Attractive

Taking into account Q2 18 figures and management guidance, we estimate that Celestica will complete 2018 with $6550M in revenues which will indicate a yearly revenue growth of 7%. We expect $98M in operating income and $65M in net earnings. At $12.00 per share, Celestica has an MCAP of $1680M and it trades at 25.8x 2018 P/E and 0.26X P/S. We believe the P/E multiple is expensive and the P/S multiple is not particularly attractive given the company's low margins. If restructuring and transition charges became subdued in 2019 and Celestica managed to double its bottom line towards $130M, the stock would be trading at 12.9X 2019 P/E. For a low-margin company that struggles with growth, we would view this multiple as fair. Therefore, we believe most of the positives that may be delivered by management over the next 1-1.5 years are already priced into current stock prices.

The Chart

CLS has a rather positive outlook from a technical perspective. The stock held firm at the formidable $10.00 support level and settled into the trading range of $11.50 and $12.50. If CLS tests the $12.50 resistance, the stock is likely to break out and reach $13.50 in a quick mini-rally.

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Conclusion

After a long period of no-growth, Celestica's Q2 18 revenue growth was freshening. Management's guidance indicates that growth will continue particularly in Celestica's more profitable ATS segment. However, the company's operating and net margin remain under pressure thanks to continuing restructuring, transition, and other charges. These charges are likely to persist at least through the end of the year, so the bottom line will not be improving significantly over the short term. Moreover, even if Celestica doubled its bottom line in 2019, the stock multiples seem to have priced it in. Therefore, investors are likely to be better off remaining on the sidelines for the foreseeable future.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.