Celestica Stock: Riding the Wave of Electronics Manufacturing Services?

Contract manufacturing deals in the global electronics and semiconductor industry came back with a bang in 2022 as supply chain bottlenecks slowly eased. The strong revenue growth momentum of last year has spilled into 2023. However, some electronics manufacturing services companies remain among grossly undervalued stocks given economic and financial fundamentals.

Canada-based Celestica (TSX: CLS) is an electronics manufacturing services (EMS) provider that recently reported double-digit quarterly revenue growth rates and stronger margins. Consequently, it upgraded its revenue and earnings outlook for this year. Despite a strong earnings show, Celestica stock hasn’t gone anywhere in 2023. Shares still sport a lower forward price-to-earnings (P/E) multiple than industry peers and shares appear underpriced.

Celestica stock in strong growth mode

Celestica is a $1.9 billion EMS business that offers a wide range of product design, manufacturing, and related supply chain services to the global technology, aerospace and defense (A&D), industrial, and health technology industries. Additionally, it is a key partner in communications, cloud computing, and enterprise equipment and storage products design and manufacturing.

Following a substantial 29% year-over-year growth in annual sales last year, Celestica generated more strong 17% year-over-year growth in first-quarter revenue to US$1.8 billion. Celestica’s business has continued to register double-digit growth rates into 2023. Its industrial business was 30% higher, and demand from green energy projects, electric vehicles, and energy storage segments remains strong.

Although its Hardware Platform Solutions (HPS) revenue is moderating after a 59% surge last year, huge corporate investments in artificial intelligence (AI) and machine learning (ML) globally should sustain strong demand for high-value, high-margin complex products in the near term.

Celestica’s aerospace and defence business is also in growth mode led by a sustained commercial aerospace recovery from pandemic lows, and increased defense spending since the breakout of a war Eastern Europe.

Most noteworthy, Celestica’s growth is convincingly sustained given its growing inventory, supported by higher customer deposits. At the end of March 2023, inventory grew sequentially by US$53 million and US$468 million year over year to US$2.4 billion. Customers displayed more production commitment given US$350 million year-over-year growth in customer cash deposits to US$811 million. Customers increasingly support inventory growth as they see growing demand for end products in their channels.

Stronger margins

Celestica’s recent revenue growth has been of high quality. It’s accompanied by expanding gross and operating margins. Its adjusted gross margin for the first quarter of 9.4% was up 60 basis points year over year due to higher production volumes, higher productivity, and favourable product mixes.

Even better, the first-quarter adjusted operating margin of 5.2% marked a third consecutive quarter of operating margins above 5%.

Celestica is growing revenue and expanding its earnings margins in a highly competitive EMS bidding environment. If the company can sustain higher margins, CLS stock value should command some premium over peers. Speaking of peer comparisons, Celestica stock actually appears undervalued right now.

Celestica stock undervalued

Celestica stock looks underappreciated given its strong earnings growth momentum and low valuation multiples compared to industry peers.

The company lists its major competitors as Benchmark Electronics, Flex Ltd., Jabil Inc., Plexus Corp., Sanmina Corp., and Foxconn’s parent Hon Hai Precision Industry Co. Ltd. Competitors have higher valuation multiples than Celestica, as seen in the table below.

According to current Wall Street and Bay Street analyst estimates, the company could grow earnings at an average annual rate of 18.7% over the next five years. Shares sport a forward price-to-earnings (P/E) multiple of 5.2. Thus, Celestica’s price/earnings-to-growth (PEG) ratio could be a low 0.3.

Investment guru Peter Lynch strongly believed that fairly valued stocks should have forward P/Es that at least match their long-term growth potential. A fairly valued stock should thus have a forward PEG of 1.0.

In our case, Celestica stock has a PEG much closer to zero than it is to 1.0. Shares could be grossly undervalued.