Celestica Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Celestica Inc. is a global provider of end-to-end supply chain solutions for electronics manufacturers, offering services from design and engineering to manufacturing and after-market support.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

  • Core Business: Celestica primarily operates as an Electronics Manufacturing Services (EMS) provider. This entails designing, manufacturing, and distributing electronic components for other companies. Their services span the entire product lifecycle, from early design stages to manufacturing at scale and after-market support.

  • Revenue Distribution: Celestica’s revenue is diversified across sectors, with significant contributions from:
    • Hyperscale and Cloud: This segment is the largest and fastest-growing, driven by the increasing demand for cloud infrastructure and related technologies.
    • Connectivity and Aerospace: This segment includes high-margin products with demand based on multi-year projects.
    • Other Diversified End Markets: While smaller than the other two segments, this includes Healthcare, Industrials, and the Capital Equipment sectors.
  • Industry Trends: The EMS industry is experiencing significant trends:
    • Demand Growth in Hyperscale and Cloud: This segment is growing rapidly, driven by the demand for cloud computing, AI, and high-performance computing infrastructure.
    • Supply Chain Challenges: Global disruptions have pushed many companies to seek regional partners with more secure supply chains.
    • Increased Complexity in Manufacturing: As technology evolves, manufacturing processes are becoming increasingly complex.

  • Competitive Landscape: The EMS industry is quite competitive, with several large players including Foxconn, Jabil, and Flex. Some key features of the industry:

    • Global competition: Competitors are often globally diversified companies.
    • Cost pressures: Cost pressures are significant, requiring companies to be highly efficient.
    • Customization needs: Customers are increasingly demanding that their needs are specifically addressed with their own tailored solutions.
    • Technological capabilities: Having state of the art manufacturing and supply chain processes is a must to win contracts.

What Makes Celestica Different

  • Strong focus on supply chain solutions: Management has stressed the importance of delivering end-to-end supply chain solutions rather than just focusing on manufacturing and design. This is meant to offer customers a more comprehensive offering.
  • Hyperscale Focus: Although they have customers across different industries, their biggest focus and investment appears to be in the hyperscale and cloud segments, positioning the company to participate in this high growth sector.
  • Diversified Customer Base: By diversifying across different end markets, Celestica is able to partially mitigate the effects of downturns in particular industries.
  • Geographic Reach: Celestica has a global footprint, which has been important for its clients looking to set up regional manufacturing hubs.

Financials:

  • Revenues and Earnings: Celestica’s revenue for 2022 was $7.4 billion, showing a steady increase over the past few years.

    • The company has continued to grow sales and is predicting stronger growth in the future, helped by a stabilization in the supply chain and a high demand environment for hyperscale products.

  • While revenue growth is stable, the focus for investors is on profitability and cash flow, and management has guided for improvements on both of these metrics for 2023.

  • Profit Margins: As the company has a diverse customer base across various segments, margins also vary and the most attractive margins appear to be for their connectivity & aerospace sector.
    • Their focus on the hyperscale sector will put pressure on the company’s margins as this is a low margin and high volume sector.
    • However, the company is also focused on getting a higher level of automation, which should boost margins going forward.
  • Return on Invested Capital (ROIC): The management has been actively targeting improvements in ROIC for 2023, they are specifically targeting a ROIC greater than 15 percent for long-term financial goals.
  • Free Cash Flow: Free cash flow has been consistently positive in recent years, with the company actively seeking to increase it further.
  • Capital Structure: While a small portion of the company’s invested capital comes from preferred stock and leases, the majority of capital used to generate profits has come from debt and equity.

Recent Concerns/Controversies

  • Supply chain problems: The recent COVID crisis has greatly disrupted supply chains in all industries, and Celestica is no exception. The company has seen multiple shortages and increased lead times in procuring components, leading to project delays and a negative impact on cash flows and the company’s revenues. Management has stated that they expect these problems to subside in the coming quarters and are implementing strategies to try to make their supply chain more secure.
  • Increased pricing pressures from customers: In the latest earnings call, the company noted increased competition in the market, which will put downward pressures on profit margins. Also, if there is a big drop in demand, they may face challenges in maintaining profitability. Management is focusing on increasing automation and efficiency to mitigate the margin pressure.
  • Macroeconomic Uncertainty: Given the company’s international presence, fluctuations in currency exchange rates and economic activity can have a significant effect. Furthermore, a global recession or a continuation of trade tensions could hurt Celestica. The company notes that they have a hedging program to protect from currency fluctuations, but that it has been difficult to forecast trade changes.

Moat Assessment:

  • Intangible Assets: Celestica possesses some intangible assets such as customer relationships and their intellectual property, but it’s unclear how significant their competitive advantage from it is as customers are typically large manufacturers.
  • Switching Costs: Switching costs are relevant to companies like Celestica, since it often requires time for the customer to transfer their product lines, and it’s harder for the competition to understand the customer’s business and manufacturing needs. In addition, given the time requirements for the customer to switch suppliers, there is an advantage to be a supplier with a good history of customer relations.
  • Network Economics: No evidence of a direct network effect.

  • Cost Advantages: The company has a large global network, meaning they likely have scale advantages in purchasing and operational efficiency. There might be a location advantage since they set up production locations to cater to specific geographies, and many companies find that easier to establish the first location.

  • Moat Rating: 2/5. While Celestica shows some signs of competitive advantage with its network and switching costs, and it also benefits from economies of scale, there are multiple competing companies with strong offerings in this space. The barriers to entry are not as formidable, hence, the narrow moat.

Business Resilience:

  • Diversification: The company has a good mix of diversified industries it operates in, which can help smooth out revenue during times of economic shocks.
  • Large customer base: Their established relationships with multiple large clients can help keep a stable and predictable revenue and cash flow stream.
  • Financial Stability: The company has been improving its financial metrics, which makes it more resilient to negative external shocks.

Understandability Rating:

  • 3 / 5. While the general nature of its business—supply chain solutions for electronics manufacturers—is understandable, the details of its global operations and different value chains, along with the complexities of forecasting its earnings and cash flows can make this quite complicated.

Balance Sheet Health:

  • 4 / 5. While debt isn’t minimal, the balance sheet is showing great progress on reducing leverage and increasing liquidity.

    • The company has significantly reduced its debt and appears to have sufficient cash to meet any future payment obligations.

  • The company has also seen an increase in its assets (both operating and non-operating).

Conclusion

Celestica is a company that is operating in a high-growth sector while also making improvements in its internal processes. However, this improvement needs to translate into consistent profitability and earnings growth before the company can be valued at a higher multiple.