Stifel’s Matthew Sheerin thinks the recent sell-off in shares of Celestica Inc. have brought a “compelling entry point” for investors, leading him to raise his rating to “buy” from “hold” previously.
“The EMS company’s stock fell 10.6 per cent last Friday (vs. down 1.7 per cent for the S&P500), and is down 35.2 per cent since July 16 (vs. down 4.6 per cent for the S&P500),” he said. “We attribute the sell-off to concerns of slowing AI investments from hyperscale customers following key supplier earnings reports (including NVDA and AVGO).”
The equity analyst thinks earnings expectations for the Toronto-based company “remain reasonable despite negative market sentiment.”
“Despite negative market sentiment on the AI investment cycle, we see no material change to conditions since Celestica reported Q2 earnings on July 26, when management clearly articulated key drivers (and potential headwinds) for growth from hyperscale customers, which account for 70 per cent of Celestica’s Connectivity and Cloud Solutions segment, and 40 per cent of total sales” said Mr. Sheerin. T”he company said it expects a shift in product mix in 2H24 within CCS, as incremental growth in networking and storage products is expected to offset a reduction in AI/ML compute products, which is being driven by technology transitions to next-gen compute programs, including liquid cooling, as well as the second-sourcing of some programs to a competitor. Current-gen compute shipments are expected to plateau in late FY24, while new programs begin to ramp in mid-to-late FY25. Meanwhile, management expects strong 400G switch demand through FY24 and into FY25, while 800G demand is expected to accelerate exiting FY24 and ramp through FY25. We note that Celestica is one of the leading ODM providers of data-center network switches to hyperscale customers, with a roughly 25-per-cent market share, and has at least two major hyperscale customers.”
Also seeing an enticing valuation for Celestica shares, he maintained his US$58 target. The average on the Street is US$64.11.
“Shares now trade at 10.2 times forward EPS and 6.7 times EV/EBITDA and trades at or below all key EMS comps, which we believe is unjustified given its best-in-class margins, diversification within the broader industrial markets, and defensible position within CCS given Celestica’s ODM model in the networking space,” he said.
“We believe Celestica will continue to benefit from multiple expansion as its years-long investments into more design and engineering-driven relationships, and its shift in focus to higher-margin “emerging” end markets, where outsourcing represents no more than 10-20 per cent, bears fruit. We also credit Celestica’s partnerships, IP, and know-how for proprietary compute products for AI/ML applications, which has enabled Celestica to benefit from the growth in AI infrastructure in recent quarters. We expect the transition in AI/ML compute programs to be a headwind to CCS growth in 2H’FY24 and into FY25, though we believe continued strength in networking and storage demand will somewhat offset those declines. We are positive on the stock, with shares trading at just 10x our FY25 EPS estimate.”