Celestica: This Is A Hidden Gem For AI Investors (NYSE:CLS)

Celestica Inc. (NYSE:CLS) is a high-performing IT solutions provider in the electronic manufacturing services industry. Although it’s categorized within the tech sector (XLK), Celestica is a relatively low-margin service provider, given the nature of its business model. Investors keen to learn more about its business can consider looking through Celestica’s company presentation prepared in 2023.

Celestica operates two critical revenue segments. The ATS segment captures a myriad of businesses, including defense and industrial verticals. The CCS segment incorporates customers situated in the communications and enterprise market. It also includes services provided to hyperscalers, a key driver of Celestica’s recent growth, lifting buying sentiment. As a result, Celestica believes it offers its customers a wide range of solutions, giving it significant exposure to the AI hype cycle that has broadened out from Nvidia (NVDA).

However, the company operates a relatively low-margin business, necessitating capacity expansions in less expensive regions. Celestica management highlighted its undertakings in Thailand and Malaysia, adding about 180,000 square feet of additional capacity. These are designed to meet “strong demand from customers in the CCS segment.” As a result, it should help Celestica continue to pursue robust growth dynamics from its hyperscaler customers, bolstering its recent momentum.

Despite that, the company didn’t upgrade its 2024 adjusted operating margin guidance at Celestica’s fourth-quarter earnings release in late January 2024. Accordingly, Celestica maintained an adjusted operating margin outlook of between 5.5% and 6%. Analysts’ estimates suggest Celestica could be conservative, as they project a metric of 5.8%. It represents an improvement over FY23’s metric of 5.6%. However, Wall Street expects Celestica’s revenue growth to decelerate from last year’s momentum, affecting its operating leverage gains. Accordingly, Celestica is expected to deliver an adjusted operating profit growth of 14.4%, down from last year’s 24.4% surge.

Despite that, management is committed to delivering solid execution as it continues to track rapid expansion cadence in the enterprise market. In the CCS segment, Celestica reported revenue growth of 46% in enterprise in Q4, which was “significantly above expectation of high-20s percentage increase.” As a result, I believe Celestica needs another solid year or outperformance to maintain the stock’s upward surge, even though some CLS bulls could argue that its valuation isn’t expensive.

As seen above, CLS is assigned a “B+” valuation grade that aligns with its peers. However, its profitability grade isn’t best-in-class, which could be a decisive factor in a further valuation re-rating. I stated earlier that the market could still price in a growth deceleration over the next two years unless Celestica can significantly outperform. Is this possible?

I believe it depends on whether you are convinced that the AI hype is in the early stages of a broader expansion. According to Wedbush, the AI spending cycle could broaden to supporting industries as it attracts increased spending from companies across the value chain. Therefore, Celestica’s growth spurt could be extended further than anticipated, helping to sustain CLS’s recent upside bias. With CLS still valued reasonably, I believe the risk/reward profile seems reasonable if we think the AI spending cycle is slated to broaden.

CLS’s surge has undoubtedly caught the market’s attention. With an “A+” momentum grade, it could also be argued that CLS is in the later stages of its recent surge. From the price action perspective, I gleaned that CLS faced selling pressure over the past two weeks at the $50 level. If buyers can’t find sufficient momentum to break above the $50 level decisively over the next four weeks, I anticipate a pullback toward the $35 zone before a consolidation.

While I would usually be cautious over stocks with such a price action profile, suggesting imminent distribution, I view CLS’s medium-term thesis favorably. In other words, I believe CLS’s bullish bias should be maintained as it goes through a transitory consolidation, supported by its relatively attractive valuation.

Rating: Initiate Buy.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking. Note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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