Stock Analysis & Ideas

Celestica Stock: Potentially Undervalued, but May Not be Worth Buying

Story Highlights

Although Celestica looks like it’s undervalued, I believe that there are better opportunities elsewhere. Celestica doesn’t have a quantifiable competitive advantage, and the market has been presenting many other high-quality opportunities lately.

Celestica (CLS) (TSE: CLS) is a profitable company that is currently undervalued. However, it doesn’t have a competitive advantage, meaning that there are likely better opportunities elsewhere.

Celestica provides supply-chain solutions globally to original equipment manufacturers and service providers in various markets.

Celestica Does Not Have a Competitive Advantage

There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating a company’s earnings power value (EPV).

Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value (the cost to reproduce/replicate the business) can be measured using a company’s total asset value. If the earnings power value is higher than the reproduction value, then a company is considered to have a competitive advantage.

The calculation is as follows:

EPV = EPV adjusted earnings / WACC
$1,349 million = $139 million / 0.103

Since Celestica has a total asset value of $4,848 million, we can say that it does not have a competitive advantage. In other words, assuming no growth for Celestica, it would require $4,848 million of assets to generate $1,349 million in value over time.

The second method to determine if a company has a competitive advantage is by looking at its gross margin because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present.

If a company has no edge, then new entrants would gradually take away market share, leading to decreasing gross margins over time due to pricing wars.

In Celestica’s case, its gross margin has no real trend and hovers in the mid to high single-digit range. As a result, its gross margin indicates that a competitive advantage is not present in this regard.

However, it’s worth noting that its margin of 8.9% is the highest its been in at least the past 10 years. If it continues higher or sideways from here, a potential competitive advantage could have formed – but it is likely too early to say right now.

Celestica Stock Appears Undervalued

To value Celestica, I will use a single-stage discounted cash flow (DCF) model because its free cash flows are volatile and difficult to predict. For the terminal growth rate, I will use the 30-year U.S. Treasury yield as a proxy for expected long-term GDP growth.

My calculation is as follows:

Fair Value = Average FCF per share / (Discount Rate – Terminal Growth)
$13.62 = $0.94 / (0.1 – 0.031)

As a result, I estimate that the fair value of Celestica is approximately $13.62 under current market conditions. At a share price near $9.70 currently, there is a good margin of safety.

This means that even though the company does not have a competitive advantage, its valuation is low enough to potentially justify a position in the company.

Analysts See Upside Potential as Well

Celestica has a Moderate Buy consensus rating based on one Buy and two Holds assigned in the past three months. The average CLS price target of $13.33 implies 37% upside potential.

Final Thoughts: There Likely are Better Opportunities Elsewhere

Although the company is likely undervalued, as both analysts and the single-stage DCF model arrive at similar valuations, I believe that there are better opportunities elsewhere.

This is because the company doesn’t have a competitive advantage. The current bear market has created many opportunities by placing companies that do have competitive advantages into value territory.


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