Put yourself, for a moment, in the shoes of the management of contract electronics maker Celestica Inc.
It couldn't have been good in recent years to tell investors that your biggest customer was the struggling Research In Motion Ltd. It must have been worse, in June, to announce you were losing all the RIM business, nearly 20 per cent of your total revenue.
Then to miss revenue targets in the third quarter and reduce guidance for your RIM-free 2013, as the company did last week? Positively painful.
It helps explain why Celestica's shares hit a 52-week low last Wednesday. There is well-founded skepticism about whether the company can replace RIM with lucrative new customers, and the next several quarters look to be rocky ones.
That makes the stock one of the cheapest on the TSX, according to several different earnings multiples. It also suggests investors who have faith that Celestica's management can turn things around, and who can stick it out for a couple of years, might be rewarded in the end.
Although RIM was Celestica's biggest customer, the company has a far broader product mix than just communications devices, which made up 37 per cent of sales in the third quarter. The company's electronics go into servers and storage devices, aerospace and defence electronics, health care products, and green technology such as solar panels.
Prior to losing RIM, Celestica management set goals of annual sales growth in the 6 per cent to 8 per cent range and operating margins of 3.5 per cent to 4 per cent; those have since been scrapped, with management now saying revenue will decline in the first half of 2013 and operating margins of 2 per cent to 2.5 per cent are more likely.
Celestica's management is cautious about the macro environment and, wisely, is unwilling to forecast strong demand in the next few months. But the near-term problems are also the residue of design: Celestica plans to spend in order to drum up business in its profitable "diversified" segment, where it sells to industrial, aerospace and green-tech customers. It also seems to be eschewing winning new customers through margin-killing price wars.
"We believe the strategy is the right one for the medium/long term," says analyst Robert Young of Canaccord Genuity, "but we are concerned that a lack of top-line growth and a weaker than expected margin structure in the near term will limit the share price."
Mr. Young cut his recommendation from "buy" to "hold" after last week's earnings, removed Celestica from the firm's "focus list" of top picks, and reduced his target price from $9.50 to $8. Strong stuff.
But he also notes there's near-term support for the company's share price. The company's board has launched a stock buyback to repurchase $175-million in common shares – roughly 12 per cent of the company – at not less than $7 per share. (The company has committed to a modified Dutch auction where sellers can tender shares at prices of their choosing between $7 and $8).
Celestica can afford the buyback because of its healthy balance sheet, another point in the company's favour; it has no long-term debt, just $44.1-million in short-term borrowings, and nearly $600-million in cash.
With a market capitalization of about $1.4-billion, cash makes up roughly 40 per cent of Celestica's value – which also plays havoc with its earnings metrics. Mr. Young says Celestica trades at 8.3 times estimated 2013 earnings, which makes it seem more expensive than peers Flextronics and Jabil, at P/Es of 5.9 and 6.7, respectively. But adjust the figure to reflect more than $2.50 of cash per share, and Celestica's P/E is a much more attractive 4.9, Mr. Young notes.
A measure of the company's enterprise value – market capitalization plus net debt – puts Celestica at just 3.4 times its forecast 2013 EBITDA, or earnings before interest, taxes, depreciation and amortization. That, too, makes it slightly cheaper than peers.
Is Celestica poised to shoot upward? Unlikely. Half the analysts who cover the company have "hold" ratings, expressing concerns similar to Mr. Young's about 2013 being a transitional year. Will 2014 bring happy days back to Celestica?
Todd Coupland of CIBC World Markets, who has an $11 target price and is one of four analysts with an "outperform" rating, says company's return to past sales and margin levels by then is "quite achievable." That would mean profits from today's bad-news price.