PI drops target price on Celestica after Cisco split

Electronics manufacturing services company Celestica (Celestica Stock Quote, Chart, News TSX:CLS) just dropped its largest customer in Cisco Systems but the loss is no worry, says analyst Gus Papageorgiou of PI Financial, who thinks CLS’s margins are likely to improve.

On Friday, Papageorgiou delivered a corporate update to clients on Celestica, wherein the analyst reviewed the company’s latest quarterly financials and discussed the Cisco split.

Toronto-headquartered Celestica released its third quarter 2019 financials last Thursday, coming in with revenue and EBITDA slightly ahead of expectations. But perhaps the bigger news was notice that it was parting ways with its largest customer Cisco, which currently represents 13 per cent of Celestica’s consolidated revenue.

Celestica is in the midst of a review of its CCS segment, which is made up of its enterprise communications, telecommunications, servers and storage businesses. The company announced in its third quarter comments that, so far, disengagements in the sector should make for an aggregate revenue decline of over $400 million for 2019, with the plan to conclude the process by the end of this year.

On Cisco, in particular, management explained that returns have been lower than targeted, hence the parting of ways.

“Although we have been in active discussions with a number of our Communications customers in an effort to improve our returns, we have come to a mutual agreement with our largest customer, Cisco Systems, Inc, to a phased exit of existing programs commencing in 2020. As a result, we are adding our Cisco programs to the CCS segment disengagements currently underway, thereby expanding the revenue impact of our CCS Review to include our revenue from Cisco,” wrote management in the quarterly press release.

Papageorgiou says Cisco’s revenues were dropping over the last few years along with profitability, and thus, with Cisco gone Celestica’s overall margins should improve, working capital requirements should drop and cash flows will likely improve.

“We generally agree with the direction management is taking the business, however, it is a difficult and tedious process. Losing your biggest customer is never easy but in this case we believe it was the right decision,” writes Papageorgiou.

“There may be concerns that other big customers such as Juniper are also susceptible to disengagement but we remind investors that CLS is a much more meaningful supplier to Juniper than Cisco; Juniper reduced its suppliers back in 2013 and chose CLS as one of those suppliers and negotiations have been going on for over a year and if it were to happen we believe by now it would have,” he says.

On the quarter, the analyst says that Celestica’s revenue of $1.418 billion and EPS of $0.13 per share were both five per cent better than expected, with cloud and connectivity and Enterprise revenues stronger than expected. Increased volumes in capital equipment helped margins, he says. (All figures in US dollars unless where noted otherwise.)

Looking forward, management guidance of about $1.475 billion and EPS of about $0.15 per share were also much in line with the consensus expectation.

With the update, Papageorgiou is maintaining his “Neutral” rating for CLS while decreasing his target price from C$9.30 to C$8.80, which represents a projected 12-month return of negative 2.1 per cent at the time of publication.