Celestica Inc. (CLS)

Executive Summary / Key Takeaways

• Design-Centric Platform Integration as Margin Engine: Celestica's 2018 pivot from low-margin assembly to high-value Hardware Platform Solutions (HPS) has created a structural margin inflection, with gross margins expanding from 10.4% to 13% and operating margins hitting a record 7.6% in Q3 2025, driven by 79% HPS growth that now represents 44% of total revenue.

• AI Data Center Arms Race as Secular Tailwind: The company commands 41% cumulative market share in high-bandwidth Ethernet switches (200G/400G/800G) and 55% in custom solutions, positioning it as a critical enabler of the AI infrastructure buildout that management projects will drive CCS segment growth of ~40% annually through 2026.

• Customer Concentration: Moat and Risk Simultaneously: Three hyperscaler customers represent 59% of Q3 2025 revenue (30%, 15%, 14%), creating deep entrenchment and switching costs but also exposing the company to demand volatility and pricing pressure from its largest customers.

• Capital Efficiency Defies Traditional EMS Economics: Despite 28% revenue growth, Celestica generated $302M in free cash flow YTD while spending only 1.2% of revenue on capex, achieving a 37.5% ROIC that nearly doubled since 2022 and demonstrates the quality of its asset-light, design-heavy model.

• Valuation Premium Requires Flawless Execution: Trading at 50x earnings and 108x free cash flow, the stock prices in management's ambitious 2026 guidance ($16B revenue, $8.20 EPS) with no margin for error on execution, customer concentration risks, or potential AI capex slowdowns.

Setting the Scene: From Assembly Line to AI Architect

Celestica Inc., incorporated in Ontario, Canada in 1994, spent its first two decades as a traditional electronics manufacturing services (EMS) provider—building other companies' designs on assembly lines across Asia, competing on cost and scale in a race to the bottom on margins. That identity began dying in 2018 when CEO Rob Mionis, who took the helm in late 2015, executed a fundamental strategic shift: aggressively ramp investment in design engineering and technology roadmaps for data centers while deliberately disengaging from low-margin, low-complexity programs that offered limited differentiation.

This wasn't a minor portfolio adjustment—it was a complete business model transformation. By 2020, Celestica introduced its 400G switch, establishing its presence in the high-performance Ethernet switch market within its Hardware Platform Solutions (HPS) business. That product launch marked the inflection point where Celestica stopped being a contract manufacturer and became a design-centric platform integrator. The company now leverages vertically integrated capabilities—design, engineering, manufacturing, supply chain management, software, and aftermarket services—to provide customized solutions that enable customers to deploy leading technologies at scale with rapid speed to market.

The timing proved exquisite. As hyperscalers began their massive AI infrastructure investments, Celestica had already built the engineering muscle and customer trust to capture the opportunity. Today, the company operates through two segments: Connectivity & Cloud Solutions (CCS), which focuses on communications and enterprise (servers and storage) end markets for AI, cloud, and hybrid cloud infrastructure; and Advanced Technology Solutions (ATS), which serves aerospace and defense, industrial, HealthTech, and capital equipment markets.

This positioning within the value chain matters profoundly. Celestica doesn't just manufacture components—it solves the hardest integration challenges for the world's largest data center operators. When a hyperscaler needs a rack-scale liquid-cooled 1.6T networking solution to accommodate the increased density and power requirements of next-generation AI platforms, they turn to Celestica not for its factories, but for its 1,100+ design engineers (including nearly 400 software engineers) who can stand up an operational prototype in days rather than weeks. This shift from manufacturing to problem-solving is why gross margins expanded 260 basis points year-over-year to 13% in Q3 2025, and why the company's non-GAAP operating margin reached a record 7.6%.

Technology, Products, and Strategic Differentiation: The HPS Moat

Celestica's competitive advantage centers on its Hardware Platform Solutions portfolio, which delivered approximately $1.4 billion in Q3 2025 revenue—44% of total sales and up 79% year-over-year. These products are accretive to both consolidated and CCS segment margins, creating a powerful mix shift that drives profitability expansion even as the company invests heavily in growth.

The technology leadership is stark. Celestica's cumulative market share across 200G, 400G, and 800G Ethernet platforms is 41%, more than double the next largest competitor's volume. In the custom solutions segment for high-performance AI networking platforms, the company's share is even more pronounced at 55%. This dominance isn't accidental—it stems from Celestica's ability to manage increasing technical complexity as each generation of technology advances. As Jason Phillips, the company's technology leader, noted: "As the technical complexity rises with each generation of the technology, designing high-performance switches becomes increasingly challenging and fewer and fewer competitors can do it effectively."

The company's R&D investment reflects this commitment to staying ahead of the curve. R&D spending increased more than 50% in 2025, with at least another 50% increase expected in 2026 to support new program wins ramping over the next two years. This investment is directed precisely where it matters: networking, AI/ML compute, storage, rack-level solutions, and the orchestration layer that brings fully integrated systems together, including software, liquid cooling, and power management.

The 1.6T switch development illustrates the moat's durability. After receiving initial Tomahawk 6 silicon samples earlier this year, Celestica quickly stood up an operational prototype and believes it was the first team anywhere to achieve this. The program is scheduled for mass production next year. This speed-to-market capability matters because hyperscaler customers are racing to deploy next-generation infrastructure, and being first with a working solution creates incumbency advantages that last for multiple product cycles. As Stephen Dorwart explained: "Our recent experience with 1.6T is that we've had demonstrated very strong performance here in delivering solutions from the initial receipt of silicon to complete functional power on the systems. We've done it in days. And I think Broadcom (AVGO) knows would acknowledge that typically with some of our OEM and ODM competitors, they measure that achievement in terms of weeks."

The software dimension adds another layer to the moat. Celestica has grown its global software engineering team to nearly 400 dedicated engineers, with deep expertise in SONiC (open-source network operating system) and the ability to customize and harden features for bespoke solutions. For hyperscalers using proprietary network operating systems, Celestica provides critical support with switch abstraction interfaces, ensuring silicon interoperability and assisting with debugging and testing. This software capability transforms the company from a hardware supplier into a system-level solutions provider, increasing switching costs and expanding the addressable revenue per customer.

Financial Performance & Segment Dynamics: Evidence of Strategic Success

Celestica's Q3 2025 results provide compelling evidence that the transformation is working. Revenue increased 28% year-over-year to $3.19 billion, while adjusted EPS of $1.58 beat analyst estimates by 7.63%. More importantly, the quality of this growth is exceptional. Gross profit increased 60% year-over-year, driving gross margin expansion from 10.4% to 13%—a 260 basis point improvement that reflects the power of the HPS model and operating leverage.

The segment performance reveals the strategic divergence between the growth engine (CCS) and the optimized cash cow (ATS). CCS revenue surged 43% year-over-year to $2.41 billion, representing 76% of total revenue. Within CCS, the Communications end market exploded 82% to $1.94 billion, driven by strong demand in data center networking, primarily from ramping 800G switch programs across largest hyperscaler customers. The Enterprise end market declined 24% to $470 million due to a technology transition in an AI/ML compute program, but this is temporary—management expects growth to resume in Q4 with a low-20s percentage increase as the next-generation program ramps.

The ATS segment, while declining 4% year-over-year to $781 million, demonstrates the portfolio optimization strategy's success. The revenue decrease stems from discontinuing a margin-dilutive program in aerospace and defense, yet segment margin increased to 5.5% from 4.9% a year ago. This is the "strategic pruning" that Todd Cooper described: "We're really happy with the margin expansion that we've seen in ATS already. And we think that there's opportunities to continue to expand and get it above 6%, hopefully in the near to medium term."

Cash flow generation validates the model's quality. Year-to-date free cash flow of $302 million increased $92 million compared to 2024, driven by higher cash earnings. This occurred despite working capital requirements increasing due to business growth, primarily in the CCS segment. The company's disciplined capital expenditure approach—spending just 1.2% of revenue YTD, tracking toward 1.5% for the full year—demonstrates the asset-light nature of the design-centric model. As CFO Mandeep Chawla noted: "Only about 40 basis points of our CapEx spend is maintenance. And so if we're going to spend 2% next year, then that means 1.6% is all on growth, and that gives us a tremendous amount of discretion on where we put those dollars."

The balance sheet provides strategic flexibility. With $306 million in cash, $728 million in gross debt, and $739 million available under the revolver, Celestica maintains approximately $1.1 billion in total liquidity. Net debt of $422 million is manageable relative to EBITDA generation, and the company remains in compliance with all financial covenants. This financial strength supports the planned increase in growth capex to 2.0-2.5% of revenue in 2026 ($300-400 million) to fund capacity expansion in Texas and Thailand.

Outlook, Guidance, and Execution Risk: The $16 Billion Question

Management's guidance reflects extraordinary confidence in the trajectory. For Q4 2025, revenue is projected between $3.325 billion and $3.575 billion (36% growth at midpoint), with adjusted EPS of $1.65-$1.81 (56% growth at midpoint). This implies full-year 2025 revenue of $12.2 billion (+26% YoY) and adjusted EPS of $5.90 (+52% YoY), representing the fourth consecutive guidance raise in 2025.

The 2026 outlook is even more ambitious: revenue of $16.0 billion (+31% vs. 2025), with CCS growing approximately 40% driven by continued networking strength and AI/ML compute program ramps. ATS is projected to grow flat to mid-single digits as portfolio reshaping activities moderate. Non-GAAP operating margin is expected to expand 40 basis points to 7.8%, driving adjusted EPS of $8.20 (+39% YoY). The company is targeting $500 million in free cash flow.

Several factors underpin this confidence. First, the TAM for high-bandwidth Ethernet networking is projected to reach $50 billion by 2029, with the 800G+ segment growing at 54% CAGR. Celestica's 41% market share and technology leadership position it to capture disproportionate value. Second, the custom ASIC segment of accelerated compute is forecasted to grow sixfold over the next several years, and Celestica's focus on this high-value segment leverages its customization strengths. Third, the company has visibility to multiple program ramps extending to 2027, including 1.6T networking upgrades and the digital native customer's rack-scale AI system.

The digital native win represents both opportunity and execution risk. Management expects this program to generate "at least a few billion dollars in the first year, multiple billions of dollars"—potentially reaching revenue levels similar to its largest hyperscaler customers. However, mass production isn't expected until 2027, with timing gated by silicon availability. As Chawla explained: "Our plan of record right now is that we would not see mass production begin in 2027. And so when we've given an outlook of $16 billion for next year, that does not include any meaningful level of revenue coming from this digital native opportunities."

Execution risks are material. The guidance assumes no material changes in tariff or trade restrictions, continued strong AI infrastructure investment by hyperscalers, and successful ramp of multiple new programs. Any slowdown in AI capex, loss of a major customer, or execution misstep on the 1.6T transition could derail the trajectory. The concentration risk is stark: three customers represent 59% of revenue, and while this creates deep partnerships, it also means Celestica's fate is tied to the strategic decisions of a handful of technology giants.

Risks and Asymmetries: What Could Break the Thesis

Customer concentration isn't just a risk—it's the risk. The three hyperscaler customers that collectively represent 59% of Q3 2025 revenue have immense bargaining power. While Celestica's design-centric model and technology leadership create switching costs, a strategic decision by any one of these customers to bring more manufacturing in-house or shift to a competitor could create a revenue hole that would be difficult to fill quickly. The company's success in deepening these relationships also makes it more vulnerable to their caprice.

Trade policy uncertainty represents another material threat. Management explicitly states that guidance assumes "no material changes in tariff or trade restrictions compared to what is in effect as of October 27." Uncertainties resulting from government policies or legislation, and/or increased political tensions between countries, may adversely affect business. While Celestica expects to recover substantially all tariffs from customers, any increase in costs not recovered would directly impact margins. More concerning is the potential for trade restrictions to delay customer capacity additions, particularly in the semiconductor capital equipment business, which is already experiencing moderation due to foundries holding off on capacity additions.

Technology transition risk is inherent in the model. The 24% decline in Enterprise revenue in Q3 2025 due to a technology transition in an AI/ML compute program demonstrates how quickly revenue can shift between generations. While management expects this to recover as the next-generation program ramps, the pace of technological change in AI infrastructure is accelerating. If Celestica were to miss a critical transition—say, from 800G to 1.6T or from scale-out to scale-up networking—it could lose incumbency advantages that took years to build.

Competition is intensifying. While Celestica maintains technology leadership, traditional EMS competitors like Flex (FLEX) and Jabil (JBL) are also targeting AI infrastructure opportunities. More concerning is the acquisition activity: Sanmina (SANM)'s purchase of ZT Systems aims to double its size in AI data centers. Every now and then, a competitor will chase a program on price only that 3 to 6 months later haven't come back due to challenges with execution and delivery. This suggests that while Celestica's execution moat is real, price competition remains a threat, particularly as new entrants seek to buy their way into the market.

On the positive side, the asymmetry could be substantial if execution exceeds expectations. The digital native customer program could ramp faster than anticipated if silicon becomes available sooner. The 1.6T transition could accelerate, with more customers moving to the new technology in 2026 rather than 2027. ATS segment margins could expand above 6% faster than expected as portfolio reshaping completes. Any of these developments would drive upside to the already ambitious 2026 targets.

Valuation Context: Premium Pricing for Premium Growth

At $310.11 per share, Celestica trades at a market capitalization of $35.65 billion and an enterprise value of $36.13 billion. The valuation multiples reflect the market's recognition of the transformation: a P/E ratio of 50.48, price-to-free-cash-flow of 108.14, and EV/Revenue of 3.20. These are not traditional EMS multiples—they're technology platform multiples.

The comparison with direct competitors illustrates the premium. Flex trades at 0.81x sales and 25.2x earnings, with operating margins of 5.1% and ROE of 17.45%. Jabil trades at 0.76x sales and 35.7x earnings, with operating margins of 5.84% and ROE of 40.38%. Sanmina trades at 1.05x sales and 34.5x earnings, with operating margins of 5.2% and ROE of 10.87%. Only Plexus (PLXS) has comparable margins (5.01% operating) but trades at just 0.97x sales.

Celestica's multiples are justified by its superior growth (28% vs. low single digits for peers), margin expansion (7.6% operating margin vs. 5-6% for peers), and returns (37.25% ROE vs. 10-17% for most peers). The EV/EBITDA multiple of 32.45 is high, but it reflects the market's expectation that EBITDA will grow substantially as the HPS mix continues to shift toward higher-margin solutions.

The valuation also prices in management's 2026 guidance. If Celestica achieves $8.20 in adjusted EPS, the forward P/E would be approximately 38x—still premium, but more reasonable for a company growing revenue at 30%+ with expanding margins. The risk is that any execution stumble would likely result in multiple compression back toward traditional EMS levels, which would be painful for shareholders.

Conclusion: A Transformation at Scale, Priced for Perfection

Celestica has executed one of the most successful business model transformations in the EMS industry, evolving from a commoditized assembler to a design-centric platform integrator that occupies critical control points in AI data center infrastructure. The financial results validate the strategy: 28% revenue growth, 260 basis points of gross margin expansion, record operating margins, and 37.5% ROIC demonstrate that the HPS model creates durable competitive advantages and superior economics.

The investment thesis hinges on three variables. First, can Celestica maintain its technology leadership as networking speeds accelerate from 800G to 1.6T to 3.2T? The company's track record of being first to market with working prototypes suggests yes, but the pace of change is relentless. Second, will the digital native customer program ramp as expected in 2027, providing a third major growth pillar alongside the two largest hyperscalers? The potential for "multiple billions" in revenue makes this a critical swing factor. Third, can the company manage customer concentration risk while deepening these strategic relationships?

The stock's valuation at 50x earnings and 108x free cash flow leaves no margin for error. While the growth trajectory and margin expansion justify a premium to traditional EMS peers, any slowdown in AI infrastructure spending, loss of a major customer, or execution misstep on technology transitions would likely trigger severe multiple compression. For investors, the risk/reward is asymmetric: the upside requires flawless execution of an already ambitious plan, while the downside risks are material and concentrated.

Celestica's story is compelling because it represents a rare combination of cyclical timing (the AI infrastructure boom) and structural improvement (the design-centric transformation). The company has proven it can capture value in the AI stack beyond mere assembly, creating a moat through technology leadership and deep customer integration. Whether that moat is wide enough to justify the current valuation will be determined by execution against the $16 billion revenue target in 2026 and the successful ramp of the digital native program in 2027.