Knowles Corporation: A Solid Investment Idea – Knowles Corporation (NYSE:KN)

Moderately fast growers (20 to 25 percent) in non growth industries are ideal investments. Look for companies with niches. Managerial ability may be important, but it’s quite difficult to assess. Base your purchases on the company’s prospects, not on the president’s resume or speaking ability.

– Peter Lynch

Tech is everywhere, and it’s a word the stock markets can’t seem to get enough of. With valuations skyrocketing, although nowhere near the “Dot.com” crash, finding suitable tech companies that can grow modestly and weather the storm is proving more difficult day by day. The essence of tech is its ever-changing shape, where ideating occurs daily, if not hourly, and the iteration of a product today could be vastly different than what it is tomorrow which makes investing in companies difficult. This is where Knowles Corporation (KN) comes in. Not a name brand by any stretch, like the high-flying stocks most people have heard of, but has been in the market longer than Netflix (NFLX), Amazon (AMZN), Google (GOOGL) (GOOG) and Facebook (FB) combined and has literally been to the moon and back (supplying Neil Armstrong and team microphone equipment in 1969).

Knowles Corporation is a market leader and international supplier of audio processing, advanced micro-acoustic and precision device solutions. The company primarily integrates and works with: mobile consumer electronics, military, aerospace, industrial markets, communications and the medical sector. Knowles has seemingly mastered and in many respects cornered the market in MEMS (micro-electro-mechanical systems), which is used in microphones to enhance the audio capabilities of optimizing and processing acoustics to improve user experience across technologies we know and love: smartphones, tablets, and wearables. According to its latest annual report, Knowles will be shipping its 10 billionth SiSonic™ MEMS microphone.

The company is no spring chicken; founded in 1946, it is headquartered in Itasca, Illinois, and has 8000 employees spread over 12 countries. However, Knowles is relatively new to the stock market, IPO’d in 2014 and received anything but a standing ovation – dropping ~43% from the initial price.

(Chart Source: Charles Schwab)

The price drop was simple. The company was privately held for almost 60 years before it was acquired by Dover Corp (DOV) in 2005, and never had to withstand the scrutiny of a less-than-stellar year or show CAGR increase YoY. When the company was spun off as an independent entity in 2014, Dover shareholders got 1 share of Knowles for every 2 shares of Dover they owned (almost 85 million shares were distributed that way) – in my opinion, creating a large shareholder bloc that may or may not have really wanted to own the company outright, and sold it when they got the chance or deemed the numbers were unimpressive.

As you’ll see on the chart below spanning back to 2010, the company really was showing promising YoY revenue growth and steady cash flow until end of 2014. It would make sense why Dover and the market priced the company as it did.

(Chart Source: S&P Global)

So when it showed declines YoY for 2014 and 2015, the stock tanked to its lowest point in early January 2016. Good news is on the horizon as it has beat earnings the past 9 quarters and I’d argue, could beat earnings again consistently moving forward. We’ll see what happens next week, when it announces Q2 earnings July 26th. If revenue, operating income, and EPS continue to increase and furthermore show signs of stabilized growth YoY, it’s hard not to see this company get back to its IPO price hovering in the low 30s by 2020.

The three main business segments Knowles operates in are: Hearing Aids and related technology, voice processors, and smart phone microphones and audio enhancement hardware and devices.

Hearing Aids

The hearing aid market has continued to increase YoY and shows no sign of decreasing. Population increases and baby boomers getting older will only make demands for hearing aids and assistants more prevalent and expand the market.

(source image: HearingReview.com)

Knowles, with its verticals in acoustic and microphone technology, will continue to iterate in this space and should be primed to be at the forefront in hearing technology for the impaired as well as other use cases.

Voice Processors

Annoyed by voice prompted messaging services? Have a high or low voice that always redirects you to the wrong department? Knowles is working to fix that. Voice and its importance in the technological age will only increase; whether it’s to secure passwords, open your house/car, make calls, or dictate tasks into a computer, voice is the ultimate evolution of tech fused innovation for goods and services. In Knowles’ annual report, Jeffrey Niew, President and CEO, had this to say:

Voice is becoming a more prominent user interface for automation, access, and consumption of goods and services. Consumers are recognizing the power of voice, and this is driving increased interest from all types of customers in the IoT market. The rise of connected devices is propelling the need for more microphones. Potential new customers – that do not have expertise in audio for connected home applications in entertainment, security, appliances, environmental and we are well positioned to address the rising needs of our customers across the Mobile, Ear, and Internet of Things markets. Apple’s Siri now handles more than 2 billion voice commands per week, and 20 percent of Google searches on Android-powered handsets in the U.S. are input by voice.”

Smartphone Microphones and Audio Enhancements

By Statista’s chart below, within the next 3 years, the smartphone market will increase over 500 million units, not to mention replacing all the current units with newer technology and software – wireless technology being on the forefront of this push.

Knowles is positioned with its audio and acoustic technology and hardware to increase market share and continue to capture more products and spaces, as it transitions into leveraging a wireless platform.

Second Level Analysis

When considering an equity for investment, knowing the shareholder base is crucial and may even be critical for stock movements, based on current events, market sentiments and even investment philosophy. Businesses, hedge funds, institutions, endowments, and so on, all have reasons for investing in certain companies and industries, and those reasons can often differ. So when I noticed an investment company called Shapiro Capital owned an 11.57% passive stake in Knowles, as of last year’s filing, I had an itch that I had to scratch. Its website won’t win any CLIO or Cannes Lion awards, but as the non-digital world would say, you can’t judge a book by its cover. After perusing the site (took a matter of seconds), I came across its investment philosophy, which furthered my conviction in Knowles and my long-term horizon of this investment.

Avoid High-Risk Businesses:

  • Computer hardware business – products almost immediately become obsolete

  • Airlines – an industry without control of its own destiny

  • Biotech – “unanalyzable”

  • Fads – sales provide negligible sustained enterprise value

  • Start-ups

Search for established operations which possess these desired attributes:

  • Provide high returns on invested assets >= 20% pretax

  • Provide product or service with minimal chance of obsolescence

  • Possess franchise-like characteristics with significant barriers to entry

  • Substantial operations – Market leadership

  • Sound management with an equity interest

(From: Shapiro Capital Website)

Now every investment firm has its own investing philosophy and the key tenets a company should have to invest in. However, I find it most interesting that this company would invest in Knowles so heavily when Knowles is indeed a “tech” and hardware company. To me, it has identified parts of Knowles’ business that will continue to increase and are not susceptible to market disruption like other tech companies out there. An analysis I’d tend to harbor as well.

Current Sector & Analyst Sentiment

Information tech has been skyrocketing and I don’t see any future scenario where this would change. You can see in the chart below, every sub-index to the S&P has outperformed this year. The only thing odd about this chart is how Knowles has not gone up the same degree.

(Chart Source: Charles Schwab)

I wouldn’t be too troubled by this, and as my initial quote from Peter Lynch states, I’m all for companies that show modest growth, or in Knowles’ case, rebounding from their earlier highs…modestly.

Analysts tend to agree. Knowles is currently favored among the investor community with a 2.1 rating (Buy) from 8 analysts. The firm, Dougherty & Co recently initiated coverage on Knowles with a Buy Rating and a $22 price target.

Can You Hear Me Now?

Let us remember, the real winner in the gold rush wasn’t any lucky prospector who struck it big, but the guy supplying the dreamer with a shovel, a pan, a tent, and oh yes, a pair of Levi Jeans. Similarly, in the tech space, the companies that will survive any future bubble burst or at some point when there is a correction due to the market coming to its senses about realistic valuations based on earnings, the companies that will be shielded the most will be the suppliers. Of course, factoring in that they are well-diversified in their client base – unlike what happened with Imagination Technologies (LON: IMG) and Apple (AAPL).

Not everything is red and rosy for Knowles and any investor should consider the cyclical nature and dependency on the mobile handset market Knowles is intertwined in. Around 34% of revenue comes from this unit, and drops based on demand are all but certain. Therefore, its success in mitigating this fluctuation by further investing and growing mobile headsets, wearables and IoT hardware/software will further strengthen its income statement and bolster its stock price.

Disclosure: I am/we are long KN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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