FBR Downgrades Knowles Corp, Reveals Big Picture Concerns

• Knowles Corp KN shares are up 9 percent since September 28, with significant volatility over the past three months.
• FBR & Co’s Christopher Rolland downgraded the rating on the company from Market Perform to Underperform, while reducing the price target from $18 to $15.
• While the company’s 4Q guidance is poor due to disappointing mobile growth, the main issue seems to be pricing, Rolland mentioned.

Knowles reported its 3Q15 results broadly in-line with expectations. Analyst Christopher Rolland added, however, that the company’s 4Q15 guidance is worse than expected due to:

1. A heavy shift in iPhone build exposure into 3Q15
2. Sequential decline in Samsung
3. Launch delays of numerous Chinese handsets
4. Potentially weaker-than-expected 4Q15 iPhone 6s builds

“Regardless of the puts and takes of unit growth, we think there is a bigger issue at hand . . . pricing,” Rolland wrote,

He said that Knowles’ top-line revenue growth in the medium term is likely to be significantly below expectations, with the company targeting a CAGR of about 7 percent. The shortfall is expected to result from:

1. Growing global MEMS units: At around 10 percent per annum
2. Deteriorating ASPs: A 5 percent y/y decline with quality improvement, and a 15 percent y/y decline like-for-like)
3. Increased contraction in the company’s market share: From about 4 percent per annum over the past few years to about 60 percent currently.

In the report FBR & Co noted, “Without substantial top-line growth and with intensifying competition, we believe gross and operating margins will expand much more slowly than expected, perhaps delivering less than half of KN's targeted improvements (and well below its 39% target).”