GM: The Most Undervalued Company?

BOSTON (TheStreet) -- General Motors (GM), which released earnings today, is expected to reclaim a global sales lead, overtaking quake-damaged Toyota (TM). GM remains a compelling long-term value, and its stock has rebounded 5.4% since hitting a post-IPO low on April 19. A recent uptick in auto optimism, helped by a solid quarterly report from arch-rival Ford (F), is just the latest reason to consider this undervalued stock for 2011.

This morning, GM posted first-quarter sales of $36 billion and net income of $3.2 billion. On an adjusted basis, the automaker reported earnings per share of 95 cents. Both the top- and bottom-line results exceeded analysts' consensus expectations.

The analyst sentiment for GM remains overwhelmingly positive, with 75% of researchers in coverage advising clients to purchase shares and 25% recommending they hold them. A median 12-month target of $43.29 suggests that the stock is almost universally considered undervalued as that mark suggests a 32% advance. The equity currently costs an enterprise-value-to-EBITDA multiple of 3.9 and a free-cash-flow multiple of 4.7, 52% and 74% peer discounts.

Ford's stock has risen marginally since it released first-quarter earnings, though its report was well-received. Ford increased its adjusted earnings 29% to 62 cents, beating consensus by 25%. Sales, up 4.9% to $33 billion, outgrew the consensus by 7.6%. GM, which has a fast-growth China unit, had similarly strong beats. The consensus profit forecast for GM trended up by a cent in the past four weeks. And, on Tuesday, UBS, previously cautious about GM, lifted its rating on the stock to "buy" and boosted its 12-month price target 20%, from $35 to $42, while altering its thesis.

The Swiss bank cited Japan disruptions as a catalyst that will propel the stock. GM shares rallied more than 2% intraday on the sentiment shift and news that April U.S. sales jumped 26%, beating the expectation for a 14% gain. But, bears note that inventory, which is quickly depreciating as auto models lose value rapidly, has risen to an elevated 577,000. Critics, calling this "channel stuffing," argue that headline performance is overstated, and car sales, at a still below-trend 13 million annualized pace, indicate that demand is weak. But, the recent rate decline is attributable to Japan manufacturing disruptions, helping GM's market share.

UBS believes "GM will be the biggest beneficiary of the upcoming Japan-related inventory shortages, with the potential to gain as much as 110 basis points of additional share in 2011. We expect these gains can boost 2011 EBIT by $1 billion and EPS by 60 cents."

A 60-cent uptick in fiscal earnings per share is no minute addition. It could materially help the outlook for GM's stock. The new $42 target at UBS is equivalent to a 2012 enterprise-value-to-EBITDA multiple of 4 for core auto operations, with $6 a share for China joint ventures, $4 a share for NOLs, or net-operating loss carry forwards, which may allow GM to shield anywhere from $14 billion to $19 billion of profit from taxes. UBS also allotted $1 a share for a stake in Ally, made up of GMAC assets, which may go public.

While online-financial Ally is a valuable asset for GM, its NOLs are even more valuable, especially for those considering a comparable auto stock like Ford. When GM filed for bankruptcy, its bondholders and stockholders were essentially wiped out, but the new GM has a claim on their losses, which allows it to avoid taxation. This seems incredibly unfair as better-managed Ford, which avoided bankruptcy, has no such tax advantage. This is a classic example of moral hazard. Where is the incentive to be risk-averse when losers are rewarded and survivors are punished? This sort of behavior irritates laissez-faire economists, but it provides a rare opportunity to stock investors.

One potential overhang still deterring investors from buying GM is a sale by the U.S. government, which still controls 33% of the float. A government sell-out would dilute existing shareholders. However, the market has largely priced in this outcome and, arguably, this is one reason that GM trades at a peer discount to Ford. While UBS sees Japan as the catalyst for GM, it also has upgraded its estimates for first-quarter adjusted earnings, expecting $1.09, substantially higher than the Wall Street consensus of 93 cents. UBS expects a jump in North America volume, but concedes that commodity inflation and incentives are relevant concerns.

Another potential headwind for GM is a second oil spike. UBS believes that a spike could present a $1.5 billion obstacle for GM. Consumer spending is extremely sensitive to gasoline prices, which are at fresh three-year highs. Should commodity momentum continue, GM's stock may suffer. On the other hand, the new fuel-efficiency tilt of its product mix should help retain brand relevance, should a secondary spike occur. Crude oil is off its 2011 high, helped by news that the U.S. Navy SEALs killed al-Qaeda leader Osama bin Laden on Sunday.

GM has a foothold in emerging markets and is growing rapidly, particularly in China and Brazil. Of its fiscal 2010 cumulative sales, 14% came from international operations, with 7% coming from Brazil alone. GM is investing $5 billion in China, according to management, attempting to double its regional sales to five million vehicles a year by 2015. A weak dollar supports this effort as there is greater flexibility for pricing in appreciating emerging-market currencies. GM is launching a China-exclusive brand, Baojun, to assist domestic branding efforts. The first model, the 630, a low-cost, mid-sized sedan, is due this year.

-- Written by Jake Lynch in Boston.

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