GM Is a 'Best Idea,' Morgan Stanley Says

BOSTON ( TheStreet) -- General Motors ( GM) stock has rebounded 11% from its 52-week low, but remains in deep-discount territory, even as analysts boost their earnings forecasts.

BusinessWeek, on Tuesday, broke a story about the company's channel stuffing, or flooding of dealers' inventory to goose profits. Betting on a strong rally in SAAR, or the seasonally adjusted annual rate, for cars, some dealers now have excess inventory, presenting risk to GM, which may have difficulty maintaining its sales and profit levels.
GM

For investors, or potential investors, in GM, this isn't news. Bears have been touting this practice for months as a reason to avoid the stock. Along with souring economic data, channel stuffing is a relevant counterargument to the bulls. Nevertheless, savvy investors know to build positions amid negative news flow because once it dissipates, stocks tend to rise.

Regardless of channel stuffing, GM remains a compelling long-term value, selling for a 2011 price-to-earnings ratio of 7.8 and a free-cash-flow multiple of 8.3, 49% and 75% automobile-peer discounts. Yesterday, Morgan Stanley added GM to its Best Idea List, which comprises just a handful of the bank's favorite risk-adjusted investments. It also upgraded its auto-industry view to "attractive." GM replaced Ford ( F) as the bank's "top overall pick."

Still, Morgan Stanley rates Ford "overweight." It says GM "offers a powerful combination of positive near-term earnings revisions and negative investor sentiment, held up by open-ended questions surrounding the U.S. Treasury hangover, UAW labor negotiations and the deployment of GM's fortress balance sheet." Morgan Stanley isn't alone. Three-quarters of analysts rate GM's stock "buy." But, Morgan Stanley has the highest 12-month price target, at $50, suggesting a 60% return. The next-highest target, at $49, is offered by Credit Suisse.

Morgan Stanley predicts that four catalysts in the second half of 2011 will attract investors to the stock: (1) Positive earnings revisions. Strong demand growth, offset partially by high inventory, has led Morgan Stanley to estimate $5.20 of 2011 earnings, giving the stock a current-year multiple of just 5.9. (2) Uncertainty stemming from the Treasury's additional half-a-billion share sale and a new United Auto Workers' contract will be alleviated by mid-September. (3) The European Opel unit may gain more market share than currently expected. (4) A product cycle revival is going to coincide with a higher SAAR, elevating sales.

A sum-of-the-parts analysis is one justification for Morgan Stanley's $50 target. First, nearly half of the current stock price, or $14, is accounted for by cash on hand. The bank estimates the value of deferred tax credits and NOLs, or net operating losses carried from the bankruptcy, at $9 a share. The NOLs allow GM to defer profits from state and federal taxation. Morgan Stanley values Chinese joint ventures, critical to growth, at a conservative $5.

Thus, "one can account for nearly 100% of the GM share price before considering its consolidated operating business." Morgan calculates a bear-case target of $22, assuming a modest recovery to a 12 million SAAR, a European margin at negative 2% and no growth in the Chinese ventures. Its bull-case price target is $72, meaning the stock could rise 126%.

In truth, the most likely scenario is an ongoing shift to a weaker product mix in the U.S., where consumers have developed a taste for fuel-efficient vehicles, and rapid growth in BRIC nations. Relative to Ford, GM is leveraged to these growing markets, which should drive sales and margins, going forward. In addition to more amenable labor agreements, the new GM has a vastly superior balance sheet, with a net cash position (cash minus debt) of about $25 billion. So, those who argue that channel stuffing is proof of a resumption of bad habits are making a selective argument. Net liquidity, a U.S. tax shield until 2018 and developing market leverage are solid investment merits.

With that being said, the domestic business remains pressured, especially as gas prices rise. Crude oil remains near $100 a barrel. On Tuesday, Barron's made the case for $150 oil by next spring, citing fundamental evidence for a sustained uptrend. In such an environment, consumer spending will, again, be crimped and many would-be car buyers will delay new purchases, even on fuel-efficient vehicles, which still require a substantial up-front cost. Morgan Stanley may have gone out on a limb with its forecasts.

For example, its 2012 earnings estimate, at $6.60 a share, is 31% above the Wall Street consensus. Its 2013 projection, at $7.90, is 24% above the consensus. Even though these estimates appear aggressive, the central thesis is not. GM's stock has a median price target of $43.55, suggesting it has 40% upside, and is considered, even by those with "hold" recommendations, to be undervalued. GM is a bargain for long-term investors.

-- Written by Jake Lynch in Boston.

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