Stock of the Week
July 8, 2011
NYSE Symbol: GM
Industry: Auto sales.
Price as of 7/8: $31.58
The major averages have come back to life in the last two weeks thanks to improving economic numbers. The Dow rallied 6% last week and performed well until Friday of this week when, once again, the unemployment number came in well below expectations. The major averages should hold up ahead of earnings season which starts in earnest in two weeks. Most sectors have rebounded excluding the financials which can't shake the constant drum beat of litigation, congressional reform concerns, and the housing mess. This week we'll highlight the auto sector following a sector upgrade by Morgan Stanley. The featured stock of the week is Morgan Stanley's Top Pick, General Motors. We highlighted GM last fall when it came public following their bankruptcy. The stock initially did well, but then succumbed to profit-taking, falling below its' IPO price. A number of negative issues cropped up for GM including a possible large block sale by the federal government. The recent economic slowdown and supply disruptions due to the Japanese earthquake and tsunami have caused the stock to underperform so far this year, but things may be turning around. Morgan Stanley predicted a number of catalysts to get the stock going once again with a price target of $50 a share or a 50% above current levels. The stock may remain range-bound in the short term, but longer term, GM is well positioned with a strong balance sheet, great earnings potential, and a cheap valuation. Insider buying by the CEO back at the start of May around $31.33 a share is also a good long term indicator. Investors looking for exposure to the auto industry should consider GM trading for 6 times next years' earnings.
Back at the beginning of May, GM reported its' fifth straight quarter of profits thanks to strong sales of small fuel efficient vehicles. GM recorded a near record profit of $3.2 billion, or $1.77 a share, up from $865 million, or 55 cents a share, a year ago. The earnings results included the sale of their stake in Delphi Automotive accounting for 82 cents a share. Excluding that one time sale, earnings came in at 95 cents a share beating estimates of 88 cents a share. Revenue rose to $36.2 billion from $31.5 billion, easily beating estimates of $35.3 billion. GM North America was a key driver of the improvements as earnings surged to $2.9 billion from $1.2 billion. The first quarter results added to 2010's profit of $4.7 billion, the company's best year in terms of earnings since 1999. Looking forward, the company sees more of the same in the coming quarters, citing better pricing and improved fixed costs that should offset higher commodity prices.
Even though the first quarter earnings were strong, GM's stock did not performed well until recently. Morgan Stanley's upgrade this week included four catalysts for the rest of the year. First, they expect positive earnings revisions. Morgan Stanley's earnings estimates are way above consensus estimates. Second, Morgan Stanley believes the 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. Third, the European Opel unit may gain more market share than currently expected. And fourth, a product cycle revival should coincide with higher seasonal sales to boost revenue. GM is also leveraged to the foreign BRIC markets in particular, China. Just this week, GM disclosed encouraging sales numbers out of China.
If Morgan Stanley is even right about half of what they expect, it should bode well for GM. Currently, the stock trades for 0.33 times sales, 8 times earnings, 6.4 times 2012 earnings, and 1.6 times book value of $18.54 a share. Thanks to the bankruptcy, the company has $17 billion net of debt or $11 a share in cash. The cash accounts for 22% of the market cap and 34% of the current stock price. As mentioned, Morgan Stanley is expecting earnings much higher than current estimates. Morgan Stanley has GM making $5 in earnings this year, $6 next year, and $7.9 in earnings per share in 2013. If this best case scenario plays out, GM is currently trading for 6.4 times earnings, 5.3 times 2012 earnings, and 4 times 2013 earnings.
Even if these earnings estimates don't pan out, one thing is certain the auto industry has changed for the better.
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