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Wednesday, September 20, 2006

A Pessimistic View of General Motors (GM)

By Yaser Anwar, CSC of Equity Investment Ideas

GM shares hit a 52-week high last week on September 13th. I believe investors may have gotten a little ahead of themselves.

The Street's 06 EPS estimate of $4.13 is quite optimistic. Despite $4.5b in additional cost savings GM faces production issues. Current Street estimate implies an additional $1b in cost savings, which I do not expect in the near-term.

I also see additional downside risk given the Q2 GMAC weakness, down 20% excluding one-time gain and potential for increased warranty reserves due to the new extended warranty plan. GM's reserves declined $300m in Q2.

Investors should remain cautious. Recently Daimler Chrysler warned us about a shortfall & so investors shouldn't think that GM is immune to the pressures facing Daimler Chrysler & Ford. Tahoe sales posted their weakest month of the year in August and inventory levels are high.

Talk of alliances involving GM came after GM shareholder Kirk Kerkorian, who owns an almost 10% stake in the company, called for GM, Renault and Nissan to pursue an alliance.

Carlos Ghosn, the chief executive of Renault and Nissan, has said the benefits from an alliance would be similar to the gains from the Renault-Nissan alliance, which have included cost savings from joint purchases of auto parts.

Something fruitful hasn't come out of the Nissan deal that was being touted, yet. Investors should remain skeptical on the benefits of a Renault-Nissan alliance, though talks are said to be "constructive". Failure to reach an agreement paints a negative picture for GM shareholders.

We have seen a low SAAR (Seasonally Adjusted Annual Rate of Sales) in three of the last four months. Investors should continue to expect lower sales, around 16-16.2 mil units in both 06 & 07, down from 17 mil in 05.

As you know, momentum is with Japanese automakers as they can gives consumers more mileage per gallon. Investors should expect the Big Three US automakers to lose market share to foreign car makers, such as Toyota, Honda in the remaining 06.

The highly profitable light truck, minivan, and SUV segment is facing increasing pricing pressure now that the Big Three's dominance is waning (Toyota launched its Tundra for SUV & several well recieved models such as the new Camry), gasoline prices are still high even though their recent decline, and sales of lower-margin crossover utility vehicles are taking share from SUVs.

Two thirds of GM's cost savings come from legacy liabilities. I expect some headwinds when these liabilities are measured at year end. Restructuring and other cost-reduction efforts should offset some of the margin pressure in 06 but will it be enough, remains to be seen.

Keep in mind that the auto industry is highly cyclical, vulnerable to sudden shifts in consumer sentiment, employment, interest rates, and general economic activity. Automobile manufacturers typically have significant unfunded postretirement liabilities, which may be highly sensitive to asset values, interest rates, healthcare inflation, and other unforeseen changes.

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