Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
It's the first full trading week of the new year, and Wall Street is finally getting back to business.
So far today, StreetInsider.com reports that Wall Street analysts have announced no fewer than 67 separate upgrades -- and 70 downgrades. Out of such a wealth of choices, which upgrade or downgrade will we focus on today?
I'm picking General Motors (NYSE:GM).
Upgrading General Motors
I admit that now isn't the most obvious time to be recommending General Motors stock. GM shares looked a lot more attractive a year ago, when they were trading for as low as five times trailing earnings. After taking a big charge to earnings in Q3 2017, however, and suffering an even bigger loss from tax reform in Q4 2017, GM's GAAP earnings are now in recovery mode. The stock looks a lot less attractive (on the surface), with a trailing P/E of 66.
Regardless, GM is the stock that BMO Capital picked to outperform the market today, assigning these $34 shares a target price of $41 apiece -- and the reason is precisely because BMO does believe GM is in recovery mode, and could surprise investors in the year to come.
Battening down the hatches
Why does BMO expect GM to outperform? There are a couple of big reasons, although they, like the valuation, may seem counterintuitive.
GM caught a lot of flack late last year, as you may recall, when management announced a major restructuring of its North American operations. Five factories would be idled as GM shifted production away from lower-margin cars like Cruze and Impala, and toward higher-margin trucks and SUVs. Fifteen percent of the company's workforce would be laid off.
GM would take between $3 billion and $3.8 billion in up-front charges to make these changes. In exchange, though, the company hoped to grow its annual cash flow by as much as $6 billion by 2020, giving it more resources to invest in high-margin and breakthrough technologies in the future, and also more financial flexibility to weather any recession that may be impending.
This is key to BMO's recommendation. Although the up-front costs may be big, and the political fallout from layoffs unpleasant, the analyst argues that the changes GM is making "will drive better profitability and FCF, as well as improve cyclical resilience."
Unfurling the sails and getting ready to "Cruise"
At the same time, BMO notes the "we expect a brighter spotlight to be placed on GM Cruise" -- the company's self-driving car technology unit -- in 2019.
Last year, analysts at RBC Capital -- like BMO, a Canadian bank -- posited a $43 billion valuation for GM Cruise, should the unit ever be spun off. In making this bold claim, RBC argued that whether independent or contained within GM, a Cruise business providing transportation as a service could conceivably produce $32 billion in annual revenue for GM by 2030 by building and operating "a fleet of ~800,000 vehicles ... driving ~58 billion miles [and charging users] $0.55/mile."
What's more, RBC argued that revenue would carry an incredibly high margin -- earning GM as much as 29% before taxes, which would be a big improvement over legacy GM's current operating profit margin (according to data from S&P Global Market Intelligence, it's less than 6%).
Suffice it to say that if by cutting bait on a few old sedan lines, GM can free up the cash needed to grow its Cruise business (the company plans to double its investments in electric cars and self-driving vehicles), then this would be a sacrifice worth making. BMO, however, believes that the market is not yet pricing in an "appropriate value for" GM Cruise.
A 2019 IPO could be just the thing to change that.
Check out the latest GM earnings call transcript.