Merrill Lynch downgrades General Motors (NYSE:GM) to Underperform from Buy lowering their price objective significantly to $7, and lowering estimates to significant losses for 2008 and
2009. The key change in firm's outlook is a much lower forecast for U.S. auto sales that is driving a higher cash burn necessitating a much larger capital raise than the market is currently anticipating. Furthermore, they believe there is potential downside in the stock below $7 and that bankruptcy is not impossible if the market continues to deteriorate and significant incremental capital is not raised. Although they believe GM has made strides in restructuring and has built a solid product pipeline, there are three recent factors that dwarf management’s best efforts.

Merrill now believes that much higher cash burn is likely to result in the need for a larger capital raise than anticipated, likely about $15bn (including revolver draws), which would materially dilute return of value to existing shareholders. They also believe the company has not recognized the stress in the capital markets. As time passes, the supply of capital for GM to bridge the gap to 2010 is becoming increasingly scarce, which is at least driving up the cost.

The recent drastic drop-off in sales, which is likely to continue through 2009, has been more severe than anyone anticipated.

The mix shift away from body-on-frame large SUVs that was generally expected over the next few years has been pulled forward to present day with the spike in gas prices and has been more extreme than expected. This has essentially rendered the large SUV segment obsolete, cutting into GM’s profit potential.

Notablecalls: Lots of unhappy buyers from yesterday. I suspect GM will trade below $11 as soon as today.