By any measure, 2010 was a bad year for auto safety recalls across the board. Automakers such as Toyota (NYSE: TM), Ford (NYSE: F), Honda (NYSE: HMC), General Motors (NYSE: GM) and others recalled more than 20 million vehicles for a wide variety of safety-related issues last year — the industry’s highest number since 2004. But how auto stocks manage recalls and whether bad PR beats up the brand’s name has a far bigger impact on earnings than the actual cost of fixing problems.
Consider Toyota Motor Corp. (NYSE: TM), which led the recall pack in 2010 with 7.1 million vehicles recalled in 19 separate campaigns. The company, whose worst recall year on record included problems with unintended acceleration, also faces hundreds of lawsuits and has paid almost $50 million in government fines for not initiating three of the recalls quickly enough.
In large part due to the fallout of the recent recalls, Toyota’s share of the U.S. auto market last year fell from 17% in 2009 to 15.2% in 2010, with December sales alone falling by 5.5%. By comparison, December sales at Ford (NYSE: F) and General Motors (NYSE: GM) strengthened as auto buyers headed back to the showrooms after a recession-fueled hiatus. While both companies also issued vehicle recalls last year (and Ford recalled 400,000 Windstar minivans last week) none of the recalls has generated the backlash experienced by Toyota.
Toyota’s stock price has tailed off recently in the wake of these poor sales — declining about 4% in two weeks while the broader stock market has squeaked out a small gain. But more importantly, TM stock is still slightly below pre-recall level over $90 a share a year ago.
However, in hindsight it’s interesting to note that the first reports of unintended acceleration were barely a blip on Toyota stock prices. When a floor mat recall was issued, the market viewed it as a run-of-the mill event. In fact, Toyota shares rose from $79.12 on Nov. 3, 2009, to $91.78 on Jan. 19, 2010. That’s a 16% run for TM stock inthe period.
But when Toyota shifted its focus from sticky floor mats to sticking accelerator pedals, and later, anti-lock brake software, there was a severe reaction in the market. As Toyota recalled 2.3 million vehicles on Jan. 21 and temporarily halted sales of eight models on Jan. 26 due to faulty accelerator pedals, the stock dropped like a rock — losing over 20% in two weeks. Government investigations and congressional hearings into Toyota made matters worse, raising questions over whether the company cared more about profits than people.
So why did Toyota see such a sharp drop in sales while all automakers admittedly had a horrible year in regards to product recalls? At the heart of the issue for automakers is the debate over perception and reality.
Voluntary safety recalls have been a common event for auto manufacturers over the past 40 years. Since few recalls involve dangerous issues and most fixes are cheap, the impact on stock price is usually small and temporary — less than 60 days. So automakers’ profitability is unlikely to hit the skids in 2011 because of the actual cost of repairing or replacing problem components.
But damage done to an auto manufacturer’s brand potentially can have an impact on earnings. If consumers perceive that a brand is less safe than its competitors — regardless of whether they’re right or wrong — they may buy elsewhere, reducing actual sales. Negative PR surrounding a recall is more likely to impact earnings than is the actual cost of fixing the problem.
While Toyota’s stock price has since rebounded into the low $80s, recalls of another 1.7 million vehicles announced last Wednesday likely will continue to rough up the brand’s image, at least in the short term. In an effort to put the bloom back on the rose, the company has announced plans to open an advanced safety research facility and spend $50 million on the project over the next five years. Unlike competitors who can endure a minor recall or two with little share price impact, Toyota has to be on its best behavior.
We’ll see if the manufacturing improvements result in better perceptions or share price for Toyota in the future. But other automakers should take notice that an ounce of prevention is worth a pound of cure when it comes to the sales impact of significant recalls.
As of this writing, Susan J. Aluise does not hold a position in any of the stocks named here.