How Toyota Motor Corp.'s Recalls Could Hurt the Company in the Long Run

Toyota Motor (TM +0.01%), the world's largest automaker, has been doing very well. The company expects record earnings this fiscal year on the back of a weaker yen, low costs of production, and the roll-out of new models. However, the automaker's decisions to recall many vehicles in 2013, and then to start 2014 with another spate of recalls, could hurt Toyota's brand image in the U.S. and abroad. In addition, the recalls of the company's high-profile models, such as the Lexus and the Prius, could lead to market share losses in both the luxury and eco-friendly car segments.

Solid expectations
Toyota is upbeat about its prospects in the U.S. market. Despite poor sales in the last month, the Japanese automaker expects a mild recovery this year. It expects vehicle sales in the U.S. to increase to 16 million in 2014, a slight increase from 15.58 million last year. As such, Toyota expects sales of the Prius, which came in at 234,228 units last year for 17th place among vehicles sold by volume in the U.S. according to Autodata, to perform well once again. 

Moreover, Toyota is focusing on various segments worldwide to improve its profitability. Its expectation of an increase in operating profit suggests that it will continue to perform well. However, the fact that Toyota took a hit to its reputation in the recent past because it recalled millions of vehicles due to the serious problem of unintended acceleration cannot be ignored. 

The recalls might hurt
Last month, Toyota recalled 295,000 Lexus and Toyota brand vehicles worldwide due to faults in various safety systems, such as stability control and anti-lock brakes. Most of these recalls are in the U.S. Since Lexus is a premium Toyota brand, the company runs the risk of losing customers to the competition. Both General Motors (GM 0.01%) and Tesla Motors (TSLA 0.01%) are aggressively pushing their premium models, respectively the Cadillac lineup and the Model S.

Last year, GM received permission from Chinese authorities to build a $1.3 billion plant to manufacture Cadillac vehicles in China. General Motors looks to benefit from the growing luxury-car market in China while Lexus is still off balance in the world's most populous country. Toyota isn't pushing the Lexus brand as aggressively in China as it probably should when considering the efforts of other players, such as General Motors. As a result, Toyota could end up lagging behind in the luxury-vehicle market in China.

Also, the recall of Toyota's Prius could hurt the company's prospects in the hybrid market. Toyota is recalling 1.9 million Prius vehicles due to faulty software in the car's hybrid-control system. It won't be surprising if Toyota loses some share in the electric-vehicle market to Tesla's Model S. Tesla is seeing rapid growth in sales and has moved up to third place in the important California market.

Moreover, Prius sales have been falling in the past couple of years. In 2012, the Prius was among the 10 top-selling cars in the U.S. However, Prius dropped to 17th last year, which means that the model has gradually lost its charm in the market, while Tesla's Model S has only gained steam. Also, a recent report by the Los Angeles Times says that 15.5% of Toyota owners buy a Model S, and the Prius is probably to be the biggest loser of that statistic. In addition, one out of four owners of a Toyota premium vehicle, such as a Lexus, are reported to have switched over to Tesla. 

So, Tesla's premium positioning and eco-friendly nature are helping the brand take away share from both Toyota's high-end Lexus models and its Prius models.

Tesla is now planning to take the Model S to China, a move that could compound Toyota's troubles in the region. The Chinese government will provide larger than expected subsidies to electric-car buyers, which could be a tailwind for Tesla in the long run if the company decides to set up production facilities there. Moreover, Tesla's Model S has received the best-ever score from Consumer Reports, and the car has a solid reputation of saving its occupant when in trouble. So, if Toyota doesn't pick up its game it could lose some share to Tesla, both in the U.S. and China.

The takeaway
So, despite a positive forecast, Toyota could be a risky investment. The numerous recalls of Toyota's vehicles due to technical issues, and the aggressive moves of Tesla and GM could eventually hurt the company in the long run.