Costs of Toyota Recall Could Reach $5 Billion

The worldwide financial repercussions of Toyota’s recalls could surpass $5 billion over the coming year, primarily because of additional incentive efforts, litigation costs, and marketing campaigns by the struggling auto maker, industry analysts say.

The most important question remaining for the world’s largest automaker is how long the backlash from the recalls will hinder vehicle sales in North America, Toyota’s biggest market. After a slow beginning, Toyota has started striking back at critics and has started an aggressive U.S. sales campaign that features zero-percent-interest, five-year financing offers, free maintenance on most of its model lineup, and competitive lease agreements.

Impact Manageable So Far

In spite of the deluge of negative press from late January on, Toyota’s share of the market in the United States only dropped to 12.7 percent in February from slightly higher than 14 percent during the previous month. “The fact that Toyota slipped by only 130 basis points from January to February was pretty impressive,” explained Kurt Sanger, cars analyst at Tokyo’s Deutsche Bank. “How much they can rebound and at what cost will be critical going forward.”

Toyota is still expected to announce an 80-billion yen, or $886 million, net profit for the fiscal year that ends March 31, in contrast to a net loss of 437 billion yen last fiscal year, the automaker’s first loss in 59 years.

“As there is less than a month left for this fiscal year, the impact won't be significant. But it will severely weigh from the next fiscal year. It is hard to say if Toyota will be able to post a profit easily in the next fiscal year,” explained analyst Tatsuya Mizuno of Mizuno Credit Advisory.

Estimating Recall Costs

For the current fiscal year, Toyota has accounted for a recall cost of 180 billion yen, which is the only public estimate the automaker has provided of the controversy surrounding the company. However, analysts say expenses in the future will be much higher. A spokesperson for Toyota on Tuesday refused to comment on analysts’ predictions of its expenses from April 1, 2010.

J.P. Morgan predicts that Toyota’s one-time, total recall-related expenses should amount to 400 billion yen, with an additional 100 billion yen for addressing litigation-related expenses. Kohei Takahashi, autos analyst for J.P. Morgan, has reduced his operating profit goal for Toyota to 540 billion yen from a prior prediction of 760 billion yen for the fiscal year that ends March 31, 2011.

Deutsche Bank predicts that the recalls will affect its operating profit by 290 billion yen.

Ongoing Challenges

Toyota’s toughest challenge is to keep luring customers to the brand and to convince those who are on the fence about the automaker. According to automotive marketing research company CNW Market Research, seven percent of consumers who previously intended to purchase a Toyota will now not do so.

“It’s the people that are sitting on the fence that Toyota is trying to convince,” explained autos analyst Christopher Richter of CLSA Asia-Pacific Markets. “Toyota still has a significant core audience, but a smaller percentage of people are still moved by safety concerns.”

The automaker also must maintain its pace of sales to prevent a build-up of inventory or having idle U.S. plants. “Toyota had been facing excess production capacity...even before the recall problem occurred. If its sales drop, this capacity problem will increase its fixed-costs,” explained Mr. Mizuno.

Toyota is trying to win over its skeptics by offering a wide variety of incentives, with Deutsche Bank approximating that Toyota’s incentives will increase to $2,500 on average in the first half of the new fiscal year, up from $1,450 in the previous fiscal year. Nevertheless, the automaker’s incentives fall below the industry three-month average of $2,650.