Toyota's Got Bigger Problems Than the Recall

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Toyota recalBy Eric Volkman, The Motley Fool

Now is not the best time to be Toyota (TM). The company just announced a large-scale recall due to a potential fire hazard with its driver-side power window assembly. Unfortunately, this applies to approximately 7.4 million of its vehicles around the world -- more than one-third of which are in the United States.

This isn't the company's first mass recall in recent times. In 2009-2010 it was forced to issue a pair following revelations that certain models were at risk of unintended acceleration. Those twin recalls affected nearly 6.7 million cars.

On top of that, thanks largely to political circumstances outside of its control, the company is suffering from steep declines in one of its most important markets.

Chinese Walls

Right now in China, anything related to Japan -- and the products it peddles -- is off-the-charts out of favor. This is because the two countries are in dispute over the possession of a set of small, uninhabited, privately owned islands in the East China Sea (called Senkaku by the Japanese and Diaoyu by their rivals). Japan has reached a deal to buy these strategically placed but otherwise uninteresting chunks of land, stoking nationalist sentiment from a country it has been at odds with numerous times over the centuries.

This anger and ill will has taken the form of vandalism and sporadic acts of violence against high-profile, ubiquitous proxies for the country, like its cars (and in one unfortunate case, a driver of same).

No one wants to get attacked for driving the wrong vehicle, and there are many who won't consider buying a product originating from the country seen to be stealing pieces of their nation.

Toyota's China sales have dropped precipitously of late, sputtering at a queasy 49% lower year over year for the month of September. And it's not the only Japanese manufacturer suffering for its flag; Honda's (HMC) sales were off 41% in the same month.

This is going to affect Toyota's results. In 2011, the company delivered around 883,000 cars in China. This constituted a robust 44% of its total Asian unit sales (excluding its home market of Japan). Looking more distantly in the rearview mirror, that number was around 12% of total worldwide unit sales. China, in short, is a country that matters a lot to Toyota.

America's Not the Bad Guy This Time

To be fair, no one's really doing all that well in China at the moment.

The country's once-fiery growth has cooled, and its monetary officials are trying -- but so far not succeeding -- to prime the pumps. Construction, industrial output, and retail sales have all been relatively soft lately.

But the nearly 50% sales drops for Toyota and its fellow national champions are stark and scary, especially when compared to some of their global rivals:
  • September sales in China for Ford (F) (and its local joint ventures) leaped by 35% year over year. This wasn't just a knee-jerk flight to non-Japanese producers -- the American company posted an even better number (39%) this past August.
  • Even General Motors (GM) posted a modest year-over-year increase of 1.7% in September.
Like the recall, which is only a few years separated from a similar big-scale operational nightmare, Toyota's Chinese slump comes on the heels of a big problem the company hoped it had recovered from. This was the brutal one-two punch of the earthquake and tsunami that hit Japan in March 2011, badly affecting deliveries from local suppliers and thus affecting output from the company's 17 factories in the country. As if that weren't bad enough, the flooding in Thailand later in the year also put the crunch on operations.

Although Toyota still managed to grow Asian sales that year (by 5% annually), global sales dropped by 6%. That knocked the company from its position of No. 1 carmaker in the world; it was eclipsed by GM, which managed to ship nearly 8% more units that year.

Time for a Contrarian Buy?

And yet, Toyota's stock hasn't been battered as much as might be expected. At around $75, the shares trade more or less in the midpoint of their one-year range. They're down since the news broke of the Japanese government buying the islands, but only by around $7.

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It's possible they haven't suffered more because Toyota's forecasts for 2012 remain rosy. Before the government decided to buy the islands and angry Chinese started assaulting the company's cars and drivers, Toyota anticipated solid 28% growth in global unit sales for the year. Even when making an extremely conservative estimate of a decline in China sales for the year (a clean 50% from 2011's numbers), that still pegs global sales at around 8.4 million units for a nice 22% rise over the previous year. Meanwhile, the shares currently trade at a forward P/E barely above 9.

Granted, at the moment few of the world's carmakers have to contend with such challenges in Asia's biggest market -- or wipe lots of egg from their faces because of a huge recall. The political crisis over the islands doesn't look as if it'll subside anytime soon. But hopefully for the company, the recall won't be too prolonged or expensive.

Motley Fool contributing writer Eric Volkman has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford and General Motors.

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