Investing In The Age Of Giant Auto Recalls

Includes: F, GM, HMC, TM
by: Kevin Greenhalgh


Modular platforms will lead to larger and larger recalls.

Stock prices are often not immediately impacted by recalls.

They are impacted by government hearings and fines.

This gives investors an opportunity to get out before the fall.

Some of the biggest news in the automotive industry so far this year has been recalls. This year automakers have already recalled between 9 and 13 million (estimates vary) cars in the US. This represents a record pace for recalls. The current record for most recalls in one year was 30.8 million in 204. Most notably has been GM's (NYSE:GM) ignition switch recall which affects approximately 2.5 million vehicles. The faulty ignition switch can turn the car off if the driver has a heavy keychain or drives down a bumpy road. The effect of switching into the off position is not only the engine shutting off, but also the loss of al electronics, including power brakes, power steering, and airbags. This means the driver will have a very hard time stopping or steering to avoid a collision, and when they do crash the airbags will not deploy. Officially 12 people have been killed because of this faulty part. Now GM is scrambling to maintain its already imperfect image by repairing the recalled cars and trying to explain why they did nothing about this problem until now even though they have known about it for years.

A big reason why so many vehicles were involved in this recall is the number of different models involved. This recall applies to every 2003-2007 Saturn Ion, 2005-2010 Chevy Cobalt, 2005-2010 Pontiac G5, 2006-2011 Chevy HHR, 2006-2010 Pontiac Solstice, and 2007-2010 Saturn Sky. These cars are all based on the same platform and therefore share a large number of parts, including the ignition switch. GM announced Thursday that they expect the recall to cost them $1.3 billion.

On Wednesday Toyota (NYSE:TM) announced that they were recalling 6.4 million vehicles worldwide due to five defects. Only two of these defects affect US models and account for 1.8 million of these vehicles. These two defects alone affect nine different models.

These are not the only recalls either. Nissan has recalled 1 million vehicles for a software glitch affecting four different models that could cause the passenger airbag not to deploy. Honda (NYSE:HMC) has recalled 900,000 minivans for a fire risk. Ford (NYSE:F) has recalled over 400,000 vehicles for two different recalls involving rust and improperly manufactured seats.

So why have these recalls become so large? Shared parts. Automakers no longer use parts that are unique to one model. Sharing parts allows the companies to buy or manufacture parts in much larger quantities which means they can do so more cheaply. This means they can make and sell their cars for a lower price. The hottest trend right now in auto manufacturing is the modular platform. These are flexible platforms that can underpin and huge variety of models.

One of the most well known modular platforms is the Volkswagen (OTCPK:VLKAF) MQB. This platform allows Volkswagen to manufacture cars of different shapes and sizes using the same engine and transmission mounting points as well as a number of other shared components. This means they can manufacture many different models in the same factory, using the same methods and parts. The MQB platform is currently used for five models across four of their brands and is expected to be used for another six models over the next few years. These models range from the Audi (OTCPK:AUDVF) TT to the Volkswagen Passat.

Every automaker is moving towards this modular style of platform. While this does mean we will get lighter and more efficient vehicles for cheaper there is a risk. Having such a wide variety of models based on the same platform means that if a problem is discovered with that platform in the future it will affect all of those vehicles.

From an investment standpoint these recalls can obvious impact the price of automotive stocks. GM fell 5.5% on the news that House and Senate committee meetings has been scheduled and the justice department had opened an investigation. Interestingly, however, the stock price does not appear to have been impacted by either the initial announcement of the recall (which started at ~800,000 vehicles) or when it was expanded to ~1.6 million vehicles. This shows that while the recall itself did not significantly bother most investors, the government investigation did.

Meanwhile, Toyota is down over 3% at time of writing following the news of yesterday's 6 million vehicle recall. The news of a recall more negatively impacts Toyota because they are still recovering from the public relations blow they took from the unintended acceleration problems from a couple years ago. When investors here the words "Toyota recall" they remember the investigations into unintended acceleration and resulting $1.2 billion fine.

From here on out GM could be in the same situation as Toyota. GM's reputation has been hit hard by these investigations and it may take years for them to restore their reputation. In the future investors will hear "GM recall" and think about the investigations that are happening right now as well as the fines that are likely to follow.

What does all this mean for investors? Be wary of recalls. They will keep getting larger as modular platforms are adopted by more automakers. This means they will get more expensive to fix and if they are serious enough to cause deaths the automaker's reputation could be damaged for years to come.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.