As a current car ad suggests, if something happens once, it could be a fluke, but three times suggests an important trend could be developing. So, what should we call the streak Polaris Industries (PII -4.12%) is on? It's certainly not one investors will appreciate, as the powersports vehicle maker has issued its third big recall in a year that involves some of its most popular off-road vehicles.
According to the Consumer Product Safety Commission, the latest recall is for Polaris Industries' 2015 and 2016 Ranger 570 side-by-sides, which are subject to overheating "during heavy engine loading, slow-speed intermittent use and/or high outdoor temperatures, and catch fire." It received seven reports of these incidents, and though no injuries or deaths were associated with them, it recalled all 43,000 vehicles from those production years.
That's likely because it's not the first time Polaris' off-road vehicles have suffered from "thermal issues," as it calls them. In April, it announced a massive recall of 133,000 RZR 900 and RZR 1000 side-by-sides that could "catch fire while consumers are driving, posing fire and burn hazards to drivers and passengers." While those numbers also included some 53,000 vehicles that had been previously subject to a recall in October, there was one death associated with the incidents in which a 15-year-old was killed when a RZR overturned and a fire broke out.
Polaris has also had a number of smaller recalls. In December, it recalled 4,700 snowmobiles because of steering problems that might cause drivers to lose control as well as some 2,200 2016 RZR XP Turbos that had oil leaks that could result in fire.
The April recall occurred just before the powersports vehicle leader was due to post first-quarter results, yet the size of the recall resulted in gross margins plunging 180 basis points. Now with its second-quarter earnings just weeks away, the impact on results of that recall and the latest one could be substantial.
In the past couple of years, Polaris Industries has generated a fair amount of positive press for its motorcycle division, and not undeservedly. The successful resurrection of the Indian Motorcycle nameplate from bankruptcy after so many previous owners failed is a noteworthy achievement, particularly as it took on Harley-Davidson (HOG -2.35%) and stole large swaths of market share from the industry behemoth.
However, motorcycles aren't its real profit center. The division represented just 15% of revenue for the powersports vehicle company last year and 14% of its gross profits. Even with the phenomenal growth it continued to enjoy in the first quarter as sales rose 18% year over year, motorcycles still account for less than 20% of total revenues and 15% of profits.
Rather, it's Polaris Industries' off-road vehicles -- the RZRs, Rangers, and snowmobiles -- that account for the bulk of its sales: 79% in 2015 and and 73% in the first quarter of 2016. They also accounted for around 30% or so of gross profits in both periods.
The recalls on its popular vehicles are coming at a particularly inopportune time. The market for ORVs has been especially soft, leading to an environment of discounting and promotion that's sapping the strength out of earnings. And although the first quarter was better than expected, Polaris still suffered a 12% decline in ORV sales.
Rival Arctic Cat (ACAT) fared a little better, with sales higher in the quarter that ended in May, though it was still below its own expectations. It has aggressively ramped up its production of off-road vehicles and improved upon its Wildcat brand that began nipping at the RZR's heels. In a challenge to Polaris' dominance, Arctic Cat has introduced more powerful Wildcats and has expanded the new Alterra ATV brand as well.
When Polaris introduced its RZR side-by-side vehicles in 2007, they changed the industry because they were the first ATVs to meet federal trail rules that impose a maximum width of 50 inches on vehicles. Polaris quickly became the industry leader and maintains that position today, but there are a lot of competitors on the market now, and Polaris Industries can't afford to have its commitment to quality questioned by a string of product recalls.
Certainly, recalls can happen to any company (Arctic Cat, for example, had a recall of 1,600 snowmobiles in February because of the potential for brake failure), but repeated trips to the dealer to get recurring issues repaired can only cause buyers to look elsewhere for a purchase, and if that persists, it will cause investors to also start looking elsewhere for an investment.