Often times when major automakers announce a recall, the first question investors ask is: "Is it going to hinder earnings?" Generally, unless the recall is on a massive scale similar to General Motors' ignition switch recall, the answer is no. That's because major automakers set aside capital for warranty reserves that pay for the defects when necessary without hindering the quarter the problems arise in. Sometimes, though, the estimates for the amount saved in reserves isn't enough.
Unfortunately, for Ford Motor Company (NYSE:F) investors, this is one of the uncommon scenarios where the automaker is lowering its third-quarter results after expanding its original recall from earlier in August.
Expanding on the original recall
In early August, Ford announced it was recalling 830,000 vehicles in North America. Among the recalled vehicles were some popular models including the Escape, Focus, and Mustang, because the vehicle doors might not latch properly and could possibly open while being driven. While many recalls are precautionary, this one has some risk of injury possible.
Thursday, though, the news turned worse for investors. Ford expanded the previous recall to include an additional 1.5 million vehicles, bringing the total to 2,383,292 vehicles. Ford has identified one reported accident and three reported injuries that could be related to the defective latch.
How large of an impact will this have on Q3?
The total cost of the recall is now estimated to be around $640 million and will be recorded in Ford's third-quarter 2016 pre-tax results. The costs will largely be incurred by Ford's highly profitable North America business region.
That charge was enough for management to lower Ford's full-year adjusted pre-tax result to check in at $10.2 billion, down from the prior estimate of $10.8 billion. Ford also mentioned that management expects its total company adjusted pre-tax profit in the third-quarter to be roughly 10% of its full-year results. For investors, it comes at a rough time because the third-quarter was already going to be negatively impacted by costs associated with the Super Duty launch.
It's also important for investors to have context surrounding Ford's third-quarter results, which will likely bring some pretty large declines and negative headlines. For instance, if the third-quarter results check in at around $1 billion in pre-tax results, as 10% of full-year results would suggest, that will be down a substantial 60% from the prior year's $2.7 billion pre-tax result.
Investors have to remember that last year Ford's profits shifted toward the back half of 2016, which is unusual, because of the slow ramp up of Ford's 2015 aluminum bodied F-Series. That situation helped inflate last year's third-quarter, which was already going to make a tough comparison before adding in this year's costs for the Super Duty launch and then this expanded recall.
At the end of the day, recalls are simply a part of business in the automotive industry. This recall, while expanded and a hindrance to third-quarter results, shouldn't change an investing thesis in Ford. Further, take headlines touting a potential 60% decline in third-quarter pre-tax earnings with a grain of salt, because you now have the context to better understand the situation.