Polaris Industries (NYSE:PII) is on fire, but it's not how you think, and it's not in a good way. The power-sports vehicle maker continues to be dragged down by recalls related to fire hazards that it still hasn't been able to get under control, and it's now also warned investors they should prepare themselves for more recalls to come.

The three-wheeled Slingshot may just smoke Polaris Industries earnings because of a new recall. Image source: Polaris Industries.

Hot, hot , hot

This "thermal hazard," as Polaris terms it, first reared itself a year ago, and though it initially thought it had the problem in hand, it instead turned into a wildfire that led to a series of recalls across the year. The conflagration was ultimately responsible for the horrible quarterly earnings report Polaris just turned in.

As CEO Scott Wine remarked during his conference call with Wall Street analysts, "It seems like Polaris has been consumed by recall news this year."

Indeed it does. Just this year alone, the powersports vehicle maker has had at least four major recalls that affected some 231,000 vehicles, all related to fire hazards that subject riders to burns. But the problem extends back into 2015, and this past summer it was forced to issue a stop-ride/stop-sale advisory for its 2016 RZR Turbo.

ModelsDateHazardNo. of Vehicles
2013 to 2016 RZR 900 and RZR 1000 4/19/16 Fire/burns 133,000
2015 and 2016 Ranger 570 6/28/16 Fire 43,000
2016 RZR XP Turbo and RZR XP 4 Turbo 9/1/16 Fire/burns 13,000
2014 Ranger XP 900, XP 900 EPS, and CREW 900 9/15/16 Fire/burns 42,000

Data source: Consumer Product Safety Commission.

The effect has been devastating. Sales of off-road vehicles plunged 23% in the quarter to $923 million, while gross profit plummeted 40% to $231 million, representing gross margin of just 25.1%, compared with 32.6% last year.

Cold dose of reality

There was no way Wine could sugarcoat the impact, calling the drop-off in RZR sales this summer "precipitous" and "hard to look at." And with the stop-ride/stop-sale order on the Turbo for almost the entire month of August and part of September, the decline on those vehicles was equally dramatic.

What's worse, it's not over yet. Wine says its popular Slingshot three-wheeled motorcycle is now subject to a recall. On Oct. 18, the National Highway & Transportation Safety Administration is recalling all 2016-2017 Slingshot motorcycles manufactured between Dec. 15, 2015, and April 27, 2016, because of a brake-pressure switch that may have been overtightened. The result is the seal could be damaged, which would allow brake fluid to leak, reducing brake performance and increasing the risk of a crash.

Polaris originally said more than 3,800 vehicles were subject to the recall, about 3% of the total, but just four days later expanded the recall to cover over 6,800 Slingshots. Although Wine says the powersports-industry recalls will always be with us -- and both it and its rivals have indeed had numerous recalls over the years -- these problems are especially troublesome.

Despite their immense popularity, sales of Polaris Industries RZR side-by-sides have plunged in the wake of fire hazard recalls. Image source: Polaris Industries.

The biggest risk

First, off-road vehicles such as the RZR and Ranger are Polaris Industries' main means of making money. The division accounts for more than three quarters of its revenues but almost 90% of gross profits. It can't afford to have its reputation tarnished like this.

Second, the Slingshot has been a good part of the resilience Polaris' motorcycle division has shown since it was first introduced, though the Indian Motorcycle nameplate has done a yeoman's job of lifting sales by double- and triple-digit percentage rates each quarter. While sales of the trike have eased back in recent periods as the larger motorcycle industry has weakened, adding a new recall to the mix at a time when Polaris is already struggling to maintain its reputation for quality won't help.

The powersports-industry leader also warns that the recall trend has yet to run its course, even if it does appear to be abating. That means Polaris Industries can expect its earnings in the current quarter, and probably the next quarter as well, to take a hit. Investors should expect its stock to burn some more, too.

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