Warren Buffett famously said, "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."
It might not be in a matter of minutes that the reputation of Polaris Industries (NYSE:PII) is coming undone, but its repeated product recalls is surely undermining whatever shred of credibility it had in building quality vehicles. The question for investors is whether the company will do things differently to prevent further erosion. By the looks of it, one could be forgiven for thinking no.
Recall when recalls weren't a problem?
Typically companies celebrate achieving certain milestones. Polaris would instead like you to forget the one it just hit. In the past two and a half years, the Powersports vehicle manufacturer has been forced to recall over 400,000 vehicles for manufacturing defects, and all the good work Polaris has put into building trailblazing, award-winning vehicles is at risk of being damaged because it can't find the right fix for its manufacturing problems.
Several weeks ago Polaris issued two additional recalls: one for 25,600 Sportsman 570 all-terrain vehicles for fuel leaking into the headlights, and one for 1,160 of its off-road RZR 570 models where the front brakes could detach. The combination brought Polaris to its dubious watershed moment.
Unfortunately, it ended the month of July issuing yet another recall, this time for its youth RZR 170 models due to cracked fuel tank necks along with reports of burning, smoking, melted, and shorted wires. Each sets of recalls was accompanied by a small number of actual fires.
The high cost of do-overs
There is obviously a price tag associated with these recurring manufacturing problems. Last year Polaris reported an increase of approximately $31 million in its cost of sales due to higher warranty costs associated with the recalls while having to add $62.8 million to its warranty reserves. It ultimately paid out more than $132.3 million in warranty claims in 2016, almost 90% more than the year before.
So far this year, Polaris has paid out $72.7 million in warranty claims and boosted its reserves by over 40% from the same time last year.
This is the tangible impact of Polaris failing to get a grip on its manufacturing issues. Although the company reportedly initiated a top-to-bottom review of its processes and appointed specific people to oversee the effort -- it was the review that led the Powersports vehicle maker to recall the RZR 570s -- the subsequent recall of the RZR 170s, which includes the model years from 2015 to 2017, shows there's still a breakdown along the way.
A light at the end of the tunnel -- eventually
The internal review process should allow Polaris to end up producing a better, safer product in the future, and the toll taken on sales probably still has as much to do with the overall industry slowdown as it does with the manufacturing problems. Investors are also still giving Polaris a pass, as its stock is up 10% in 2017 (and only down around 5% over the last 12 months). But at some point the vehicle manufacturer is going to burn its reputation -- if not beyond repair, then enough to damage its ability to recover when the industry itself makes a U-turn.
Manufacturing problems are not always fatal, even a string of them. Boeing (NYSE:BA) infamously had significant and serious issues with its 787 Dreamliner aircraft that resulted in numerous delayed deliveries and canceled orders, but it was able to get back on track and score more orders at this year's Paris air show with the 787 than its rival Airbus could with its competing A380.
So Polaris Industries still has an opportunity to correct this deep problem, and it's planning for 2018 to be better than this year. But it's also thought it had these issues licked before.
Unfortunately, more recalls are likely in Polaris Industries' future, and if they're issued at the same level the most recent ones were, the Powersports vehicle maker should surpass the next ignominious milestone of half a million vehicles recalled.