The Leather Pipeline - 06.09.16
06/09/2016
There was no big news from the financial market; it was as though the big players had extended their holidays.
Most of the focus continues to be on the interest rate policy in the US. The latest statement from the chair of the board of governors of the Federal Reserve, Janet Yellen, left investors under the impression that interest rates could still go up in the US this year. This was followed by weaker than expected labour data, which calmed the enthusiasm a bit.
Stock markets reacted to the interest rate expectations and all major commodities continued to trade within their established narrow trading ranges. The only exception might be oil, where the speculative enthusiasm continues to fade with clear signals that supply will be abundant, despite all the efforts to get the supply origins to reach agreement and demand not really rising because of the success of efforts to increase the energy efficiency of cars and the generally flat global economy.
Prices came down to the mid $40s per barrel and were only supported by the outlook that interest rates might not go up as early as expected.
The automotive market delivered very weak sales for July in Europe and the US with double-digit declines in sales versus a year ago. Most say that July, as a summer and holiday month, does not reflect the real market conditions and so we might wait for August and September to see if this important sector is showing some fatigue.
Economic data from China was a bit of a mixed bag, not really offering any clear picture. The Caixin Index came in at 50 points, which was less than expected and right in the middle between a contracting and expanding economy. At the same time, the ISM purchasing manager index quoted 50.4, which was considered positive, and the index for service industry at 53.50, which is a decent figure, but below expectations.
In Europe things did not look too well with the purchasing manager index falling to 51.7 points from 52.0.
Market Intelligence
The much-anticipated All China Leather Exhibition in Shanghai closed its doors last Friday afternoon and left everybody scratching their heads, unsure if it brought anything really new for the players in the market.
Whatever the statistics say, everyone had the impression that the number of exhibitors and visitors was substantially lower than a year ago. However as usual it doesn’t really matter how many visitors turn up; the real question is if the quality of those visitors is up to expectations. Independent of the number of visitors, we would say that we did not seen anybody on the stands just sitting and killing time. Most staff were pretty busy and people walking along the aisles did not seem just to be out for a stroll; they were there with clear intentions and directions. This does not mean that business is good, but the people had a clear agenda, a clear idea of what they wanted to do.
Even on the last day attendance was still quite reasonable and people were generally not packing up early.
Most of the discussions were about the situation of the leather industry in China and the consumer sentiment there. The Chinese government continues to be very strict in its environmental policies and has announced that a new 5% effluent tax will be imposed on tanners, making people worry that production costs will continue to rise. Cost is one of the major problems for the Chinese industry anyway. Until a short time ago China was one of the cheapest places for production, with a good infrastructure and a large local market. Capacities were quickly expanded in the expectation of rising demand and the security of a very favourable production and cost environment. Most leather producers were convinced that their competitiveness on a global scale, in combination with their domestic market possibilities, would give give them a definite advantage versus the majority of their competitors in other parts of the world. Of course quite a number of the parameters are still valid, but two of the main ones did not develop as positively as the tanners were expecting. Production costs have risen rapidly and demand for the leather they produce has not increased owing to competition from alternative materials.
This has now brought us to a situation in which low-price leathers in particular are facing massive headwinds and cannot find enough customers. These leathers are no longer fully competitive as a material in the production of mass-market consumer goods. This began two years ago and is now reaching the inevitable conclusion.
From meetings in Shanghai, it’s clear that the Chinese tanning industry is now trying to upgrade the quality of its leather and to find markets for which leather as a material is still appreciated and an adequate price for the product is paid. Being just the sub-suppliers of big brands for whom size is what matters seems to be no longer an option. Tanners in that position were able to defend their strategy by offering the critical mass large brands require. Units producing for the automotive industry are thriving on the rising production of vehicles in China. The large producers in this field are even expending their productions and are getting bigger. Their main problem is sourcing adequate quantities of uniform and standard raw materials, because their set-up does not allow too much flexibility in the production process or adjustment to many of the types of raw material available around the globe.
For other tanners in China, they have to find a new business model that will allow them to survive under the present market conditions. There is very little indication that oil prices will increase in the short term and that means that alternative materials will continue to be the biggest competitor in terms of price. It sets price limits that can only be met with much lower-price raw material from lower-quality hides; other costs will certainly not decline. In Shanghai it was obvious that tanners with the necessary confidence in their production capabilities are realising that the biggest market potential at the moment is in higher-quality upholstery leather. This led to a situation in which most of the interest displayed was for hides that are suitable for this market segment.
For the rest, there was either no interest or price ideas were exceptionally low and far away from the present official market levels. The decision of the majority of sellers was to refuse to accept these low price ideas, so we have come to the conclusion that not too much business was actually booked during the show.
Summarising the raw material trade at the show, one could draw the conclusion that various trials in smaller quantities for heavier and better-quality hides were booked, while low-quality material attracted barely any buyers at realistic prices. The industrial producers of standard products from the main supply origins had already finalised their purchasing programmes with their suppliers in the weeks before the show. This is leading to a situation in which one could expect that the price spread between various raw materials will continue to increase.
Coming back to the situation in China, the production of leather in various regions was also hindered by another round of government shutdowns owing to the G20 Summit in Hanghzou. Although it is definitely not only the tanning industry that was affected, production restrictions were imposed on tanners to make sure there was blue sky in the relevant parts of the country during the summit.
There are a lot of suggestions around that the Chinese government will continue to work on polluting industries with, in the case of the leather industry, the extra taxation mentioned above. Some pundits are even discussing the possibility that the Chinese government could come to the conclusion to restrict raw material imports by either imposing further import taxes or forbidding raw material imports completely.
Even with all the difficulties at the moment there are quite a number of expansion programmes for beamhouses, with some new beamhouses being built. These units will definitely have state-of-the-art water effluent treatment plants and so it is very difficult to believe that the government in Beijing will ban imports of the raw material these facilities will process. Talking to officials, it is clear that the present government is serious about dealing with the environmental problems in the country and even the biggest players in the Chinese leather industry are afraid that the industry is simply too small and of too little interest in the great scheme of things to secure enough support if someone in the government comes to the conclusion that wet-end production in China should be avoided.
Very few of the smaller Chinese tanners, particularly from the north, visited the the fair in Shanghai this year. The Chinese Leather Industry Association traditionally holds important meetings the day before the show and this has frequently brought a lot of smaller tanners to the exhibition, at least for the first day. Very little of this was seen this year, which inspires little optimism for these smaller companies’ business in the short term.
Apart from general industrial problems, it has become clear that finance is another big obstacle in the market. It remains unclear to us what the real problem is. Some people say that many business people have withdrawn capital from manufacturing to invest mainly in property. The real estate market in China, despite all the empty flats and houses, is still seeing rising prices, in particular in the large cities. With business results and other assets not yielding very well, Chinese investors are still buying flats and houses at rising prices and do not even care that these properties may be empty for quite a while.
All of this suggests that banks and the grey capital market, which has traditionally financed a great part of the leather industry, are no longer an easy source of finance. If you take emotion out of it, this is not really a surprise given the results that the industry is presently achieving. Despite all the discussions about market trends, a lot of people are admitting that payments and letters of credit are meeting constant delays, which cannot be considered a positive sign.
The situation for splits is not improving either. Some months ago we were a little more optimistic; there were some signs of improvement in the suede sector. However, that has not spread into the rest of the market and the suede business itself hasn’t got much better since then. Somebody called it a ‘Vale of Tears’ and tanners are missing out on split returns, which makes their price calculations difficult. The prices of gelatine and collagen have slightly decreased since spring and returns for tanners serving this sector have declined too. If our reading that cheaper leather products face problems is correct, hope is fading for the coming months for split leather and the returns for tanners have little chance of improving in the short term.
The skins market remains as before; here we can see what happens when a product loses its market. Lamb nappa hasn’t made it into bag, shoe or any other leather market, even though prices are so low they cannot fall any further. Prices for many skins are below processing and distribution costs and in many origins large numbers of skins are going to waste. Only some few niches can still achieve acceptable sales and prices, but far from enough to clear productions. However, we must not give up hope because a natural and sustainable raw material at the lowest price level ever must attract the interest of the market eventually.
Trying to find the bright spots, some shoe brands are considering the material again as lining, and in the garment sector we were impressed in Shanghai by several waterproof lamb suede and nappa options which are already being used by some fashion brands for this season, in combination with other materials. The material had been made into really beautiful designs with a fantastic hand. If the waterproof production is accepted by the consumer it might be also a good chance to bring lamb nappa back into retail. For this winter season it’s too late, but if the trend-setters are successful it could possibly trigger something for the following seasons.
It’s fair after fair in September. Consequently, many people are already thinking about the next show they have to go to. The next fair will be held in Europe and will possibly be even more influential. They will tell us about materials, fashion and retail sentiment. We remain positive for every part of the business in which leather is heavy and natural. Where leather can display its beauty and individual, specific character the market and demand are still there. In the sectors in which we are paying the price of all the ambition of the industry to improve finishing technology to make it ‘flawless’ (which has meant making it look like plastic) we do not see how leather can win the battle against the artificial alternatives. That means there is no reason why the consumption of this type of leather should rise again and ease the present problems of the tanneries that depend on this part of the market.
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