The Leather Pipeline - 04.04.17
04/04/2017
Financial markets and political activity have been reasonably quiet over the past two weeks.
The UK has signed the Brexit papers and is slowly beginning discussions over what the real consequences are, politically and financially. Day by day the complications become more visible mainly considering that the UK is larger than England only. Also for the former partner members the consequences will be negative.
Stock markets were facing some negative sentiment after President Trump failed to erase ObamaCare. This was considered as a sign that he could have more difficulty than expected in fulfilling his campaign promises. This had a negative influence on the US dollar, but this trend reversed quickly and the dollar finished the period back at $1.065 against the euro.
The markets were looking forward to the meeting between Donald Trump and China’s President Xi Jinping this week in Florida in the hope of more indications regarding future trade policy. America First and import taxes will have been high on the agenda, quite importantly for global trade considering the notorious trade deficit the US has.
Also commodity prices remained in narrow ranges with only oil prices rebounding slightly into the low $50s. The OPEC group of oil-producing countries is discussing an extension of production cuts that have supported oil prices for the moment.
Market Intelligence
The past two weeks were completely dominated by supplier trips to Asia and the gathering of the trade for the APLF exhibition in Hong Kong. It has become common for very little to happen in the week before the Hong Kong show and for whatever raw material suppliers experience or achieve during the trips to be kept quiet. This year was no exception; everyone had to wait until the global trade reached Hong Kong and met up.
The first impressions of the Hong Kong event were pretty positive. Despite general problems in the leather pipeline the attendance beat the expectations of many. Yes, we could definitely discuss the layout of the show and if the aisles might be too narrow while the space of the whole exhibition area was not fully used. All in all, the attendance was quite impressive and most exhibitors were satisfied in terms of visitors and activity at their booths.
Even the last day one did not see empty stands or staff just waiting for people to come. All this can definitely be rated as a good sign. Considering that most of the visitors were coming from Asian countries it at least confirmed that interest in leather and products made from leather continues intact.
As positive as all this may sound, the situation is not evenly spread and there was also a significant amount of conversation about the key problems the industry and the leather pipeline are dealing with. Staying first with the good news then we think it is absolutely fair to say that at least those European tanners who are offering superior-quality leathers had a very positive event. There is definitely nothing wrong with demand for leather that is well made, environmentally friendly and safe, that has the right fashion and hand-feel and can be turned into superior-quality finished products.
Rising production costs in many Asian countries are closing the price difference between the top end of the quality range and the cheaper alternatives; if you want to attract customers and achieve a certain price level, the quality of the material has to be outstanding and beyond question.
The main concern of the tanners today is how and where to get adequate raw material in terms of quality and price. Many tanners are complaining that the quality of even prime-quality raw material is deteriorating and the selections cannot compare to what used to be available in the past. Obviously there are big discussions between suppliers and customers about whether there is really a decline in quality or an increase in expectation.
Profitability in the leather industry is, with some exceptions, a pretty difficult issue at the moment. Almost everywhere production costs are rising due to increasing labour cost as well as rising chemical prices. Other parts of the calculation, such as environmental costs, transportation, energy and water, also feature. In this regard, the latest new from the leather chemical industry was also intensively discussed among the tanners. The takeover of the BASF leather chemical division by Stahl was noted with considerable surprise; it will create by far the largest if not a dominating supplier to the industry. What is considered by Stahl to be of great benefit to the industry is considered by many tanners to be a big risk of becoming too dependent on a single supplier and, consequently, an easy victim of reduced competition.
All the rising costs would be far less frightening if we had met anyone who had hope of being able to pass this on in increased leather prices. While at the bottom end this can be understood owing to the competition from non-leather alternatives, it is difficult to understand that in the medium and high-end the same complaints are heard. Limited supply of adequate raw material, a limited number of manufacturers who can achieve the quality and production standards required should mean a demand that outpaces supply. In business theory, prices rise until the balance between supply and demand has been reached.
The explanation constantly given is the purchasing power of the brands, but the true answer might actually be more simple and closer to the text book. If one looks at the absolute premium material, we have no real market issues because the French luxury brands buy their own raw material and control their own supply chains. In consequence, French calfskins continue to rise and will continue to do so as long as players do not pull out. If the price of leather rises it seems not really to matter for this part of the business.
The situation changes immediately when the same companies buy leather from other tanneries. Suddenly price is the leading factor and it seems the leather made outside is not nearly as exclusive; suddenly there is competition and tanners have the (correct) impression that they could be substituted. Another issue is the monoculture in the customer structure. In most cases the top brands are such a big part of the business of the tanners that they dare not lose any client, which makes their defence pretty weak when it comes to price.
Let us return to the findings and results around APLF. Independent of price, better-quality leather is still selling quite well and even Chinese tanners are focusing more and more on higher-quality raw material. This creates another problem. Stocks of low grades continue to grow, in particular in wet blue and crust. This is not new, but in times of low interest rates and easy access to finance many tanners and dealers have closed their eyes to the situation, put all efforts into the development of better-quality, higher added-value material and left the lower selections to one side. Stocks began to rise a while ago and nobody really checked what their market value was. With a rising raw material market, the general position was that it couldn’t be wrong to own hides, even when the grades in question were not too popular. At the same time demand, due to substitution of leather in the shoe sector and a declining market potential for corrected-grain articles in other sectors, went down while supply continued to be very steady at the better end. The problem is now that for many there is no outlet for these selections and no solution in sight. That makes valuation of the existing stock pretty difficult.
A number of players have begun to realise that something has to be done about this. As long as commodity leather sees no improved market conditions, which depends to a great extent on the price of oil, or new articles and fashion begin seriously to favour leather again it will be difficult to clear stocks. It will only be possible when demand outstrips supply. As long as cash-flows do not require tanners to liquidate these stocks there is no problem yet.
In view of the talks during the fair automotive is still possibly the steadiest performer, depending on the region. China is projected to increase sales and production by another 5% in 2017, which makes this market pretty safe. In Europe it depends a bit on the brand. However, in the premium market it seems that if tanners lose with one brand, they will be well compensated by others. Central and South America seem to be the weakest spots presently. Looking a bit further down the road the situation is a bit more unclear. There is a growing number of people claiming to know that in the automotive industry too an anti-leather trend is beginning to emerge. Some people close to the business strongly deny this, but we tend to believe in the maxim that there is no smoke without fire. The reasons quoted are various, from quality issues in production to vegan and anti-beef motivations. However, it is also true that at this stage this is no more than hearsay and even if it turns out to be true it will have little effect for the next two years, if at all.
In shoes there is no improvement. Mass shoe production is happy with non-leather articles and there is no reverse trend in sight. The good news is that this has freed up raw material for other sectors. However, here too lower grades are a problem. In shoes it’s easier to absorb lower-quality selections because of the options available for finishing and cutting them.
As far as upholstery is concerned, we are entering the low season and this is adding to the general problem of price. Dairy cows for example have seen a 20% rise or more in prices over the past months and the cost-averaging effect has now gone. Although the outlook for demand is good, the economics seem less positive and this is why tanners were aggressively bidding prices down at APLF. Generally tanners expect positive news from the US and China, with further strengthening of the property market in both economies. For the moment however orders are seasonally down and tanners from Hebei province did not bother to come to Hong Kong in great numbers; they tend only to come when they desperately need raw material.
Bags are also a good performer, but are extremely price-sensitive. Plastic can be used in handbags but leather continues to play a very important role. And although big brands are ruthless in their price negotiations, bags are still not eating into the low-selection potential yet.
The split market continues to show slow signs of recovery. Nothing special, but gradually the stocks are cleaning up and prices here and there are trending a fraction higher. It’s hard to say if this is because of price or fashion, but we will take good news when it comes. What is good news for leather is bad news for gelatine, it seems. After a very modest recovery at the beginning of the quarter this market has become pretty bad once again; prices of gelatine splits in Europe have declined.
Skins have not been in focus much in the past few weeks and the situation has not really changed. Fine and dense woolskins are in demand and are moving. Specialties for decoration and high fashion too, but the standards still struggle and despite declining supply the situation is not improving and this remains a real worry. There is valuable and good-quality raw material at basically no cost and still nobody wants it or has any idea what to do with it when it comes to leather production.
In the coming two weeks the market will have to digest the new findings. Asian tanners will do their utmost to squeeze raw material prices down. At first they will be successful, but only to a limited extent. In any case we can expect a moderate correction. In Europe prices, in particular for the fancy material for luxury and premium cars, have little room for any short-term adaptation. Kill is lower and demand is still pretty stable, which will put sellers in a comfortable position again, to the regret of tanners. We strongly believe that eventually hides will reflect the market value for leather and that is also why we believe that a certain adjustment over the summer will be the most likely outcome and also the most desirable one. However, it might take a bit of time.
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