Market Intelligence - 11.12.12
11/12/2012
The global economy is not sending any balanced or clear information. While the US and China were sending some data that could be interpreted as an improvement, the euro zone again delivered bad information and a negative outlook.
In the US, the labour market pleased observers and a moderate recovery of the housing market also lets people hope for a much-needed recovery of the economy. In China industrial production expanded again, leading many observers to expect a soft landing for the economy there and a possible rebound in 2013. However, there are still a lot of people warning that the value could be limited and the numbers just polished and published to offer the country’s new leaders a decent start to their term in office.
In Europe however, the situation isn’t getting any better. Some officials from the EU Commission have said that the worst could be behind us, but the official outlook from the Organisation for Economic Co-operation and Development (OECD) for the next year is far from promising. The south of Europe is still contracting and nobody knows what results the upcoming elections in Italy, for example, will deliver. At the same time the forecasts for Germany are being cut to almost zero. France remains a headache and the economy and government there remain in a fundamental conflict over what is good for businesses and what is good for the country. The results so far are rather frightening.
Looking on from the sidelines, even the tigers are not performing so well and one of the economies of the famous BRIC community, Brazil, is struggling; growth has fallen to a meagre 1%.
The financial markets are still driven by the excessive liquidity circulating the globe. Stocks are being bought because they are believed to provide protection against inflation and are, in many cases, a higher-yielding investment than any other alternative. Commodities were being bought, but some are losing their shine despite all the positive comments and supportive reports and analysis. Sugar, just to name one of the fundamental ones, has lost 27% from its peak earlier this year.
Oil prices have been pushed up by investors again and again and they always find a reason why they think oil prices should rise further, even when the physical balance of supply and demand does not justify it. Any riot in the Middle East, even far away from the wells and transport routes, is a good enough excuse to push prices higher. However, the market realities are catching up and prices fell back again last week; we have to wait and see if new investment capital has the motivation to go into this basic energy resource.
The currency market seems to be in range-trading mode as the end of the year approaches, with the US dollar trading in a narrow bank around $1.30 against the euro for a while. As the markets are getting thinner now it seems that only some large position-taking in the last trading weeks of the year will move the currency.
Market intelligence
The past weeks have been a repetition of the previous ones; market conditions have not really changed. Under the lead of US beef packers the market continued to be supply-driven and interested buyers had to follow the ideas of the sellers and were forced to buy at steady or slightly higher prices. Control of raw material remains the strongest force in the market.
We have discussed already the possible consequences of rising raw material prices. There is no option for tanners to raise selling prices for leather if raw material levels do not adjust quickly, because productivity gains or cost reduction in other areas of production are either not available or not possible. If you cannot increase the price of leather and face losses, sooner or later you will go out of business. This will reduce production capacity and possibly increase the demand side, with a more balanced situation between supply and demand. The entire balance between the volume of raw material available and leather produced will never change, because every hide and skin preserved for slaughter is used for leather production, while raw material that doesn’t exist cannot be made into leather.
The supplier point of view still considers hides and skins to be a limited raw material. The price development of the last years supports this position and suppliers are convinced that the manufactured product, leather, has to follow this this idea. A consumption boom in the emerging markets and cheaper production costs in Asia, predominantly in China, have kept raw material demand high and finished leather prices stable. This effect is now fading. Production costs are rising and raw material prices too. This has quickly closed loopholes for holding product prices stable and in the last seasons prices for shoes, leathergoods and upholstery have only been protected by substituting or reducing leather content. In the recent past, part of the price problem was balanced by better demand in China and the revaluation of the renminbi, which was buffering some of the price rises in other currencies. With the reasonable performance of the consumer market in China and higher inflation, better prices have become achievable there.
With the rising prices, tight supplies and the outlook for falling slaughter, the large players have been forced into constant replenishment of raw material inventories. Production costs are based and calculated on full use of capacity and so the strategy was to keep production running full and hoping either for a drop in raw material prices or an increase in finished leather prices. Except for small variations, none of these options really materialised in 2012 and margins constantly shrank or even became negative. This excludes, of course, the premium and luxury part of the market.
With the deteriorating situation in the leather industry many tanners are trying to find answers for 2013. Just going on as they did in 2012, waiting for the right move in the market, hasn’t worked. Running at the same capacity as in 2012, with the same or possibly less raw material supply, will not work. This is independent of questions over the availability of raw material and the possibility that wet blue supply will be limited by excessive wet blue production by packers.
It seems that many tanners have finally realised how the situation is and have begun to decide on strategies. Success can only be obtained if you become the absolute cost leader or reach sales price targets that allow you to become a price leader, producing profitably. In Europe the decisions are taken already. Price leadership is the target and anyone who cannot make it is slowly losing their position and is likely to be disqualified from the race.
In China and other Asian countries many of the small and medium companies have taken the traditional third way, cutting production to wait for better times. What might work for a small minority with depreciated factories and limited overheads cannot be the solution for the majority. Others have tried to stay on top of costs either by using cheaper contract operations for part of the production process, mainly in the wet end. The rest are presently trying to upscale their quality and climb the quality ladder. Some tanners supplying premium domestic brands for women’s shoes and leathergoods have already made a successful move into calfskin production and superior quality lines, while others are presently starting to experiment with high-quality bovine supply, in particular from Europe, to enter the premium market for shoe upper and upholstery leathers.
In the automotive leather sector, we see the same trend but for a different reasons. Here it is less the tanner trying to upscale and more the need and demand from the car manufacturers to manage increasing protectionism, which is forcing the global premium brands to manufacture locally, including component supply. A number of strong export markets (Brazil and Russia, for example) are imposing high taxes on imported cars and are asking at the same time for local suppliers to remain part of the growth story.
Whether efforts at upscaling of quality in Asia prove successful will depend on how manufacturers deal with the other issues, such as image, more demanding clients in quantity and quality, smaller production lots, more fragmented and selective raw material purchasing, more flexibility, more creativity, constant and innovative research and development, a bigger sales force and so on. It will be a big challenge and will certainly not fit into everyone’s plans.
However, the question of greatest importance to the sector centres on the levels leather prices can rise to. If raw material suppliers continue to insist on the price levels we have reached, it is naïve to believe that leather manufacturers can handle these levels continuously. Cheaper raw material has been eaten up already, some of the relief of the rise of drop split revenues is also fading and there is no sign of a short-term chance to convince sellers of a lower return on their major by-product when they consider their strategy for 2013, in view of their own troubles with production and margins.
The first quarter of 2013 will most likely deliver further information on how the leather pipeline will react and which of the trends will materialise. For the moment, most are taking a rest. While the western world is already winding down for the Christmas break, Asia is also slowing purchasing and production plans for Chinese New Year (February 10).
Logistics have become a challenge too. Not only does the leather pipeline have problems, shipping lines do too. Vessels are being taken out of service and slow-steaming is making shipping plans pretty unreliable. Asian tanners are afraid that shipments scheduled to arrive in the week prior to start of the Chinese New Year holiday could be delayed by the shipping lines and vessels will not arrive in time. Consequently in Europe many suppliers are complaining about clients postponing their shipments for January for arrival after the Chinese New Year.
Looking at trading and market activity, we find it remarkable that US market reports talk constantly about great forward positions and weekly rising prices. Well, when we look at the statistics and official export sales reports from the US Department of Agriculture and compare them with the past we can’t find the large forward positions in the numbers; it might even be the opposite, unless packers have built even bigger wet blue inventory positions and have worked into their budget calculations already a drop of 20% in slaughter for 2013. Even then one should still balance the short position for salted material and the long position for wet blue to get a realistic view of the physical situation with a serious balance of supply and demand. It is one of our priority topics for 2013 to see how the numbers and real situation match up in the end – and they will, one way or another.
The split market remains firm for limed material in Europe. Reduced soaking and high demand from the collagen sector are keeping prices high. In China drop split prices are slowly eroding. We find this pretty interesting with the situation in the hide market and a shift to split in leather production. We will continue to monitor to see if it is a temporary issue or a business indication.
The skin market continues to be steady or even a fraction firmer for some nappa skins from Europe. Chinese buyers have been reasonably active in the past weeks and bought their preferred items, such as older lambs and sheepskins. Prices went up by a few cents here and there. The freezing cold winter in Russia and south-eastern Europe should help Turkish double-face sellers and retailers to clear stocks for the winter season. Shoe lining has had a boost in demand and a number of suppliers have been talking about decent spot orders for immediate shipment from existing stocks, which also confirms that the cold weather and the amount of snow in the region has satisfied the hopes of many for a cold winter after mild conditions in previous years left quite a few with high stocks of finished product.
For the coming weeks we would be surprised to hear of much activity. It seems to us that most of the pipeline has closed its books for 2012 and is happy to wind down for year end administration or to make plans for 2013. Some manufacturers might still be hoping for quick sales due to the weather conditions and to see some more stocks leaving their books before the end of the year. Raw material suppliers are pretty confident in their outlook for 2013 and are hardly concerned about any decline in sales and activity. Slaughter in many countries will be down by the Christmas holidays, which fall right in the middle of the week this year, keeping many beef plants closed.
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