Market Intelligence – 16.04.13
17/04/2013
In Europe, politicians are still dealing with the debt crisis, the problems in Cyprus and its bailout – which will most likely be higher than the ‘absolute limit’ the EU is willing to offer. However, the big news was that for the first time, bank customers have to pay too. Knowing that Cyprus’s domestic banks hold large deposits, particularly from Russia but also possibly from Greece, it seemed easy for the EU to ask for something they have never done before. Right or wrong, it is a new stipulation of the rescue package.
Additionally, European politicians are busy trying to fight tax evasion. Differences in taxation around the globe has always been an issue. It will never be equal, because that would mean that there would be only one tax system and this is pretty unlikely. European politician have taken the opportunities the crisis has presented to increase their tax income, while they might be better advised to think about where and how they are spending the money these days.
Although she was 87, the news that former UK prime minister Margaret Thatcher passed away shocked many who spent years with her as a major political figure. As divisive as she was during her life, so she was in death. The old conflicts surrounding Thatcherism broke out immediately and demonstrated how much society inside and outside Britain is still split on her opinions and policies.
The US economy is still not showing the strength and performance many had hoped for and the Japanese government continues to flood the markets with cheap yen. Further concerns about the general global outlook in combination with the only positive signs from China have been weighing on the commodity markets and, in particular, oil prices, which fell by as much as 5% in the past two weeks.
Despite the problems in Europe and no light at the end of the tunnel, the European currency benefitted from the flood of cheap yen and the weak performance in the US and was able to gain almost 3% at levels around 1,31 against the US dollar.
Market intelligence
Two weeks ago, the trade gathered again in Bologna for the spring fair Lineapelle. Attendance was pretty reasonable considering that just the week before, most of the people had been in Hong Kong [at the Asia Pacific Leather Fair] and so one couldn’t argue about the visitor numbers. However, as we mentioned in our last report, the target group of this fair is very different to the one in Asia. Consequently, a lot of buyers from the shoe and accessory industries as well as designers were seen strolling along the aisles.
The fair organisers are trying desperately to keep raw material suppliers, and a number of people from the supply side were seen too. In general, there was pretty much the same mixture as in the past. One could discuss if the attendance was better or worse, but in general we prefer to talk about the quality of visitors and the general climate on the individual stands of the tanning industry.
It is always a pleasure to visit this fair, because many of the stands show fantastic leather articles that are beautifully designed and are a great example of outstanding Italian creativity and taste. In some ways, it has more spirit than the other leather fairs. This is also possibly due to the fact that Bologna covers a wider range of leather production than the others, which tend to be either focused on individual market segments or are fashion fairs, too. Of course, they are well-designed and well-presented, but if we are just talking about the material, the show in Italy is something special.
We were very curious to see if there would be any new articles or direction at this trend-setting show, but we couldn’t see much on those lines. There were beautiful colours, fantastic articles, possibly the best you could make from what nature offers to the tanning industry. However, the focus was again more on natural and classic articles. This can be understood, because this is what the luxury industry is demanding at the moment. Unfortunately, nature doesn’t always offer flawless, perfect raw materials, and by tanning 100 units you always have a decent number that cannot perform as high-end natural articles. They are left behind and need to be handled and produced into leather too. Apart from the price rises for raw material, the question of how this problem can be solved was one of the main topics of conversation on the stands.
Leather buyers have become as reluctant to give in to rising prices as tanners have to raw material cost. How far raw material prices and leather prices can rise seems a never-ending discussion, but the supply pipeline is fighting for its fortune since hardly anyone is paying voluntarily more than he has to. Since the global market has become so transparent, the leather buyers are fully aware of the trends of the raw material markets in the past two or three years. With many raw materials having reached historical levels it is pretty obvious for the leather buyer that he can fight for the price, but in the end he has to consider that his price will be higher than ever if he’s not willing to accept lower selections, reduced quality, less cutting yields or different articles which allow more economical raw materials to be used.
Not an easy task for anyone. The rule of the game in the supply chain is that for every 10% raw material rise the tanner would be happy to make 5% more for the leather and the retailer 2% for the finished product. This is possibly a bit oversimplistic but the logic is correct.
In particular, when the raw material prices are rising constantly and more than 10% throughout the season, it is pretty tough to manage. And even the butcher – who is said to be the only one to be benefiting from the situation – is just investing the increased revenue for his by-product into the price for the cattle. So, in the end, the only one who benefits might be the farmer who gets a better price for his cattle. The fact of the matter is that retail prices are hardly rising due to the intense competition, so most of the raw material price increase is taken out of the margins of the industries in between.
This leads us to the fact that we are dealing with the battle for margins. If it was just the battle for positive margins this might be easy, but in many cases it has become a battle against negative margins, better known as losses.
Unfortunately, this is the situation in the entire leather pipeline. The margin and cost situation is so different, possibly more than ever before. The luxury industry for leather accessories and the strong demand for premium vehicles has triggered such a strong demand for premium-quality leathers over the past few years, combined such a high leverage for the material price in the finished product, that the rest of the industry can hardly manage the material price situation.
The elasticity of leather prices is simply not high enough to manage the sharp price increases which we have seen over the past 24 months. Better technology, higher yields, better split returns and cost savings have been brought in to help tanners with the resistance of their buyers against higher leather prices. However, the leather buyers couldn’t resist and leather prices have gone up too.
For the top end of the quality range the situation is not dramatic yet, but it is starting to get painful, because if one considers that the cost of a veal skin today is the almost the same as that of a heavy bull hide but offering hardly half of the size (quality and exclusivity aside), then one can see that a lot has happened at the price front in this section, too.
A lot has to do also with trends in the various retail markets around the globe. In a debt crisis-ridden Europe and in the only very slowly recovering economy in the US, the price competition at retail level is fierce and sales in volume can only be maintained if prices are calculated extremely sharply. The average income in many countries is shrinking and people are not in a position to spend more for normal consumer products.
However, the situation is different in the emerging markets under the lead of China. Rising income, the generally positive outlook and the attempt to catch up with the standard of living in the West makes people ready to shop and spend. One can speak to almost every manufacturer in the emerging markets and you will hardly find any complaining about sales and prices in his domestic market. Quite the reverse: many are considering the export business as production is not the basis of the business anymore. In short, most of the manufacturers are making much better margins due to better sales and lower distribution costs selling domestically, rather than overseas.
This is putting the ability of the Chinese tanning industry to pay more for raw material in a bit of a different light. Many still believe that it is only due to lower production costs and in particular the lower or uncontrolled environmental controls. This might still be true in many of the rural regions but, as a general statement and in particular for the big companies, it definitely doesn’t work anymore.
In a total cost and productivity comparison the Chinese factories are not ranking as far ahead as many people think. Their benefits lie more in the strong-performing domestic consumer market added to similar conditions in neighbouring countries. Nonetheless, factories in China are starting to hit the critical levels in calculations and complain as much as their colleagues in other countries about the raw material prices.
This brings us back to the point that if the raw material prices continue to rise the way they have done, the American suppliers are still playing the supply card and pretending week by week to obtain more money and consistent demand. Well, we have explained our doubts about the truth of the story in previous newsletters. US hides are the benchmark of the international leather industry and they are still representing the origin with the best statistical and reliable data in combination with a great number of market reports published almost daily. This sometimes gives the impression that supply variations in the US are so influential on a global scale that they can change the entire balance of global supply and demand.
We are far away from that and actually only the very tight integration between the industrial suppliers of standard raw or semi-finished product and the industrial manufacturing of leather and leather products with reduced raw material flexibility by the real big names of the industry has actually offered such an impression.
Why are we saying all this? We find it pretty interesting that around the Hong Kong leather show [March 26 to 28], the price for Brazilian standard wet blue jumped by around 10%. This could underline the rumours that some leather production shifts towards less expensive qualities and would also explain why sales for US hides – if the export statistics can be trusted – had been far less exciting this year in quantity than many reports are trying to make them. We still strongly believe that the raw material market is just moved and used to liquidate the wet blue stocks built at the present price levels in the final round of the market cycle. It will be interesting to see if we are right and then if it works.
The split market remains pretty firm as it is no secret that more shoe companies are shifting towards splits wherever they can and design and quality allow, which is also something that makes well-flayed Brazilian hides looking attractive. The full effect of the trend might be seen after the change of the next season when we will also see the full effect of potential moves in the lining segment.
The performance in the collagen market remains high where production capacities are growing faster than supply. A number of collagen products are high margin but it might take a while until expensive technology is up and running, which has left a number of capacities coming late or still in the pipeline. This explains also why the lime split market is generally more stable and did not show any short-term hiccups like the drop-split market in China where the impact of high price collagen on the split price is still far less. Consequently, we can see too much risk for the split market for the short term.
The skin market, which had shown a similar performance to the hide market, is starting to take its own path again. In particular, nappa skins lost quite a bit of their shine and, with the end of the season in Europe, prices suddenly dropped after the Hong Kong fair. We can’t see any reason other than the local problems in Hebei province in China. A number of producers had been shut down by the officials and many of them went idle for more than two weeks. This meant a lot of skins getting stuck and with the volume of production in that area, mountains of skins build up quickly. Anyone who knows the Chinese under these conditions can imagine the reaction and suddenly local prices came down by USD3-USD4 and imported skins were quoted quickly a number of dollars cheaper.
The supply markets are reacting differently in speed and extent. One of the main sources in the UK admitted that their prices for late-season lambs dropped by USD2-USD3 over the past two weeks. The situation for new-season lambs is a bit different and this time of the year, when the European season is changing, has always been pretty tricky.
On one side, we see good demand for new-season skins, in particular from the double face and shoe lining customers. The winter came late this year but it lasted longer than usual and many of the stocks and retail levels were finally clear. A number of retailers confirmed that in January they were afraid to finish the winter sale with about 70% unsold inventories. A lot of emergency plans were prepared. However, the weather is one of the most unpredictable things and so while the last three months were pretty bad for the heating bills, they were good for the sales of winter garments and shoes. A quick review in Europe confirmed that many started their spring very late and were able to sell up to 70% of their winter inventory in the past 12 weeks. Of course, some were complaining about heavy discounts.
However, this has definitely changed the position on the order situation for the next winter season and brought much more interest for lining and double face for the next season. Consequently, tanneries are a bit more optimistic and have gone into the research for supply pretty early too. How much substance this enquiry will have has still to be seen, because we have had a lot of years with tremendous enthusiasm at the beginning of the season that fades as time goes on.
For the time being, many suppliers report strong enquiries from China and Turkey and people are scratching their heads about where to quote the prices. The larger slaughter of the Orthodox Easter is still in front of us [their Easter Sunday is May 5] and this will potentially produce some more suitable skins too. With the cold weather, there are not many skins available in Northern Europe and not very many offers are around.
Consequently, most of the discussions about prices and offers are rather fictional than a concrete reflection of the market. We will keep an eye on the situation for nappa skins, because we do not believe that the demand for nappa leather has seen any changes recently. The wool market is also still in pretty good shape and so there is no real reason why skin prices should fluctuate that much other than the typical gamble in this market and the strong influence of the large traders in China.
The coming two weeks will possibly not offer many changes. Independent of what we were discussing above we can’t really see either part of the market surrendering to gain total dominance in the coming weeks. We believe the fundamental changes which definitely need to come either way are presently in the preparation process and will build their consequences slowly into the market balance. It seems, however, that we can discuss more seriously when this one-way road will be opened to return traffic or whether we are just coming to a new junction.
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