The Leather Pipeline - 04.02.14
04/02/2014
After a long period of quiet in the financial markets, the past two weeks have given us more to think about. Several emerging markets faced considerable trouble and had to fight to prevent the escape of capital. In the limelight was Turkey where the national bank had to raise interest rates by almost double to try to hold the capital outflow and stem the decline of the Turkish lira on the international currency markets.
However, other countries had to fight with similar problems. South Africa, Thailand and the Ukraine with the ones that were mostly noted in the international media. While in Thailand and in the Ukraine it is the political unrest that is making people uncertain about the stability of the local currencies, there are also general worries about many countries’ short-term economic future. South Africa had to deal with the weakness of the rand and many people began to realise by how much currencies like those of India and Indonesia had suffered in 2013.
The discussion in the financial community has started about serious parallels with the crisis in the financial markets in south-east Asia in 1997-1998. These discussions are pretty intense and experts do not agree on the situation. Certainly the situation has changed and many think that most countries are far more safe today than they were 15 years ago. Indeed, national budgets are much more intact and the general economic situation in many countries is far better than it was.
But this is not the only question. Sometimes psychology is a factor too and many of the problems in the financial markets just need someone to squeeze the trigger for them to become an avalanche. Politicians and banks are busy trying to calm the situation down and to display optimism about the financial situation in general. However, these matters can become contagious and with the western world still struggling to get out of the financial crisis of 2008, the situation remains very sensitive.
There are also discussions about the grey capital market in China and the ability of the government there to control what is going on; this is a parallel financial system that doesn’t stop either.
Consequently the financial markets today are on a much higher alert, with stock markets and commodities showing weakness and a rising level of general volatility. One thing is certain: the situation in the Ukraine and in Thailand is a headache as both countries’ stability is important in their respective regions. For the moment the big players in the international political community are trying to look for quick and amicable solutions, and the situation in Thailand is pretty local. But the Ukraine is a buffer between Russian and Western interests and is much more important. Prior to the Winter Olympics in Russia however, it is unlikely that this conflict will grow into a serious conflict between the East and the West.
The US dollar gained a bit of value versus the euro, with inflation in Europe staying low and the US beginning to slowdown its tapering (bringing an end to quantitative easing) by reducing the volume of cash flowing into the system by $10 billion a month. Neither coal nor oil have shown much reaction to the changes so far.
Market Intelligence
The leather pipeline became a bit more active in the last two weeks. In particular the Asians were pretty busy planning to cover all their raw material needs before they went on holiday for the lunar new year. It was pretty obvious that the vast majority of tanneries were not really expecting to purchase raw material more cheaply after the holidays and they got pretty clear signals from the suppliers that they were not too scared by the two- or three-week break.
We would not say it was a purchasing bonanza but the regular buyers have all been round and booked their standard material in regular quantities. There is still a high level of uncertainty about the prices of these deals. Suppliers still pretend that they got constantly higher prices, always at the high end of the weekly price range. However, quite a number of tanneries said they were able to get deals done that were significantly below quoted prices. This is all in private and particularly relates to the real big names in the trade, while the smaller, less financially strong and non-regular customers had to pay the full price without being rewarded by any special deals. Maybe both were right. On one side suppliers are quoting the best price they got, while on the other side big buyers taking regular programmes saved money by purchasing far below the official price levels.
Some well-informed people we talk to regularly have confirmed this. Players who are part of the exclusive ‘club of the big and healthy’ are being very careful about what they say, and this is no surprise because it would suit them to have a lower average price. Sellers on the other hand will be happy with a regular outflow of the majority of their production and can fine-tune their average returns with smaller customers.
A number of analysts believe that this is a long-term strategy. The concentration on the supply side of hide and skin production continues and, at least in the bovine market, the large beef companies control more and more of the slaughter and the byproducts. In addition, many of them have become part of the added value chain too and for them high returns and stability are essential.
Modern management with long-term budgeting and business plans that companies expect to be fulfilled are also dictating to operational managers the returns and results they have to achieve. This does not allow much room for flexibility on pricing and without any major macro-economic influences, hardly anyone in this business wants to see falling or fluctuating raw material prices. To achieve these targets more concentration, more market control, fewer players, less speculation and more guarantee of stable product flow is essential and there are quite a number of pundits who believe that this is the long-term target: to squeeze more trading activity and smaller leather producers out of the market. In short, kill the flexible small ships and protect the large tankers, because their routes are easier to predict and follow.
We have discussed this fundamental change in the leather pipeline already a number of times. What should not be forgotten is the fact that at the other end of the pipeline, similar strategies and interests are in place for businesses with the opposite ideas. That’s what makes it all so complicated now. It is not so difficult to understand that there is possibly a similar management policy on the beef companies’ side and on that of the brands and retailers; nor is it difficult to believe that they have totally different opinions about what the best final outcome will be for each of them.
As an example we can take the big automotive companies or even some of the shoe brands. For them, it is totally irrelevant that raw material price has moved sharply higher in the past year or so because they believe that their purchasing power and size must entitle them to lower prices and long-term guarantees. Taking many of the larger European automotive supply chains as an example, there are price negotiations ongoing for almost four months already without any clear agreement about prices and long-term price guarantees. However, leather is still being produced and shipped because the automotive manufacturers need it, so they will find a solution for sure.
But even with the growth in automotive and in the other leather sectors, the amount of leather produced and consumed is still dictated by the amount of raw material available. The parameters that can be changed are just the types of leather and the amount of leather used in the finished products, and this is dictated by price. For those in the middle (mainly the tanning industry and the contract manufacturers of leather products) times will definitely get no easier. In the free markets it is still the survival of the fittest, or maybe of the strongest. The strongest are not always the best.
So, everything points in the direction of another squeeze in the leather pipeline. Such a restructuring happens approximately every 10 years. In the past this meant a period of a year or two in which larger manufacturers collapsed with pretty large failures and bankruptcies, but today it is becoming a slower and quieter process. In Europe we have already seen in the past year either tanneries going bankrupt, closing voluntarily or, if they were part of the luxury market, escaping under the safety umbrella of one of the larger luxury brands. For those who do not have this kind of emergency exit, it is time to analyse if they are among the fittest and able to survive.
Apart from this structural analysis, we had some normal business issues too in recent weeks. A number of fashion shows took place and for us and Europe the Expo Riva Schuh fair in Italy and the IMM upholstery fair in Germany were possibly the most important ones as they are indicators for the fashion and business trends of the coming seasons.
From what we heard of the show in Italy it seems that the low-price end and Asian producers are suffering most from the present situation, owing to high prices for raw material and leather. Volume and commodity producers complain bitterly about profitability and see their businesses fading and competition growing. The good news was that it looks as though fashion trends will allow the use of lower selections of leather. Vintage fashion, seen in apparel already for some time, is now spilling more intensely into shoes as well. Where leather is not substituted by cheaper man-made materials, a lot of shoe designers and brands are experimenting with designs that allow natural defects to become part of the design. The result and feedback from retailers had been quite positive and this could allow the tanning industry to use up stocks of medium and low selections.
Reports we got from the IMM fair in Cologne were similar: top-quality and aniline leathers with natural tannages were on display with natural defects and brands were using these defects to promote a vintage trend. Generally, the tone of the fair was less optimistic because the furniture business in Europe is not particularly good at present. However, if you can attract the customer with something special there are still buyers around who are willing to spend money.
Due to price problems and the general firm trend for cattle hides, the split market remains very firm and some even say red hot. Prices continue to climb and there is simply not enough product around at the moment to cover demand for some specific sections. PU-coated and suede splits have made so much inroad into the production of shoes and leathergoods, and even into automotive, that many consumers do not realise that the split is only produced when a hide is tanned. Looking at the prices of splits and looking at the same time at the price of low-quality hides, low-quality grains might be more attractive than splits very soon. If the fashion trend mentioned above becomes established, we might see in future seasons a reduction in the demand for splits, with the quantities substituted by low-grade grains. However, there is no indication that this is going to happen very soon and the price for splits is likely to stay high in the months to come.
The skin market is suffering. High-quality double face and lining materials for winter products have seen insufficient sales in the northern hemisphere so far. The market for nappa remains pretty difficult. Prices for average-quality skins are constantly coming down and have been for the past six months. We expected them to settle and lamb leather to become a substitute for bovine wherever this is possible, but this has not happened so far. There are rumours of serious congestion of fell-mongering skins in China and about serious problems with regard to payments because of the increased stocks. For the moment everything is on hold as the main players in China are on holiday and it will take at least another 3 to 4three or four weeks for a better picture to emerge. The promising news is that the price of wool remains pretty high and this should support the value of skins eventually.
The next two weeks will still be reasonably quiet. Most of Asia is still on holiday for another week or two. In Europe everybody is waiting for a final settlement on automotive leather supplies and analysis of other leather orders for the rest of the first quarter. It is clear that we can expect hand-to-mouth buying at best. Suppliers are entirely focusing on the supply side, and this means on the kill. It is expected to fall, because most are reporting that the beef sales are not good. In particular, good-quality and prime cuts are not selling well and this means a reduction of mainly male and high-quality cattle in the slaughter mix. The beef industry will try to squeeze more money out of byproducts. Many point to the fact that the raw material markets usually trend higher until the APLF fair in Hong Kong at the end of March, but this might be one of the years in which things are different. All in all there is very little reason to believe that price volatility will be high in the weeks to come.
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