The Leather Pipeline - 24.06.14
24/06/2014
Football has taken over and many in Asia and Europe have short nights these days because of kick-off times. So far we have seen plenty and good matches with some teams already on the way home.
On the stage of general economics, the political influence continues to dominate. The conflict in the Ukraine has its ups and downs but remains unresolved. The status is very fragile and it is becoming more and more of a military conflict between the West and the East with none of the parties willing to give way. It has become fundamental for both sides, because here we are dealing with the situation at the eastern boundaries of Europe which is finally going to have a very long-term determination about the influence of an important strategic position in the south-east of Europe. At this stage one can only feel extremely sorry for the big number of civilians who are becoming again the victims of politics.
Another serious conflict has developed too over the past weeks and this is the situation in Iraq. The successful attack of the terrorist group ISIS has brought the country back into the limelight. With a pull-back of foreign troops many tended to believe that the conflict in Iraq was over. Those who are a bit more familiar with the situation knew this was not true and that local conflicts remained. The western world is tired of military involvement in this conflict and that makes it extremely difficult to take a position although peace in the region would be and is important for the safety and security in the rest of the world. All will now depend on the strength and success of the government of Iraq in handling the situation with its own resources. However, even a military success and win over ISIS would not erase the fundamental problem or restore peace.
War in Syria, the situation in Iraq, terrorist activities in Pakistan and Nigeria, plus a number of very local conflicts such as in the South of Thailand, Libya or even in China should make us all aware how much the problem has developed again, how unstable the situation in many regions is.
For the moment the only impact the global economy is feeling is the rising price of oil in response to the situation; prices have risen by about 4% to 5% in the past weeks. Also precious metals were able to benefit and gold and silver made a strong recovery as well. For the general global economy people have not yet taken much notice and very few are publicly rating the risk of a slowdown very high. However, local consumption in Russia and the Ukraine are already seriously affected and if oil supplies become a problem and prices march higher, this would also quickly eat into the private budgets of consumers and on the production costs of corporations.
In the financial markets the central banks still do not trust the stability of their economies and so they continue to supply the markets with cheap money. The US Federal Reserve has not yet declared the US economy to be strong enough for it to reduce its support and in Europe we all know that it might look better to some, but the South of the EU is still in deep trouble and the North could face serious problems with asset bubbles in particular as far as real estate is concerned.
Market Intelligence
Over the past two weeks the market has developed pretty much as expected. In Europe the upcoming summer holidays are dominating the scene and with only approximately four weeks to go until the soaking of raw hides stops, most of the industry has already closed the books and put plans on hold until mid-August.
Most tanners we speak to are running on normal levels, which include a certain slowdown of leather orders due to the season. Automotive and high-quality leather producers are still enjoying very steady order books and are managing their inventories as tightly as they can to avoid any possible surprises after their return from the holidays. Most of the tanning industry in Europe will close from the last week in July until the last week in August, but the reopening of many will depend also on orders that customers place for delivery right after the holiday break.
Many producers are watching the political situation and depending on the exposure of their business to Russia, the Ukraine and the Middle East many tanneries and leather manufacturers are trying to figure out what the impact on their business will be. With high prices for raw material and a pretty high risk involved, nobody wants to be caught out. The medium- and lower-end demand in Europe is pretty much subdued and the situation in the vegetable-tanning centres in Italy is very quiet because of the problems of sales for shoulders and bellies. The large automotive tanners in Germany, Austria and Italy are still running at full capacity, which is not really a surprise knowing that car sales are exceeding the levels of 2013 and the roll-out of new models after the summer holidays traditionally requires more material.
However, the big boom in the automotive industry might slow down too. Large manufacturers with factories in Russia are already facing a massive slow-down in sales, in most cases in double-digit percentage numbers. The uncertainty about the Ukraine conflict is also beginning to worrying some of the premium manufacturers, who have seemed untouchable until now. It is true that the wealthy, with rising asset prices and low interest rates continue to spend on premium and luxury brands, including automotive, and still do not feel much of a decline. However, one has to be prepared and managing the potential risk is part of business decisions today.
In China the situation in the leather industry remains in the fog. A number of people we speak to are of the opinion that the worst is behind us and the low season of leather production in the past quarter has been used by many to reorganise their production, to do the necessary to comply with the government regulations or to relocate their production. Others are actually reporting exactly the opposite and believe that in July the situation is going to deteriorate in other regions of China , with many tanneries being forced to reduce production or close down their facilities.
For the time being it is at least fair to say that finance is the main concern in the mainland. The delays in opening letters of credit or payments have become far more plentiful in June. Most of the buyers are confirming that they are going to respect contracts, but they need to wait for the release of new credit lines at the beginning of July to meet their obligations and to take the product they bought. Possibly this might be true in part, but from our perspective the tanners are trying to delay raw material arrivals and to hold physical inventories as low as possible. Most likely the majority of leather orders are only placed from August onwards and many tanners are trying to get more reliable information about the volume of leather orders for the rest of the year.
We all know how important it is for many tanneries to get the market right, in particular at the beginning of the season. With a sharp decline in split revenues and very little indication of a quick and strong recovery, the possibility of value gains from that part of the calculation is considered to be pretty limited, at least for the months to come. This leaves much of the calculation related to grain leather and here the situation is totally unclear until retailers and finished product manufacturers put their budgets, plans and pricing on the table towards the end of the summer.
On the supply side the situation remains driven by expectations. The large protein companies continue to try and to manage their by-product revenues actively. They and we have learned in the past years that the pricing of by-products is no longer a result of what you can get on the day and taking what the market is willing to pay. Suppliers today are trying to meet budgets, price targets and long-term revenue stability. To achieve this they have become involved in added-value chains.
For the time being, many of the large supply companies have taken the decision not to become too affected by the decline in raw material demands of the past quarter. From their long-term perspective raw material demand will see temporary declines from time to time, but in the long run it will always stabilise. Raw material and leather demand will not decline, even if production and raw material demand are relocated.
As a conclusion they are not trying to push sales through lower prices and believe that the moderate correction we have seen over the past weeks has been enough. They are patiently waiting for the low season to pass and for tanners to return to the raw material market when they have to replenish their inventories to meet consumer product demand. Their message to the market is pretty clear: ‘We are not scared, we are faithful to leather demand and we are convinced that leather can be sold at the price levels that we consider to be fair and that we have put into our budgets.’
Sellers are free to put their own price-tags on their products. The assumption that production needs to be sold immediately is outdated. Looking at the available numbers for hide production and sales, and this applies in particular for the weekly statistics from the US, one doesn’t need too much background information to understand that sales and product flow have been under-performing for quite some time now. Suggestions from suppliers of excellent forward sales, strong enquiry and easy movement of hides are at odds with the facts. However, it seems to be still one of the old reflexes of the trade to repeat the same stories to make markets. In the end it doesn’t actually matter as long as suppliers are willing to manage their inventories and pricing actively, and the price levels they have in mind don’t actually reduce leather demand from season to season or create an imbalance between supply and demand due to a higher level of substitution of leather as a material.
This remains in our opinion the only question and issue to be investigated. All the arguments for or against have already been discussed everywhere, including here. We still remain of the opinion that the supply side of raw material is not going to be the determining factor. The variation of all raw material available globally for leather production is less important than short-term seasonal influences, trade barriers, production capacities, influence of general politics, the economy and the general demand for leather, which is related to fashion.
When we break this down we feel it is fair to say that it comes down to the question of whether the rise in automotive leather demand can compensate for the fall in other sectors. The sharp rise of raw material and leather prices in the past year has actually reduced the consumption of leather in global shoe production by quite a bit and even higher-wealth consumer spending has not been able to keep the content of leather in shoe production as high as it was; fashion shoes are barely made of leather any more. Where fashion and price dictate, leather is being squeezed out. It’s a similar situation in traditional upholstery and higher production costs as a consequence of the situation in China will play an additional role too.
However, if the performance of automotive leather continues to be as strong as it has been and consumption in car interiors rises at the same speed as it has done in the past years it might not matter. The leverage of the material price in cars is much lower and as long automotive manufacturers see sales and consumer demand for leather, this field can easily compensate. Having said this, it is in conflict with the aggressive purchasing strategies seen by the automotive industry. As long as their prices are a fraction better than for shoes but the more aggressive they get, it will be a problem for the tanning industry and weigh on the revenue potential for raw hides.
We are now in the low season and at the beginning of the change between the seasons. The northern hemisphere is taking a summer break and it seems to us that we will still need a little while to really experience what the above means for the rest of the year 2014. In our understanding it seems that the smooth and easy times we have seen since the big financial crisis of 2008 might be over. After the big collapse, matters for the leather pipeline stabilised pretty quickly and for a long time the industry has had the benefit of low leather and raw material prices. This business is and has always been cyclical. However, as explained above the big protein suppliers play a much bigger role now and it has become much more difficult to make any serious short or medium term predictions, because we are not dealing with a market that is created by the day-to-day activities any more.
We cannot report anything new from the split market. Maybe the decline in split prices in China has come to a stop after the drop of about 30% in just a few weeks. At least we have not heard any more about additional declines, but having said that there seems to be very little market activity and certainly no indication of a rebound. We have to admit that we are a little surprised, because we have been told that splits still play an important role in the material sourcing for the coming season and although we have certainly seen a price bubble there should have developed more demand after the decline of prices. It might be a bit early, but generally one should expect that more people would begin to buy into the falling market.
If there is a bright spot in the market it is high-quality furniture production. Heavy and good-quality salted butts are still moving quite well and the same applies for high-quality suede splits, which might see some pressure in sympathy but enjoy still fundamentally good demand for high-quality suede leathers. The market for gelatine and collagen is under pressure with many alternatives being freely available at lower price levels.
For the skin market we cannot trace any fundamental change of what we have seen already for quite some time. Skins for the production of nappa are still suffering from the shutdown of tanning capacities in China and low demand for garment leather. Summer temperatures in particular in Europe make storage of skins extremely difficult and many European suppliers face serious trouble in trying to handle the situation.
The situation in Turkey is a little better, but here the market is burdened by money shortages as a result of the warm winter last season and the totally unclear situation in one of the main markets, which is still the Eastern bloc under the lead of Russia. However, unless exports stop as a consequence of sanctions, people will still need and buy double-face leather jackets and sheepskin-lined boots so there is some business, but not too much. With the low price of skins and a pretty good price level for wool, more and more tanners are experimenting with articles to be used in shoe and leathergoods production. And indeed where price matters so much we should not be surprised to see much more lamb and goat in the production of shoes and leathergoods for next season. As long as hides remain at current levels, skins are an attractive alternative. This is good news for premium quality skins and this relates in particular to high quality hair-sheep. Demand from the premium quality industry remains pretty decent and apart from moderate corrections, prices can still hold significantly better than for the standard items.
For the next two to four weeks, it is pretty difficult to project any major change in the market situation. If we do not see any serious influence from cash flow situations, payments or general political effects, we would be surprised to see anyone seriously willing to take longer-term positions. The most price-attractive hides will be sold in small chunks on a regular basis while others may need to wait until the situation becomes clear as far as orders for the next seasons are concerned. We will keep a close eye on the situation in China, which might be the most important trigger for the next move of the market. We expect this to take place from mid-July onwards.
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