The Leather Pipeline - 05.04.16
05/04/2016
The financial markets have remained reasonably quiet over the past two weeks. The Federal Reserve in the US has clearly indicated that quick rises of interest rates there cannot be expected, which has made return to the stock market. General data from the labour market was still reasonable, which supports confidence in the outlook for the economy.
Oil prices dropped again, which is actually good for private consumers but worries investors these days. Generally the world continues to fight against deflation and oil prices keep a tight grip on the trend.
North Korea continues to test missiles and nuclear weapons and other conflicts such as in the Middle East or between Russia and the West may not be making headlines at the moment but they are far from being solved. Last but not least remain the concerns about terrorist attacks all over the world with the last one hitting innocent families in Pakistan.
A moderately better purchasing manager index in China, improving for the first time in six months, delivered a bit of hope for the economy there, but generally the concerns about overcapacity of state-owned companies and a reasonably flat consumer market remain dominating. There are rumours swirling around that at the most recent summit of G20 finance ministers in Shanghai in February there was an agreement in regard to currencies; the US was not willing to allow the dollar to appreciate any further. This would also explain why generally the US dollar is presently losing some value, which is good for US companies, but is a worry for exporters around the globe.
Recent reports from Japan delivered pretty bad news about the economy there, which, with the problems in several other parts of the world such as Brazil, did not offer a very bright outlook for the global economy.
The visit to Hong Kong which is traditionally a shopper’s paradise made it pretty clear that shopping is not top of the list for visitors at the moment. There is a wide gap between what consumer brands are presently publishing and what they are really expecting in private for the coming seasons. Management teams have not yet corrected their budgets and targets, but in many head offices scenarios of flat or even declining sales are openly discussed.
Market Intelligence
People had been waiting for a long time to get together in Hong Kong to exchange opinions, to speak to customers and suppliers and to try to get a feel for what other regions around the globe think about the raw material trends and leather business.
As usual, expectations ran very high and in most cases people left the show more disappointed than enthusiastic. Many were hoping for a breakthrough in terms of leather demand increasing. With China playing such an important role many were hoping to see tanners indicating a decent amount of optimism for their businesses for the coming months, but that could not really be seen.
However, let’s start at the beginning. The timing for the show this year was actually a bit difficult. The Easter break in many countries made travel quite a challenge. Either people had to sacrifice their break or arrive pretty late into Hong Kong. That could be seen on the first day when the morning was extremely empty and one had to realise that many had only arrived that morning and visited the show after they had dropped their luggage off at a hotel.
In terms of exhibitors it seemed to be pretty much the same as in previous years, but surprising were a number of empty spaces right in the middle of the floor what is pretty unusual; it seemed that there must have been some pretty late cancellations. The organisers are also pretty smart by narrowing a number of the aisles, giving the impression of more attendance than what is actually around. Anyway, it’s not a question of the numbers, but of the quality of the visitors.
What could clearly be seen was a reduced number of participants from mainland China. This was confirmed by almost everyone: the number of Chinese customers was significantly reduced. This is most likely also reflection of the difficult situation in the economy of China. Also the number of exhibitors from China was significantly reduced.
Consequently the show was more than ever before more of a marketplace for information and keeping contacts rather than a classical leather show. Despite concerns about the future of the fair, tanners from Europe, the Americas and the Middle East still use it as a showcase and the chance to meet with all their old customers and new interested ones from the region. Talking to many they also confirmed that this target was fully achieved. Nobody is really expecting to sell much leather during the show, but we would say that the vast majority of the exhibitors were very happy with the numbers of old and new customers passing by. It might also be fair to say that over the years there has been a shake-out in the group of the exhibitors and that those exhibiting today are now well established in the region. As far as visitors are concerned, the quality has generally gone up and people come with clear interest and intention; they know what they are looking for and whom they need to speak to.
Despite all the market uncertainty, which is still around the leather pipeline, we would say that the exhibitors of a certain standing were all pretty satisfied with the results of the show. However, having said that, we must always also understand that the exhibitors and the show are not really representing the bulk production for the volume consumption of leather. While all the major raw material suppliers are present with stands at the exhibition, the really large producers running tanneries in Asia are not really present. Of course as most suppliers made the trips around the continent already before going to the show the volume players do not represent the event.
This makes a judgement about the general market situation pretty difficult. The few large Chinese tanners that went around the show to see some of their suppliers were actually expecting raw material prices to come down. To a different extent, depending on origin and price levels, the majority of tanners are seeing leather demand generally below what they need and they don’t expect it to become better in the coming three-six months. Leather prices in general continue to be under price pressure and the big brands and consumers expect further concessions on pricing. This is so far answered by shifting to lower-priced and lower-quality raw materials, but in general it is weighing on the discussions about business. The currency situation is also playing quite a big role in those countries where currencies are presently appreciating against the US dollar and sellers are facing serious headwinds in terms of what Asian customers are willing to pay.
This brings a continuous stalemate and we have the impression that the total volume of raw material sales at the show were far below the levels we have seen in previous years. While a year ago hide prices had been hovering around record levels and many were scared about the correction, which then finally happened in the summer, most sellers today are quite relaxed and consider that hide prices after the reductions seen are adequate; they are defending their positions well.
Despite all the uncertainty, one has the impression that the raw material market in most sectors is still in reasonable balance. Most of the price tensions that one can see today are actually related more to currency than to supply and demand, and anyone who was expecting that APLF could trigger a major price move in either direction will have been disappointed. From a rational analysis one can find certain origins that tend to be a little overpriced and which may have to adjust, just for the sake of valuation. Buyers hoping to find nervous sellers willing to accept major discounts just to move product will have been disappointed too; many went home realising that they have now to sit down over the next two weeks and deal with the fact that the raw material market for the time being is not going to help them very much.
From a seller’s point of view this is good news, but one has also to accept that there are a number of dark clouds hanging over the situation as well. Apart from the games that buyers play to bring prices down to support their position in the negotiation, it is obvious that, at least for the situation in China, finance is becoming a very serious issue. This might not apply to the international groups or to those who are part of the industrial supply chain, but if we just take the market in Hebei province, which is more dominated by domestic leather business, one has to listen carefully and to understand that leather buyers today are not really great payers. Many tanneries have to sell either on credit or to reduce the volumes to make sure that they can be quickly paid for what they are delivering. Cash flow is definitely not what it should be in this important market.
It is very clear that the boom in China is definitely over. The benefit of much cheaper production costs is, in most cases, over and the strict policy on environmental issues has also taken a lot of the cost advantages away. It is pretty obvious that the more industrial tanners, such as in Shandong province, are getting back quite a bit of the upholstery business that they had lost over the past years. Several expect their production to grow again by 20% to 30% over the next 12 months. This is not an expansion of demand in a better market but just a shift back towards the levels of previous years.
The automotive industry has at least another six month of high production ahead. Roll-outs of new models are keeping production high, and with more brands focusing on the medium and high-end market, as well as improving the interior, it makes the prospects for leather production and sales still quite positive for the near future. Looking a bit more into the next year we could hear a number of voices say that they will watch this market very carefully after the summer break; sales today are being boosted by cheap finance for consumers and significant cash discounts. Going through the newspapers in Asia during the trip one could read in various countries questioning reports of the car sales published, wondering in the statistics really reflect the sales to final customers. Similar stories can also be found in the US, were brands have been accused of boosting the published sales numbers through special dealership contracts. This is never really a good sign for car sales in the long run unless markets like Russia, for example, return.
The biggest problem continues to be in the shoe sector. A lot of discussion in Hong Kong focused on the extent to which leather is being substituted by footwear manufacturers. There was a wide range of opinions about the future of leather in shoe production. General consensus so far is that leather continues to be substituted and reduced wherever possible. Certainly there are clear examples where this can be seen already to a large extent. While some are taking the position that this is a trend, considering low oil prices and the massive benefits in production when you don’t deal with leather, one could also find an increasing number of pundits who are predicting a return of leather in shoe production with lower prices being discussed now for the coming seasons.
Whatever the trend turns out to be, the industry has at least learned a lesson from the developments of the past two years: leather prices have a cap and the endless logic of ‘rising global demand meeting steady supply of raw material equals higher prices’ cannot be supported anymore. What the general price level for raw material and leather is going to be is certainly also dependent on what the various sectors are willing to pay. If automotive leather production is going to expend its market share, the average price might go somewhat higher, which could underpin raw material values in the medium and long term. However, the auto industry will become price sensitive too at a certain stage and when car sales no longer meet expectations and price wars begin to intensify, it will also be reflected in the purchasing attitudes of this industry.
We were in the end quite impressed by the situation in the upholstery business. Also here the boom may be over, but in general demand has certainly bottomed out and is more stable than one was expecting in view of what has happened in the shoe sector. In upholstery, leather seems to have a much more stable foothold as a material and the positive consumer sentiment in the United States, as well as a reasonably stable demand for quality products in China, are holding productions reasonably steady. There might have been a bit of over-optimism in China before the Chinese New Year, but in general quality products are still selling presently, and if they are declining a little now it is because of seasonal influences. Summer is never a good time for furniture sales.
To return to the raw material market, we have come to the conclusion that the risk of big price volatility in the near future has been substantially reduced. The beef industry has managed supply and prices pretty successfully and we all know that stability is more important sometimes than price levels themselves. In a perfect world it would just require minor adjustments of prices in several categories and origins and we would have pretty uniform price levels for hides.
After a long period of turmoil for very light material such as calf and kips, interest, following the massive price corrections, has gone up and these types of leathers have made a nice return into shoe production. The premium end had price corrections a while ago, but never faced the problem of consumption. The lower end of the quality range had a long period during which barely anyone was interested in the product; now these types of leather have definitely made it into collections again.
Improvements in the split market, which we have been seeing for a while, was again confirmed in Hong Kong too. It is not yet spilling into all market sectors and Chinese tanners continue to complain about the marketing of lime splits, but standard productions of wet blue splits are finding a home and volumes have significantly increased. Actually with the price of splits and the production cost for tanning and dyeing a material that can still be called leather, it is very attractively priced even compared to artificial substitutes. The market for splits has been always very volatile and price sensitive and one can only hope that the business is not quickly killed again by sharp jumps in prices. However, splits are moving again and this should make life for the tanneries producing grain leather much more predictable again too.
Bad news continues to come from the skins market. Goats seem to be a bit better supported by the shoe industry but the situation for lamb and sheep is still absolutely dreadful. With reasonable stability in the wool market, some wool-on products are still moving and also the niches for interior design are still reasonably stable. All the rest, and this is by far the majority, continue to be almost at a standstill. In many parts of the world skins are not longer available to buy from packers and a number of processors are seriously considering ceasing production until the situation improves. The question is over what will happen to the skins then. Some people consider this as an opportunity. If they have the production capacity they can recover the wool and turn the skins into piccolo wet blue, perhaps not in the hope of being able to sell them successfully, but for some who have sufficient cash it seems to be a better investment than to have money in the bank and not getting any return on it. It is still very difficult to understand why prices appear to be no real incentive for finished product manufacturers to consider putting lamb and sheepskin leather into many articles.
In the coming two weeks we think that the period of stability will continue. In Europe most tanners will continue their programmes and prices for raw material are almost fixed for the next months. The situation in Asia will now be determined by the conclusions tanners draw from the positions their suppliers are taking. At the end they will not have much choice but either to pay asking levels or close to them or to refrain from buying. This will depend on leather orders. Their inventory positions, with the exception of the industrial programme buyers, is not very high and the only unknown factor in the equation is how many hides lie in the hands of the import traders. If they have few, they will have to buy too; if they have many, they will have to decide if they want to support the valuation of the inventories.
Most of the trade is not looking for conflicts, at least not in the short term until real leather demand for the coming months is determined. It seems that the majority of players in the supply chain are quite happy to keep things as stable as possible instead of risking an aggressive position. It might be that most of the pricing is rather more currency-related than anything else and we would be surprised to see bigger price fluctuations until May or June.
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