The Leather Pipeline - 18.04.17
18/04/2017
The main focus in the world of business and politics continues to be on security and stability. The last two weeks have shown to the world once again that tensions are widespread.
Terrorist attacks in Saint Petersburg, Stockholm and Dortmund made the media headlines and displayed once again that this phenomenon can hit anybody and anywhere, which is the result the criminals are aiming for. The world has to stick together, independently of other political interests. International diplomatic activity is rising and travel for meetings intensifies.
In the general world the US air strike on Syria and the conflict with North Korea weigh on the relations between the super powers in the world. Nobody wants conflict to spread, but to find the balance between strategic regional interests and stability is presently very difficult as can be seen in particular in relation to the conflict in Syria, where the regional interests of Russia dominate. However, the situation around North Korea is also becoming critical and requires intense diplomatic communication between China and the US.
The financial markets were quiet over the past weeks without any fundamental changes. Just a few of the basic trends shifted a little. Oil prices have advanced by about 10%, seemingly in direct relation to the political tensions. The balance of supply and demand cannot justify the rise. The production cut put in place by OPEC oil-producing countries seems to be well compensated by an increase in supply from non-OPEC members.
The US dollar remains stuck in a pretty narrow trading range and its slow ascent again the euro was stopped by a statement by President Trump, who declared the dollar to be too strong and said he expected the Federal Reserve to hold interest rates low as this would be in the best interest of the US economy.
Gold prices also advanced sharply, which also has to be in direct relation to the political tensions. Stock markets continued to trade in very narrow ranges and in aggregate one can say that investors are in no real mood to change their main investment strategies in a way that would move markets to new levels.
Market Intelligence
In the past week the leather pipeline was completely dominated by company news and a typical Chinese downturn at the beginning of the second quarter, the start of the low season. On the side, there was also a notice from the Chinese government about creating another new special economic zone around Beijing, going deep into Hebei province.
Let’s start with the company news. We’ll just pick three items because they seem to us quite representative of the present situation. We don’t need to get into the numbers in detail and anyone who is interested can get them from leatherbiz.com or from any of the financial websites. Daimler reported record sales for the first quarter and almost doubled profit versus market expectations for the same period. LVMH delivered very positive results too, including growth in the leather division. Meanwhile, Payless Shoes was filing for bankruptcy protection in the US, leaving quite a few unpaid invoices.
What does all this tell us? Pretty much what we have been reporting and experiencing for quite a long time. The automotive industry, and in particular the premium segment, has performed extremely well and has accounted for a lot of the positive development for everyone in the supply chain. However, here we are talking about cars built in 2016. The performance in the premium and luxury sectors continues to be very positive and this segment is also not (yet) influenced by all the discussions about mobility and petrol engines.
Talking about luxury, we get to LVMH, one of the companies that are synonymous with high-end leather accessories. Here we see no weakness at all in demand and the top brands continue to perform extremely well. There is unbroken demand for top-quality calfskins and we see tanners trying to secure raw material supply instead of seriously discussing prices. The added value that can be generated is still easily enough and the demand strong enough for concerns over raw material price levels to be wiped away.
Although Payless Shoes is a retailer, it can still be used as an example of the other side of the coin. The need to sell cheaper all the time, which in the end leaves sellers without a margin, is something that has become common along the leather pipeline. If price is the commanding factor it is difficult to generate good enough commercial results for the business to survive. Brands supplying the retailer, contract manufacturers supplying the brands and tanners supplying the contract manufacturers are all affected if there is not enough added value to keep the Payless business running.
This is what we have been seeing for a while now around the leather pipeline. The gap between the successful products and the ones that suffer from intense price competition continues to widen, month by month. With rising production costs and the strong rise of online sales, margins for many mass producers are shrinking and the situation seems to be deteriorating even further.
There are plenty of other problems intensifying the situation. In China the pressure on the leather manufacturing industry continues to increase. The government is not loosening its grip on the industry as far as environmental issues are concerned. This is definitely good news for the environment and absolutely to be welcomed, but when the rising costs cannot be compensated by higher prices for finished leather and leather as material continues to be substituted, it raises the question of how to handle all the raw material that cannot compete in the price war. Should we just dump them, turn them into gelatine or are they to become part of the supply for pet food? This is not very likely, but solutions still have to be found.
Another big problem continues to be the product itself. The global focus of the anti-meat campaigns continues to be on cattle and beef. The big industrial players still believe that the best answer is to focus on large organisations trying to improve traceability. We are fully aware that our opinion on the subject is not very popular these days. A lot of effort is being invested in this; we are even going so far as to think about DNA analysis. What benefit would this deliver to the leather buyer and, as asked above, what would happen to all the raw material that would, necessarily, fall outside the DNA analysis exercises. What is going to happen to all the sheep, goat, horse, buffalo, deer and so on that deliver raw material for leather production as well? What is going to happen to all the small farmers and small slaughterhouses that would be unable to provide the requested analysis, because they can’t afford the necessary equipment? This would favour the big industrial conglomerates who can afford the investment and can handle the necessary administration. Maybe this is exactly what the people in the background are really looking for but we think it is high time the industry began to review what this has triggered and to think about the long-term consequences for leather in general.
We are in a classic market situation for April and for the second quarter of the year.
The weeks around the APLF exhibition in Hong Kong were the breaking point in the annual cycle, as usual. Several weeks after the event now it is obvious that the market has entered the low season. Not long ago, most big sellers around the globe were still trying to paint a picture of high volumes of sales and of desperate buyers willing to pay their asking prices. This was something that worked well in the last quarter of 2016.
However, as the first quarter of 2017 proceeded, it became obvious that in mass leather production (particularly in the upholstery sector) the seasonal dynamic was beginning to fade and the tanning industry realised that higher raw material prices did not match the price levels they had agreed for the season with customers who were not willing to commit to increases. The cost averaging effect of hides that had been bought at lower levels with the high prices of the end of the season faded as well; this meant the tanneries began to slow down their purchasing programmes as much as they could.
In the pipeline for shoe leather we have far less pronounced seasons. The simple reality is that more and more shoes are made from alternative materials to leather. This leaves leather and raw material in surplus.
The usual consequence is that raw material suppliers try to protect their revenues. They can accept falling volumes as long as they can still report steady or maybe even higher prices for what they can still sell to the industry. The general hope is that lower sales now mean that the inventory position of the industry is eroding and that the raw material stocks that are building up will come onto the market because the industry, sooner rather than later, will need to return and buy. This is a difficult subject because it is extremely difficult to get a clear picture of what the industry really needs and what future demand is like for leather-consuming products.
Again, this does not touch the luxury accessories business or the premium automotive sector, at least not yet.
Nobody can deny that production and transport costs have gone up significantly, while split credits in many parts of the business continue to be under pressure and price competition in retail (including online business) has not eased at all.
The next milestone that will help us learn what we can expect for the summer period is most likely to be the High Point Market furniture show in the US (April 22-26). Indications from the property market remain pretty positive. For the optimists this is laying the basis for very positive results for orders of upholstery leather. We tend not to disagree, but it’s extremely difficult to come to any conclusion about how positively leather will be received during the show. Whatever the result, it will not have any positive effect on the market for the next six or eight weeks. The biggest problem might be stiff competition on prices. Without a serious increase in finished leather prices, the fundamental problem is not going to be solved.
For the rest, we still see serious problems in the increasing stocks of low-grade selections that are leaving production every day. Without a breakthrough for new leather articles that can digest raw materials with natural defects, it is going to remain an unresolved problem and tanners are going to have to invest money to make the material look like plastic (leather’s main competitor, a competitor that has a price advantage). It’s a vicious circle and leather cannot win. Oil prices would need to move back to sustained levels above $100 per barrel for things to be different, but then the consumer would have much less money to spend.
The split market continues to be extremely difficult. Prices for lime splits are once again under pressure and this applies to almost every market around the globe. It’s the same scenario as we see for hides. Specialty niche products at the luxury end can pick what they need at price levels that are pretty reasonable. However, when it comes to standard products, as well as articles for gelatine and collagen, we see massive price pressure; the price has fallen significantly after the short rebound in the first quarter of this year. There is very little indication that this fundamental market scenario is going to see any kind of change for quite some time.
A look into the crystal ball for the coming weeks gives little indication of a general change in market conditions. The kill in the US is going to rise seasonally and will make more hides available. The March beef scandal in Brazil has not lasted very long and as a matter of fact the expected reductions in slaughter have not taken place to the extent most people feared. In Europe we will see the standard decline in production that usually takes place in the period from April to September. In particular, heavy males will be offered in much lower volumes and that is good news for those selling them because, despite all the question marks around the automotive industry, the production of premium cars and new models will require a sufficient amount of raw material at least until the summer break. As explained above it is likely that the upholstery leather segment will have the upper hand in the market.
We are not expecting any kind of a drama for spring and summer: for many types of raw material it might be better to be prepared for a price correction to allow the industries that are using leather as a material to make a profit.
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