The Leather Pipeline - 20.03.18
20/03/2018
At the moment all is politics and there is an endless stream of news almost every day. But no matter what happens it leaves almost no trace on the markets. Politics is almost completely decoupled from the financial markets.
It is really difficult to choose where to start: UK versus Russia, with everything that makes a espionage spy thriller? The elections in Russia, including potential manipulation, but rather more the reason why the majority of Russians are so happy with president Putin considering the economic stagnation? Mr Trump’s daily soap of hire and fire? His tariffs imposed on steel and aluminium, which raise the risk of a global trade war? Elections in Italy, making populist protestors the leaders of an important member of the EU? The critical and totally uncertain Brexit negotiations? The finally confirmed lifetime leadership of President Xi in China, which offers him Emperor status? The scandal around Japan’s prime minister? The list could be much longer.
The most interesting news from the financial markets has been from the US and most of it has been positive, such has a strong performance of consumer confidence and a healthy rise in US industrial output. Also a gain in the CPI index can be considered positive and opens the path for further interest hikes.
With all the above one would have expected the dollar to trend much firmer. However, although it ended with small gain it has been trading in pretty narrow ranges. As usual there are the conspiracy theories that the US government, despite verbal statements, is pretty comfortable with a weaker dollar and is pulling strings in the background to make it happen.
At times like these, it is better not to deal too much with conspiracy theories. There is no benefit in frightening people, but there’s also no reason to ignore that the world is changing and we are facing a rising risk of conflicts. In the 21st century military wars like those of the past seem pretty unlikely, but not impossible. The conflicts and local military confrontations that we saw in 2017 have almost disappeared from media attention. However, the situation in the Ukraine, in Yemen and of course in Syria are far from being resolved and still there are people dying every day. The rise of more and more big egos is definitely beginning to become a serious risk for the world order and the global economy. People and businesses tuning out political news is not making the risks disappear.
The price of oil continues to trade closer to the $60 than $70 per barrel. The price of gold, which is generally considered to be a safe haven, has ended the period weaker instead of being a risk indicator and closing higher. In aggregate we can draw the conclusion that the financial markets continue to be pretty relaxed about what is happening in politics. Since they are usually the most reliable indicator we have to assume that we may be overstating the uncertainties the world faces at the moment.
Market Intelligence
As far as hide suppliers were concerned all the interest last week was on the APLF fair in Hong Kong and the vain hope that the leather industry would queue up and look desperately for raw material supply.
Well, let’s start with the basics first. We are quite sure that there will be once again different opinions about the results, the importance and the attendance of the show in Hong Kong. The entire event was squeezed into one hall and that included machinery and chemicals, tanneries and raw material suppliers from all over the world. From our perspective the show has now found a solid level and let’s hope it is good enough for the organisers to maintain the event in future. A solid base of exhibitors in country pavilions, many with the help of government incentives, use Hong Kong as a platform for the marketing in Asia, except mainland China. The benefit remains that for many Hong Kong is an interesting, efficient and easy-to-reach destination that offers the guarantee that exhibitors will reach a sufficient number of existing and potential customers in the region to make the investment in travel and exhibition costs worthwhile. However, any further decrease in the number of exhibitors and it could become difficult to continue the event.
Meanwhile the number of seminars and association meetings has solidly increased too so that the loss of this meeting in March would not be too pleasant. One can discuss if the present dates, which are soon after Milan in the middle of March, might be a bit too early and a later date in the calendar might be more adequate, but a loss of such a get-together in Asia and the wide time gap to wait until Shanghai might not be the best of the options.
From our perspective the attendance at the show was not too bad. With machinery, chemicals, tanners, raw materials, components all together it made the aisles narrow, the impression of activity better and the distance shorter for those who had to cover more than just one sector. There were slow moments, mainly in the mornings, but this may owe something to the second event that the trade holds in Hong Kong on the same days, but at different times … the night shift in Joe Bananas in WanChai, which runs from 23:00-05:00 and makes the daily start at the convention centre at 09:00 a bit early for some. There were ups and downs in the attendance during the day, but in general the show was busy until the end, if we consider the real start at 11:00. Even the last day, which is usually just for staff meetings on the booths, was pretty busy until the afternoon. Although the usual suspects where packing up early, there was far more activity on the stands until 15:00 than we have been used to in previous years. Quantity is not always quality and so there will be different opinions about the value of this activity.
The situation of the leather pipeline has been analysed already and the fair in Hong Kong has not brought any turning point or delivered any indication of a short term change.
Quality leather manufacturers and automotive tanners enjoy interest and sales in Asia too and their only concern is to prevent leather prices from declining. Production costs are rising, split returns are falling, customer quality expectations are high and, due to the limited supply of adequate raw material, prices are pretty steady and margins stable. The successful tanners expressed concern that an inability to offer clients a price reduction could eventually lead to a long-term fall in leather consumption, even at the superior end. End users could begin to shave their use of leather down a bit here and there, which would increase production costs and hit capacity utilisation. This is possibly the least of the problems the industry has got at the moment.
Automotive tanners feel a strong headwind from their clients, who are desperately asking for price adjustments for the quotations that need to be made for the next models. Many mention an increasingly competitive and aggressive pricing strategy from several of the big players. The situation around GST AutoLeather has offered competitors additional volumes and this may heat up competition in the future. However, serious sources admit that there is no immediate decline in demand on the horizon for automotive leathers, although it is going to be pretty difficult to defend margins. Certainly automotive tanners are presently taking full advantage of the declining raw material prices, but business pricing is cyclical and leather prices with a certain time lag are going to be adjusted. With the rising cost structure it could be a big challenge to maintain margins when these adjustments have to be negotiated and agreed.
Many suppliers to the leather industry in general have been hiding from the trends we have frequently discussed in this publication. Already many years ago we expressed our concerns about the overcapacity of leather production in China. Overcapacity production levels traditionally inflate raw material costs and deflate finished leather prices. The Chinese industry got hit in the end from two sides, with one being the government shutting enterprises down for pollution reasons and, at the same, time massively rising production costs that made the Chinese tanning industry in most cases not really competitive any more. Like everything else, when things happen in China they happen fast and it is unlikely this would have changed much if the raw material supply industry had taken notice of this trend earlier. However, an early adjustment to prices might have had offered the chance to soften the problems we see now.
When the trend towards using alternative materials began, the industry reacted too late and found itself unable to counter the more competitive prices and production costs. That opened the door wide in shoe and upholstery production and, in part, also in handbags. Raw material prices adjusted too late and not sharply enough to be in a position to defend leather use. Now the damage is done, despite a favourable consumer market (as a result of the general economic situation and the global growth of recent years).
In most of the raw material supply origins unsold inventories have climbed with the decline of use of leather, mainly for shoe production. Many are also talking about additional stocks in tanneries and in the hands of traders, which also had to build inventories as a side effect of the continuing production of regular articles. The market has to deal with new supply from global slaughter, but has also to digest what has been left behind so far. With falling demand and shrinking capacity of leather production, mainly in China, it is quite easy to see the mismatch we have to deal with looking at the entire global market.
The situation of leather pipeline has become increasingly complex in recent years. The exclusivity of leather as a material has passed. The equation of ‘cheaper price equals more use and consumption’ has been destroyed. This was also always the base for all the forecasts and studies, which concluded: “Don’t worry about demand; it is there and will grow faster than supply.”
From generally one market, we have moved into many markets with barely any correlation or dependency anymore. Automotive, luxury, casual shoe, premium upholstery, industrial tanners are all markets on their own with their own fixed supply chains. The obsession for certification and for specialisation, the consolidation in the chemical supply industry and economies of scale have all contributed to the development of parallel universes in the industry with known winners and losers. The universes of the past, such as ovine, split, bovine tanning and so on, have now become universes on their own. All of them totally independent and different. This is why sometimes you feel like the leather pipeline has become a leather Babylon.
The meetings and discussions in Hong Kong proved that leather is still performing well where it can be distinguished and its superior functionality or beauty is part of the DNA of the finished product. The only exception might be in the auto industry, where function and beauty are hard to find for the end user because of the product made and the specs requested by the manufacturers, but here it is (still) the image that counts.
Where – as in the shoe industry – leather cannot be distinguished any more and the consumer has (thanks to smart marketing in the casual shoe industry) lost knowledge of and the motivation to care about leather as a material, consumption shrinks. This trend can only be stopped by the same people who created it and hopefully the complications that have been created by certification, labelling, consumer information and so on may not in the end turn completely against leather. Plastic can be pretty bad, but nobody cares. Well made leather is better, but everybody bothers about everything related to it.
Shoppers today want it easy, simple, cheap and safe and the leather industry has fallen into the trap of explanation, excuse and justification, which is making the product not only easier to attack, but also more complicated for sourcing and production, more complicated for the consumer to understand and more expensive. The users of manmade materials have certainly more to explain than us, but nobody is asking them and they have no reason to raise any questions either. Possibly the discussion about plastic waste is a new chance and start for leather. A successful product is easy and pleasing, makes us happy, creates a positive image and last but not least is competitive in price. It has definitely no reason to excuse and explain itself. Let the brands not hand their problems over to us and let the industry be once again be more self-confident. We cannot serve all the people on earth with leather products anyway. It is not our job to improve the image of the beef industry, but as long as meat is consumed leather will be a sustainable and renewable natural resource made from a by-product; it is already bad enough that many sheepskins are wasted and destroyed. Beef production is rising globally despite all the media attention to vegetarians or vegan food lovers.
The split market is seeing the same struggle as the hide market and we have no news. Specialty and niches are still doing well, while standard material struggles. Gelatine and collagen demand is struggling too and prices face headwinds.
There is no change for skins either. Quality sells and specialties too. The rest, which is mainly for the recovery of wool and the production of simple nappa leather, is pretty bad and skins can either not be sold or are sold at prices that do not cover the cost of processing, which means literally that producers are calculating between the cost of dumping, incinerating, landfilling and the net return from below-cost sales. For special skins and high-quality ones the market remains good. Prices are between acceptable and good and also the start of the new season lambs in Europe has been positive, with prices above last year’s levels.
Over the next two weeks the leather pipeline needs to digest the facts. Tanners, and there are quite a few, who produce for existing orders will benefit from lower raw material costs, while others will continue to struggle to fill production with new orders. Many raw material suppliers will celebrate their volume sales at low prices, which they were able to make during the show in Hong Kong and will try to use this to call demand in the market better. However, the sales made were not an indication of more leather demand or greater need for raw material.
The big question for hide sellers is where is the level that will trigger speculative interest and clear the overhanging inventory, independent of any change in leather demand.
Apart from that it is pretty difficult to see how the demand for leather can be stimulated in the short term. For better-quality hides and leather there are only two obstacles to deal with. One is the political situation, which can quickly spill negatively into the financial markets and consumer sentiment, and the second is the supply of appropriate raw material to make better-quality leather. The market for quality raw material remains in pretty decent balance and it would be difficult to convince sellers to make price concessions to compensate for rising production costs and falling split credits.
This means that in the commodity sector official adjustments in prices to the real value of the material are likely.
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