Macroeconomics

Over the past two weeks the financial community has been active and we have begun to see changes that might affect us in the course of the next few months.

The pandemic still holds the world in a tight grip. Rising number of vaccinations should begin to have their full effect in the coming two or three months. However, mutations continue to develop. Politicians are trying to offer hope and governments are discussing exit strategies, but it is still the virus that dominates.

The US experienced a major winter storm recently, which reached even the southern states and caused a lot of trouble for people and infrastructure.

The financial markets have begun to discuss inflation. It is surprising how long it took for this to come to the attention of the financial community. Officials are still playing down the risk of consumer price rises. But the pro-cyclic rise of commodity prices, the massive increase of transportation cost, the disturbed supply chains and rising production costs cannot lead to any other option than to increase prices. You can play with the statistics for as long as you want, but for the ordinary guy in the street, prices will go up. Whatever happens, the excessive money supply has to be sorted out eventually. If not now then certainly later.

The sharp rise in commodity prices and the strong rebound of energy costs on the back of a rise in oil prices will leave imprints on calculations. It will certainly leave the pockets of ordinary consumers emptier when it comes to pay the bill for heating or petrol.

Oil prices have reached a 13-month high and are targeting the $70 level. Maybe rising supply can soften or reverse the trend, but oil-producing countries will be happy to see these levels being achieved again. Other commodities, such as metals, look pretty strong and agricultural products have also moved ahead of the market and look firm. Precious metals, which one would expect to go higher owing to the risk of inflation, have seen significant setbacks.

Crypto currencies have been boosted by lot of public statements from influential personalities. Bitcoin pushed up to $60,000 before correcting. The hype of crypto currencies can be seen as  classic speculation; it will continue to attract money and speculation.

Leather Pipeline

Over the past two weeks, people in Asia have returned from their New Year holiday and supply of raw material and the weather have been the main topics of discussion in the leather pipeline. Under the lead of China, Asia has been a strong performer, driving the entire industry forward since last summer. There is also talk in the pipeline about what could happen when the upholstery bonanza comes to an end.

 Discussions with a number of quality furniture upholstery tanners in Europe have confirmed the impression that has built up over the winter. High-quality upholstery leather, in particular in Europe, has been selling very well with the tanners able to secure a sizeable volume of orders. Good access to quality hides at reasonably low prices offered many companies the chance to compensate for the losses from lockdown last spring and the higher cost of production. A number of them are still confirming satisfactory orders, which will keep them busy well into this spring, but the size and the volume of new orders is now falling rapidly.

Tannery managers were pleased by their ability to withstand the time of the pandemic so far; a number of them have even suggested that they may be one of the winner. Consumers have spent a lot of money on their homes, often redirecting budget they might normally have spent on holidays and high-street shopping to the decoration and renovation of their homes.

Quality upholstery tanners are now trying to extend this positive trend for as long as possible but they are now beginning to feel the pain of raw material shortages and the substantial rise in raw material prices. Margins are shrinking and so are the entries in their order books, which means they all expect a positive first half of this year, but remain uncertain about the second half. One manager said: “We have had a period of strong orders and very satisfying profits, but we must make sure we find solutions for the time when people will focus again on travel, holidays and spending money in restaurants. Then we will suffer. The boost in demand will be followed by a quieter period because expensive furniture is not something people will replace every year.” This leads us to wonder what will happen when the seasonal cycle for upholstery leather production comes to an end as it usually does in the late spring.

The two underperforming sectors since last autumn have been leathergoods and shoes. In our general research we have talked to a number of side leather tanners too and asked them for their opinions and expectations. The results are somewhat mixed. Tanners that are serving quality outdoor shoes are moderately satisfied. They have had to adjust their leather prices, but in general the recovery of production after the lockdown went reasonably well. They are traditionally in competition for premium-quality hides with the automotive industry and this is hitting them hard at the moment. Hides with high-quality grain and higher substance have gone up in price substantially and this is hitting the calculations of these tanners hard. More of the same and they predict a new round of substitution of leather with alternative materials and a reduced per-pair consumption of leather.

Average-price shoe leather manufacturers draw a completely different picture. They are not only suffering from a sharp reduction in orders, they also report that a lot of leather orders were not fulfilled last year. They confirm that their clients, the shoe manufacturers, are showing more activity and interest at the moment, but the big problem is that nobody is really willing to place confirmed orders of any significant size.

Everyone is playing for time because there are many obstacles. There is no clear direction on designs and fashion trends owing to the lack of shows and feedback from retail. In many markets, it is still completely unknown when shops are going to reopen. The winter season is lost already, but what to do about next summer season? It is still unclear how much stock from last year will still need to be cleared. If you look at the textile and apparel market, many of the large retailers have already begun to destroy unsold stocks of clothes from last year and many plan either massive price reductions of 80% or 90% or, if reopening continues to be delayed, further destruction of inventory.

The stock-lot pipelines that usually channel unsold street fashion into markets in eastern Europe or Africa are completely congested. The evil of fast fashion, which has been pumping out so much excess production for so long, has little option but to destroy finished products to clean up. How much this is going to hit the shoe pipeline as well is not known yet. Balance sheets and company results and not offering much reliable information.

Large streetwear brands pretend that their sales have been successful in moving online, but it’s not yet clear if this includes selling a sufficient number of sneakers and shoes. Sneaker fashion has not changed too much and the ordinary buyer is unlikely to regard stock as outdated for this spring and summer.

In the leathergoods section there are reports around of business beginning to improve. The luxury fashion houses have reported successful business in China and other Asian countries and say that they have been successful in shifting sales online. Several new online selling strategies have been implemented and it could indeed be easier to create an exclusive environment that may possibly not quite match the treatment in a shop, but if the wealthy want to spend they can do it by special appointment with exclusive online invitations. This segment of the consumer community has certainly been more active than others.

However, those at the level underneath the top brands paint a different picture. As in the shoe industry, a certain level of consumption is preserved, but there are still a lot of products stuck in the pipeline. Companies at this level cannot just wait until the stocks clear. Decisions have to be taken, new products have to be developed and the marketing people have to be fed with new trend information. They then have to bring it to the attention of potential buyers. Many of these labels are becoming livelier again. This is not really the result of secure knowledge, but more the result of hope, trial and error. Whatever happens, they have to take decisions and the supply chain has to be refilled and this can be felt along the leather pipeline too. Players are careful, but they are active.

If anyone still had any doubt about the future of leather, the sale of Birkenstock, on the market for €4 billion or more for a turnover of about €700 million and a profit of €120 million, might catch their attention. There are only a handful of brands that really epitomise leather and Birkenstock is definitely one of them. They may have expanded into other products as well, but the name is absolutely connected to the high-quality, comfortable sandals they produce. If investors are willing to pay such a price tag, they must be convinced that leather is going to continue to be an exclusive product that offers a healthy opportunity for margins and profits.

In the raw material pipeline the limelight was shifted to the situation in Europe. Almost all countries have reported a substantial decline in slaughter since mid-January but, since then, the situation has become critical. Meat companies were not expecting the fall in demand for beef that they have seen. They have had to reduce slaughter and change their plans and schedules.

The problems of logistics and shipments of hides from the UK following its departure from the European Union have added to the shortage. This has hit tanners, who had bought and planned to have UK material to process, only to find that, in some cases, it could not be delivered in a timely manner. They had to find alternatives and, in setting out to find them, may have been a bit too cautious about their requirements. They had to fill their drums just at the time when there was less raw material available on the market. This is always tricky in Europe, where so much production is based on just-in-time deliveries of fresh material. 

This is an explosive cocktail for prices. The hide types that are needed for these operations are produced almost exclusively in Europe. On the back of such a situation like the current one, it’s easy for them to be quickly propelled out of any fair valuation. The same does not apply to commodity-type hides that can be easily substituted by other origins.

Luckily for hide sellers, the shipping problems from the US and massively reduced slaughter in other parts of the world did not immediately trigger any reaction. However reliable sources confirm that the demand, in particular from Asia, has eased substantially with the new asking prices. The $1 million question is now how many hides the tanning industry still needs for the coming months and what role the delayed shipments of hides still in the pipeline will play in the procurement of more material over the next six or eight weeks.

If we follow the standard cycle, it would be no surprise to see again the situation we have seen in many other years. Sometime between mid-March and mid-April, the rise in the price of hides and skins will lead to an equivalent rise in leather prices. We will see later in the spring how this affects demand.

In the split market, there is still stable and relatively regular business for the specialty types. Higher production has also made more splits available again for the collagen and gelatine market. This has put additional pressure on prices.

The news on the skin side is a bit more interesting. Rising prices for wool and the fact that quite a number of tanners have begun to realise that the excessive stock they were able to buy for practically no money are almost exhausted. Demand for sheep nappa leather seems to be picking up and tanners are finding calculations difficult. The dream of skin prices remaining below processing costs for ever is over. In many countries either the stocks have been cleared or all the skins have been destroyed because traders grew tired of waiting for the tanners to buy them below cost.

Tanneries in the Middle East in particular run their productions on sheepskins and will have to accept that prices that cover costs will have to be the next step. Otherwise the skins will not be preserved for the leather production. At the same time, we continue to feel that there is increased interest in the use of leather in fashion again. If the pandemic had not killed fashion shows and fashion meetings, we would be convinced that demand for garment leather could justify already these more acceptable prices for raw material.

It is difficult to make any kind of prediction at the moment. We are certainly at a crucial point, because many governments are now discussing how to ease the lockdowns. It is still completely unclear where and when local retail is going to be allowed to reopen. It is also completely unknown if the vaccination and testing strategies will keep infections under control or if we will see further waves of the pandemic.

The availability of vaccinations is now rising exponentially. However, it will still take a long time until all the vaccinations are complete and we reach a sufficient level of immunity. This means we still have to expect bumps in the road ahead.

 Inflation, transport problems and even interruptions of supply chains are still also subjects that could have a serious effect on the leather pipeline too. Beef consumption and slaughter will play an important role as well. We had better intensify our research and communication to make sure we receive enough information to be able to make a fair judgement at a later stage.

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