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Market Intelligence, 20.10.03

Macroeconomics

The past two weeks (October 6-20) yielded more positive news than we were used to.  The fall in the dollar was halted, at least temporarily, and there was a bit more volatility in currency prices than we had become accustomed to.  US forecasts were generally positive as economists raised their outlook for GNP in the third quarter to 6 %, the best since 1999.

US retail sales excluding automobiles rose by 0.3 % in September with clothing and house building being the main engines for growth.   House build starts rose 3.4 %, the strongest rate of growth for almost 17 years as several major retailers posted a strong third quarter.  This suggests that despite continuing consumer worries about the state of the economy and the job market, stock is moving off the shelves.   Germany was also able to deliver some good news, the first in a long while, as auto sales climbed 7.2 % in September vs. the year previous.   The stock markets were pretty solid and posted solid gains. The strong performance of the Russian stock markets should not be overlooked in this respect. They may well  support only a minority of the population, but these are big spenders on luxury goods.

Market Intelligence

Very little has happened in the past weeks to justify us revising our outlook for the leather market and the pipeline.  Europe continued to develop according to expectations. US suppliers meanwhile tried – with the expectation of a lower kill – to support the market which would otherwise have been under much more price pressure.

Without doubt, the price list issued by one of the big players in America was the biggest single development as the prices quoted were substantially up (12-15%) up on the week before.  Once the laughter had died down, some began to think about its eventual effects.  Reading between the lines, we see the message as being: ‘We don’t want and we don’t need to sell for the time being’.  In other words,  if you’re going to insist on squeezing  the business out of us, then these are the starting prices you are going to have to get used to.

Everyone knows you can’t row back from such a position overnight so what the sellers have done is given themselves and the market some breathing space before selling in earnest recommences.  In doing so, they have also given the market a short term support.

In the previous edition of MI we forecast that the US market would see a moderate decline and the European  a more pronounced one.  Given the events of the last two weeks, it would be reasonable to ask whether same situation applies.  Despite the leather business in many areas being not in an especially good state, the number hides being sold has held surprisingly steady. This is borne out by the US sales statistics.

These show that for many weeks, though volumes have been low, they have not been low enough to suggest a real decline in tanning activity. In Europe, many sellers confirm that standard items have been moving in sufficient volume and it is our belief that it is only the non-mainstream hides that have been unable to find enough takers.  While the mass producers of side leather, upholstery and automotive are keeping busy, they are showing no inclination to experiment with their mix of raw material supplies.  Consequently, standard items from the leading suppliers continue to find no shortage of buyers.

A further reality check is provided by the respective outlooks of large leather consuming businesses such as the sports shoe brands of Nike, adidas, Puma and Timberland etc, as well as the automotive sector, where – although things are never good enough – sales are at least steady or slightly ahead of a year ago. In the final analysis, it is the medium-sized leather producers who are not producing and selling globally that are suffering the most. Without the benefit of a strong brand image or price advantage these producers are increasingly finding themselves in no man’s land.   While this is unfortunate for those businesses, we believe the disproportionate attention being given to their comments elsewhere is having a wider insidious effect, bringing the mood of the whole of the industry down. Of course, it could be argued that it is the job of those who have succeeded in establishing a global set up and who have consolidated their growth and production to counter this negativity.   But then who is going to brag about their success when there are a dozen or so competitors on the sidelines eager to follow their example. Either way, it is our belief that the complaints of those who have not moved with the times, no matter how sincerely felt, are helping to destroy the charm, culture and excitement of one of the last remaining traditional industries in the world. 

In real terms, all that is happening is that the concept of ‘big fits big’ is increasingly taking hold in the industry, as economies of scale are increasingly brought to bear.  The leather industry is still a very traditionally structured business and there remains a great deal of  room left for more consolidation.

So let’s stick with the reality, and looking at the current European situation several (real) trends are discernable:

• The timing of the pipeline is changing due to the displacement of production to Asia

• The weakness in the main European consumer markets is starting to be felt.

Timing has always been very important for the Europeans, but less for those in other parts of the world. 

In the past, demand in Europe was dominated by seasonal factors and there was a natural fit between the slaughter and  production seasons, where the increased kill was always quite readily absorbed by the rising production of the tanneries after the holidays. Enough raw material was seemingly always available for demand in the fourth quarter.  But with the aforementioned slump in consumer demand in local markets and continuing shift in production to Asia, things are now beginning to change.

In terms of male hides, seasonality is no longer the force it once was. This is because the auto tanners – a major consumer of these hides – are able to keep production reasonably current by using contract tanning operations when they are closed for their annual holidays. The lead time here is extremely short and there is little slack in the supply chain so that supply factors quickly have an effect on demand, and vice-versa.

At the same time, there has been a change in the pattern of supply from the major dairy cow producing countries which mainly supply into Asia. Many of these suppliers continue to be adversely affected by the Italian holiday season, not realising that demand has increased from Asia and declined in Europe. In order to get their supplies in time, tanners in Asia are now buying when Europe is on the beach, a factor which is easing a lot of pressure on those suppliers who have been lucky enough to recognise the new pattern.

So far so good you might say.  But then there is the problem of the weak European consumer markets. Whereas the Asians embark on their purchasing tours during the summer months, the Europeans prefer to conduct theirs during the autumn, favouring short term delivery programmes. But with the decline in the dollar and a loss of market share in the US, the European tanners are now, more than ever, looking to the European marketplace. And it is here that the problems really start as the European consumer remains firmly entrenched in the doldrums, especially where the mid-priced sector is concerned.  What demand there is only to be found at the discount end of the market and this is nowhere near enough to support European leather production.  As a result,  the general rate of raw material buying hasn’t increased leaving those suppliers who were expecting the return of normal market patterns in September and October to come around.

The high kill, Asian customers taking their shipments from sales made in time but who are no longer buying, plus a mainstream European market that is no longer able to absorb  short term availabilities - all of these are putting sellers under tremendous pressure, the upshot being that prices are now falling.  In many cases, prices have become an arbitrary reflection of the mood of the day, rather than a reflection of wider market conditions.  As a result, we now have one of the largest price spreads ever seen, with the gulf between European and US hide prices being wider than it has been for a long time.

Looking at the main markets in the autumn of 2003, it can be seen that the split market continues to be pretty steady, but in Europe the market can’t fully disassociate itself  from the general problems stated above. Split dealers are no longer willing to run inventory and are displaying more and more resistance the prices they are being asked to pay by their suppliers. Various dealers in Italy have stated bluntly that they are no longer willing to entertain the prices positions of their suppliers.  Asian demand for splits is likewise holding steady, but since there is no steady Asian demand for European splits (the same situation prevails with some hide grades) they have found few takers.

The bright spot in the European market is gelatine production which continues to find buyers. This is all the more surprising in view of the supply problems faced by the industry in terms of fewer hide soakings and more EU restrictions.

The skin market finally entered the final stages of the double face production season in Turkey and this was reflected in sharply falling prices for double face lambs. In the UK and Ireland prices fell by up to £2.00 ($3.35) per piece, though nappa skins found more interest with prices  holding just about steady. In fact, there was a fair amount of interest for nappa skins, leading us to believe this market will continue to hold pretty well.  But double face lambs will face further resistance if rumours of the existence of decent stocks of semi and finished products are to be believed.

The next two weeks will be quite interesting. US suppliers will be required to prove their  sales position so as to ensure their credibility. But if their need to sell arrives sooner than they anticipate, they could find themselves being caught out by the tanners. 

We haven’t changed our opinion. In the run-up to the Bologna fair and maybe even slightly beyond buyers will do anything to talk market prices down. With the poor state of the tanning industry in Italy and with the industry still beset by financial woes, we are not expecting a vintage Lineapelle.  At least this leaves the field open to short term bargain hunters.

Looking beyond mid November we can see that the European kill will decline again while supply from other regions of the world will remain low. Indications for the global economy are said to be more hopeful and, barring major unforeseen events in the wider world, it would be reasonable to assume that the world economy will continue to improve throughout 2004.  

If this is true, then from November onwards the leather supply pipelines will need to be ready.  The Asian manufacturers will also have to decide production levels after their New Year celebrations. If leather orders are placed or expected, the hides to satisfy them will need to be shipped from December onwards. Even assuming that raw material stocks are today quite sufficient, it can be seen that the replenishment process will need to be restarted  by mid November.

As before, however, we see little room for raw material price increases over the next two weeks. The market continues to suffer from the discount mentality and the purchasing power of the large companies   So, currency affects notwithstanding, we would be surprised if prices changed very much.  Opportunities for bargains in Europe may be  available, but expect the pressure among suppliers to sell to ease in the second half of November.

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