Macroeconomics

The financial market is not showing any clear direction or hard facts to support the divided opinions about the coming year. General consensus continues to suggest we will see a slowdown in the global economy, but good growth is still expected. Unsurprisingly, the emerging markets are still topping the list for growth. Europe, and particularly Germany and France, are expected to accelerate their rebound into 2007, but the pundits are not as united on this issue. Japan is not expected to deliver any spectacular contribution and the largest question mark in terms of economy is over the USA. This is already implicit from the amount of attention directed at all aspects of US financial data released each week.

Most of the financial community had taken an increasingly pessimistic view on the US economy for 2007 – with a number of strong arguments to support this. Questions about growth, inflation, private debt, budget and trade deficits—not to mention the problems in the Middle East—are constantly being discussed and have increased concerns about the future of consumer spending in the US. With the strong performance of the ‘new economies’, some of the burden is taken away from the US economy and global responsibility is more evenly distributed around the globe, but the US continues to be highly influential in terms of global performance.

So, it will be necessary to keep a close watch on the situation in the first quarter of 2007 as activity in the US will give the global economy direction on currency and interest rate trends, as well as the direct and individual influences on businesses.

The fundamentals of the past week changed very little. The $ remained above the 1.30 mark against the € but was able to recover from the lows seen. With the winter approaching, oil prices have increased again and a barrel is costing well above $60 again.

Market intelligence

While the year slowly draws to an end, the major story for this period has been the shutdown of two Korean tanneries in China. More significantly, these were not unknown factories — they were in fact subsidiaries of recognised names in the Korean tanning industry. The parent companies are reportedly continuing production at home.

The story as we heard it contained elements of a ‘thriller’, with the authorities planning a tax investigation and management executing what could be described as an escape plan. In a race against time, machinery, stock and management were evacuated, leaving the banks and authorities with little in their hands.

While bankrupt tanneries are nothing spectacular in the history of the trade and are not hugely surprising, a few things are probably worth mentioning, seeing as those in question were mainly operating in the garment section.

Although no one should be surprised in seeing a garment tannery going over the edge following the sector’s recent performance, it is worth noting that informed circles are mainly attributing the bankruptcy to non-payment of taxes and/or import duties. People close to the market scene suggested that it may have been not so much a problem of payments as such, but more a failure of payments in the ‘right time and place’ which finally did the damage.

Potential for further bankruptcies

This leads us on to the main concern. Very few people believe that this is an isolated case; most consider it to be a widespread problem, and the main worry is that this could spill over and affect other operators. There are a few more Korean tanneries in the Quingdao area and this leaves questions that now need answering. Did they handle the tax and duty correctly? And how will the case influence the general relationship between operators and the authorities and banks? So far no domino effect has been reported.

As far as the leather pipeline is concerned, two more issues were of interest. First, the amount of money involved in the case. Numbers between $5 and $20 million for just one major bank were swirling around the trade and 50-150 FCL of merchandise were said to have been affected by either sitting already in port or on the high seas. The figures do not appear unrealistic considering the size of the tanneries, but we still find it pretty hard to believe that a Chinese bank would actually expose itself to a foreign company to this extent. It is worth mentioning that as far as the hide situation is concerned the case has caused little more than a raised eyebrow in the market. This once more confirms the robustness of the market condition at present as a similar case in the past would have caused an earthquake within the market and, had raw material levels been what they currently are, sharp reaction would have been guaranteed.

So, with the market as it is and considering recent performance, most sellers appear to have been able to find homes for most of the material in question and were able to redirect the shipments. It was impossible to discover whether all goods stuck in the port could be freed and secured.

The most important question raised by this particular case is whether this could also happen to other Korean and possibly even Chinese tanneries. Will this be an isolated case or is it merely the tip of the iceberg? Regular readers know that we love to point the finger at the financial part of the business. While the fantastic performance of the side leather business this year should protect tanneries in this field, the situation for furniture upholstery and garments a different story. For the time being there is no evidence of any detectable problem but, whenever members of the trade sit down together to discuss the subject, a number of names are always drawn on the table for which people continually wonder how the selling prices for leather can match with raw material cost and the recent increase in production costs on the other side.

A number of Chinese tanneries are indirectly subsidised by the government with access to cheap energy, fewer effluent problems and a tremendous advantage in terms of labour costs, but even despite all this, it is not enough to create some of the miracles people are still claiming to be seeing when it comes to finished leather prices. The problem continues to be that company results and the publication of financial statements are still not very transparent and, consequently, a fair opportunity for analysis is not offered.

Questions raised over profitability

Although some are already calling us the ‘professional pessimists’, the simple facts of economics could not allow us to believe that all leather upholstery tanners in China are currently generating enough positive cash-flow to stay in business. Since nobody knows much about many sources of finance, they might be patient and strong enough to continue supplying the money needed, but these questions must be raised.

We don’t want to focus all our attention on China/Asia concerning this subject. Other parts of the world, particularly Italy, must also be mentioned. Production in Europe is not only burdened by the high labour and environmental cost and loss of the customer base, but also by the movement in the currency markets. In most cases it is not an exaggeration to say that 70% of the upholstery leather produced is ending up, directly or indirectly, in exports to $ related markets. The $ has lost about 10% of its value against the € this year and, while a fair part of the currency risk can be absorbed by purchasing raw materials in $, the problem of production costs that have to be paid and calculated in € cannot be solved. So, 2007 starts off at a less favourable level than 2006.

However, that which appears to be a disadvantage for one is of course an advantage for others. If the currency advantage from finished product importers is distributed to the suppliers—which is hardly the fact at present—this will be essential for keeping the leather industry profitable.

Since it is difficult to believe that this is going to happen, the trend of further globalisation within the supply and distribution chain and more integrated manufacturing and distribution/retail should continue to dominate the leather pipeline in 2007.

The other markets did not provide a great deal of news.

Interest for sheep and goat may be improving

The splits market remains pretty much out of the frame and, as we have mentioned before, it would take a change of fashion trends to bring splits back into the foreground.

Reports for the skin market are that it is slowly but surely performing better. Many suppliers of less privileged origins and materials from around the globe are reporting an increasing number of inquiries form the Middle East and China and are now hoping for better business in the first quarter 2007. This mainly applies to sheep and goat and we are now eagerly looking forward to hearing whether these still reasonably priced raw materials are finally being discovered.

The outlook for the New Year has little excitement to offer. The leather pipeline for standard materials remains pretty well cleaned up. Suppliers are looking relaxed for the near future, sitting on a comfortable order book and with little stress wondering where to place next week’s or month’s production. With the Christmas break in front of us there is little that could alter the fundamentals. The worst would be another round of need-to-buy which we have seen in the past, where a number of clients think it could be a good opportunity with the bulk of the trade in the Western World on holiday. What might have a bit more of an effect is the break in Asia in February which will cause a decline in physical shipments in January. Looking at the raw materials preferred for side leather production, and knowing how well filled most order books are, there is little vision for any change in the market. A number of key suppliers have extended their forward sales well into the second quarter so, from the simple supply and demand balance, there is still no sign of change on the horizon. Some tanners are even openly discussing their concerns about a general supply shortage.

Call for diversification of hide types

The upholstery market – for hides as well as for leather – still has to prove that it can generate the same performance and deliver the same security for suppliers in 2007. We still have concerns and these can only be wiped out if more hide types are accepted and used for side leather production in the coming months. If not, the financial issues could accelerate in the near future and increasingly limit the outlet. We will investigate this in more detail at the beginning of 2007 as we believe that this could be one of the most important issues at the start of the next year.

We would like to take this opportunity to wish all our readers a very merry Christmas and a peaceful, happy and prosperous New Year! We hope the issues discussed in the leather pipeline have been of interest and that some of the topics and ideas added to your own industry knowledge. We hope you will continue to share your interest with us in 2007 and the next issue will be available mid-January.