Market Intelligence - 06.05.08
06/05/2008
Macroeconomics
Over the past weeks the market pattern has shifted a bit.
Having finally broken the next magic figure of $1.60 against the euro the dollar started a sharp recovery that has led it to a gain of almost 4% in a week. Even another rate cut of 0.25 % by the Federal Reserve failed to halt this recovery.
The change in the market mood was mainly related to the hope that if there is a recession in the US it will be a mild one. If it is, and if indications of a slowdown in Euroland continue, international speculation has it that this would lead to an end of the rate cuts in the US and, possibly, stop the European Central Bank (ECB) from increasing interest rates in the old world.
While the ECB is entirely committed to the stability of the currency and prices, the FED is less independent and its interpretation of its own function is more related to economic issues.
Anyway, the gain of the dollar has also led to a repositioning in oil, metals and other commodities; they fell in relation to the increase of the exchange rate. It is now interesting to see if this going to be a new trend (as many think it might) or it is just one of the sharp set-backs we have seen before, for example, before Christmas and in early January. In fact the arguments for or against the US dollar are the same as two weeks ago.
The macroeconomic fundamentals are still negative. Trade and budget deficits are running high, the financial crisis is far from being over and consumers have still overspent their budgets. Under these circumstances it will need little to push the dollar over the cliff.
On the other side we are seeing a better than expected development of the labour market. Slower growth in the euro zone and the presidential elections this year could also change the psychological mood of the market in favour of the greenback.
In the meantime our focus remains on inflation. The globalisation factor (or, better, the China syndrome) that everything can be got cheaper every season from China has run out of steam and is even reversing. Not only are raw materials and energy prices pushing inflation there, the rising cost of environmental issues and labour have also reversed the trend for price reductions. Price rises are the issue today, in particular for products manufactured in China.
Market intelligence
We would not say that the situation has become clearer over the past weeks, despite the Lineapelle exhibition in Bologna, but there has been some indication of what might happen regarding the main questions in the market.
Let us start with the show in Bologna. Traditionally the show in April or May is not of such a great importance and is more a pre-selection for the fashion trends than a fair for sales and significant new customer traffic. It was the same this year.
As far visitors were concerned the first and second day met the expectations. The last day suffered not only from the traditional decline of the last day of a trade show, but also because of a local holiday in Italy. Many locals left at lunchtime on the last day at the latest, if they turned up that day at all to enjoy the holiday.
So the initial impression was rather positive with people in the aisles, the usual nice stands, decorations and basically people not displaying too much concern. It looked pretty good at the start and one had the impression that things would not be as bad as one thought before setting out for the show.
Articles on display were still of bright colours, shiny finishes, still a lot of patent leather and artificial prints. So, a lot of eye catchers for the summer of 2009 and actually one can have good expectations for a tasteful choice for the designers to select from.
All this added to the positive impression one had to have with the first walk through the aisles. Well, it turned out to be only a superficial impression. The good mood of Tuesday morning faded bit by bit the more the conversations one had, on and away from the stands.
What was the reason for this? Since the show is predominantly a domestic Italian trade show, with some international participants, the focus quickly moves onto the domestic problems.
Force of fashion
Again the good news first. Tanners producing fashion leathers (for shoes, bags and accessories) for the luxury market are still doing very well. With the price correction of raw materials, they are working with decent margins and, one had the impression, also generating healthy profits.
They were trying to tell everybody how difficult their lives are and how ruthless their buyers are in price negotiations, but knowing the attitudes a bit, it was quickly clear that although margins have been shrinking a bit owing to the rising cost of production, but orders are still sufficient and results are still pretty reasonable (although they can always be better, of course).
However, the number of the happy tanners is pretty limited and cannot be considered at all representative.
On the other hand
Talking to others changed the situation quickly.
Vegetable tanners in Tuscany are complaining not only about orders, but also about how much they are suffering from the weak dollar and the price competition from competitors, mainly in South and Central America.
The price difference is said to be between 30% and 40 % for standard items. As far as production is concerned even the top names in this area are said to be working at 60–70% capacity and some claim even less. Many stated, that even working at reduced capacity, input is still larger than output and inventories are rising. Fortunately the tanners in that area are traditionally well financed and this type of leather production does not require the same amount of investment as in the upholstery and shoe upper production sectors.
The normal shoe and bag leather tanners in the area delivered mixed comments about their situation. There were the same complaints about margins and the rising cost of production, but as far as general business is concerned, the situation was a bit mixed. About half of the tanners were complaining about a lack of sufficient orders because of less-than-expected reorders. Others are pretty busy and at least don’t have to worry about keeping their plant active.
The situation differs so much because of the different fortunes of the companies tanners are working for. If they are lucky enough to be a supplier to a successful brand, things seem to run pretty well, while more ‘bread-and-butter’ production is suffering and in many cases is not active enough to fill production at the moment.
Serious situation in the north
The news from the upholstery tanning centres in the north is even less exciting. In public and in small talk it seems that one is just talking to the same tanners who are always complaining.
There is little admittance that the situation is really serious and difficult. However, when the doors are closed and the conversation gets at bit more intense one gets really concerned about the information and problems most of the industry in this area is reporting. All the classical signs of a massive structural crisis are in place; many have been expecting this for some time.
The weak dollar, a lack of orders (excessive production capacity), massive price competition and sharply rising restrictions on bank credits have made for an explosive cocktail in the area.
As if that were not enough, it seems also that tax fraud is a much larger issue in the north than in the other parts of Italy. Although most are still pretty relaxed about the potential legal consequences for what has happened in past years, it would be a big problem for the ongoing business of many if this ‘assistance’ vanished eventually.
Consequently everyone in the area is nervous about the near future. Production and revenue normally reduces in the second quarter and even further in the summer and this could end in a severe financial problem for the industry.
Bank balance
The biggest problem seems to be with bank finance. Traditionally, tanners work with very little capital and use bank loans instead (for tax reasons). What used to work pretty well in the private circles between banks and enterprises could become a severe problem now.
The financial crisis and the activated risk controls since January 2008 (Basel II) do not allow any more personal arrangements between banks and clients. Capital ratios need to be kept, profitability shown and risk management implemented and many of the companies have started far too late to take the necessary care about the situation. This is now working against them in a period in which the business situation in general means many companies already need major tolerance from the banks.
So, the final impression one took home form Bologna was good as far as fashion articles and products were concerned, but the general state of the industry in Europe left a mostly a pretty concerning impression.
May day
The following week was mainly dominated by the long holiday in most parts of the world. With May 1 falling on a Thursday, it allowed many to take a long break.
In China the holiday is extended anyway and this was also felt in most of the reports we got from the trade. The record export sales which had been reported from the US until the APLF show in Hong Kong left the impression that the leather business remains strong in China and that the industry is only facing a structural problem. Well, it seems that this is not all of the story.
In preparation for the Olympics—and perhaps also to avoid presenting another issue (pollution) to the global community after the Tibet problem—the government in Beijing has become extremely strict and the tanning centres close to the capital are facing severe problems at the moment.
In particular, factories that are operating without any real pollution controls and systems are being shut down. Talking to the owners some months ago they were still pretty easy about the situation and thought that they could resolve the issue just by moving their production a couple of hundred of kilometres further away from the cities. It seems now that this is not enough. At the same time the rising cost of production here is also putting a lot of businesses under pressure.
Small company power
While many think that small tanners may not have a great influence on the market they should not be underestimated. They are mostly supplied by importers and traders, because they do not have facilities to import themselves. Many of the importers and traders are themselves not really too experienced and want just to use their infrastructures to make a small profit.
Consequently they need to buy in advance, import and wholesale, and this builds up inventory. As soon the small tanners don’t buy, the problems start as the importers have neither selling alternatives nor an infrastructure to hold the material. So, a few sources are reporting already that importers are holding stocks due to the problems of small producers without import licences.
Also the larger industry seems also to be taking a hit. In particular upholstery tanners and bag leather manufacturers seem to be facing difficulties to maintain production; many suppliers have spoken quietly about delays receiving letters of credit and delays of shipments. Wheter this is related to the holidays, lack of orders or the problems of pollution controls is still not absolutely clear.
Wishful thinking on splits?
In the split market we fail to see any improvement. Some are saying that European split tanners are reporting more interest for split leather, but whether this is really true or just wishful thinking remains unclear. We have been unable to obtain any serious indications for a return of splits into the fashion cycle yet and also the fair in Bologna did not show many new articles which were pointing to a better future for splits yet.
The skins market is also in a period of transmission. The interest for fine wool skins seems still to be all right. However, there is a significant slow down for nappa skins and the new season lamb production has also not yet received the interest from the market one would expect at this time of the year.
Also in China the demand seems to be slowing down because many of the small tanners that use sheepskins are having the same problem described already above. Turkey is not yet displaying real interest for new season material. With the lamb kill now starting quickly to reach higher levels in Europe, the concerns of suppliers are starting to rise.
For the coming weeks we are starting to become a bit more cautious again. The second quarter is difficult. Tanners are feeling the pain of rising costs.
Finance is an issue and in China the governmental policy in relation to the Olympics is showing its effects. A moderate slow-down of the global economy might also have some effect.
Producers have to be more careful these days and tanners seem to have either abundant physical inventories or enough bought material to sit quiet at the moment. Only a few exceptions can be seen. The firmer dollar should cushion the market in Europe a bit (although an exchange rate above $1.50 is not helping much) and the lower kill in Europe, with lighter weights, should also ease a bit of the supply pressure.
We don’t think, that the next weeks will force any suppliers to lower prices yet, but we would not be surprised if the pressure might start to rise.
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