Market Intelligence - 13.01.09
19/01/2009
MARKET INTELLIGENCE—13.01.09
Macroeconomics
First of all we would like to wish all our readers a very happy and prosperous 2009. The start of this new year is proving more difficult than ever as all the budgets written, all the long-term forecasts made, and most of the hopes and visions created during 2008 need to be reconsidered if they are not already null and void—at least for the year to come.
On the marcoeconomic side we are dealing with a stabilising situation at the start of 2009. Commodity prices have fallen drastically and this includes energy and also food prices. Interest rates are down and will most likely continue to decline. Stock markets are settling in and many of the main markets have already left their lows by 10 or more percentage points.
National banks and governments are flooding the markets with liquidity, incentives and bail-out programs in the attempt to stimulate economies and to save or create jobs. As much as this should be appreciated, it is also questionable. With everything one reads and hears from economists and politicians the impression becomes stronger that there is absolutely no clear idea about what is really required to get out of the crisis. One could come to the opinion that actually none of the classical tools in the drawer of the institutions is suitable to fix the damage.
Demand boost
In the end, what they are trying to do is stimulate demand and to make people consume again. The question remains over what will actually make people consume. Apart from money, the psychological factor of confidence is one of the most important. In particular politicians are demanding excessive stimulation programmes which are burdening budgets and future generations instead of delivering clear visions for the targets of our societies, and a realistic balance between free markets and necessary regulation, as well as a balance between long-term disposable incomes and realistic and affordable consumption.
We should not forget that consumers stopped spending not when the financial crisis began, but a good time before that when energy and food prices, and healthcare in some countries, became unaffordable or unpredictable. This made people stop buying non-essentials and triggered what came afterwards to a large degree.
The data flow during the period was as intense as normal, but it makes little sense to follow the numbers at the moment. They are bad anyway. Growth figures, purchasing manager indices, labour statistics, home sales … you name it, it is bad and in some cases even at a historical low. This also explains why most researchers and prophets are predicting a dramatic scenario for the global economy in 2009. Unfortunately, it is a self-fulfilling prophecy, which always works better on the negative side than on the positive, and we can only hope that the oracles will be as wrong as they have been before.
Meantime had the US dollar has had another dramatic rollercoaster ride. After sharp gains in the period up to the beginning of December, the greenback took a sharp nosedive in only a few days which had propelled it back to a rate of 1.47 against the euro. Also against the yen the USD has lost quite a bit of ground. In the end the dollar finished the year at around EUR 1.40. Sterling was under heavy pressure too before rebounding in the last week.
Stock markets were able to gain well from their lows and most of them recovered decently in the new year. Oil prices steadied at around the $40 a barrel and it might be wise—for those who can handle it—to consider some long-term hedging in the first quarter 2009.
Market Intelligence
Whether we like it or not the holiday season is behind us, the new year has started and we all have to go back to work and face our worries about how to handle the challenges of 2009. As we see above, there is not much good news around for the global economy for the near future and this is definitely going to hurt the leather industry and the leather pipeline.
From the start of the supply chain where the by-product of beef production lost a lot of its value and began burdening the revenues of slaughterhouses and farmers over hide and skin processing, into the next step of tanning and manufacturing, and finally ending in marketing and retailing, almost everyone has had either to fight with losses and in most cases also steeply falling order books.
A lot of the losses have been passed back along the pipeline. Unfortunately, commercial habits have suffered a lot in the crisis. Contract cancellations, price renegotiations—everything was passed back until the end of the supply chain, in some cases finishing with traders and processors, and in others even going back into the abattoirs. There are plenty of excuses, and a lot of tanners have been saying that their only option was to do what they have done or to go straight into bankruptcy. One thing that is definitely true is that a number of tanneries in Asia and also in Italy—where these attitudes were most popular—have protected their cash-flow positions and have certainly made it possible to postpone and to ease their misery a bit. However it should not be forgotten than one company’s gain is another’s loss, and it remains to be seen if raw materials suppliers around the globe will be able to digest all this. It is even more important to see if it really has saved leather production for a better future. If that is the case, suppliers have a fair chance of eventually claiming back what they are having to invest at the moment.
Raw materials price reduction
One of the consequences of this has been falling raw material prices—we have now reached a massive compression of raw material prices around the globe. With almost every market trying to secure sales and shipments by lowering prices, a fair relation between quality and price has been completely lost. Top-quality hides can be bought today at such cheap levels that it leaves almost no room any more for low quality, low-cost material.
This means that until raw material prices recover by 20% or 30%, neither a realistic spread in quality difference, nor a real market can be expected for the low end of the quality range. Depending on the handling and processing cost in different origins—like, for example, Africa or South and Central America—one has to expect, that the growing number of hides will not be preserved for the leather industry and the raw material will either have to be destroyed, rendered, used for collagen or gelatine or, in the best cases of all, just be stocked in speculation. Each of these different options has become common practice in some part of the globe. It is not good news that a valuable raw material does not enter into the production chain of its main use, and the worst option of all would definitely be destruction, but in the end every hide and skin should go to support the market in the medium term.
Although a number of tanners would not agree, the first thing we need, to be able to stabilise the general situation and also the market for leather, would be a rise in raw materials costs, to get back to reasonable prices and quality ratios. If this cannot be achieved in the short term by rising demand for leather, then it has to be done by a reduction in supply. The next two or three months will definitely be essential. In particular to see if leather, which can today be offered at almost never-seen low prices, can attract enough manufacturers, retailers and consumers for demand to rise quickly.
No automotive aid
What are the realistic chances of such a scenario? Well, as we know already from the last three months and from what companies and media are telling us at the moment, we cannot base much hope on the automotive or upholstery industry. In particular the automotive market is in such a state of chaos that short-term improvement cannot be expected. With the present crisis, unemployment rising and the bleak outlook for the general economy, there is not much chance that middle-class and luxury cars will sell significantly better in the near future. Not to speak about the unsold stocks of new cars which are parked today almost everywhere around the globe. The only chance for higher consumption of automotive leather would have been a quick penetration in cheaper models which are likely to be the only ones selling well in 2009 or until new models, new engines, new designs or the end of the crisis get people back into the dealerships.
Faint hope for furniture
Furniture leather might be a bit easier in the present situation. There is definitely not much chance for upholstery in those markets that are still suffering from a massive crisis in the property markets. This applies in particular to the US, but also to some European markets such as the UK, Ireland and Spain. However, we also have to expect, that the consumption of quality leather furniture could be negatively affected in the emerging markets, in particular eastern European ones.
However, it might not be completely negative. In times of crisis people are focusing on their homes again, and as we have seen many times in history, staying at home means that you like to make yourself more comfortable. Anyone who still has money to spend might spend less on vacations, eating out or new cars, and spend more money on interior design instead. This would certainly not mean any real chance of growth in 2009, but maybe this market segment can defend itself a bit better than the automotive industry.
Having said that, it would certainly require upholstery manufacturers to invest again in quality. Bad and economical leather is simply not comfortable for home use. For the private environment, leather must be appreciated, loved and has to offer serious comfort to attract people and to restore the image and the prestige of the product. When, if not now considering the low price for superior quality raw material can this be done by the manufacturers? There is presently no shortage and it does not require a massive capital investment for raw materials.
Extra disposable income
As a consequence of the above, almost all of the burden remains on the shoulders of the market for shoe leathers, bag leathers and accessories. We may leave the niches out as market influence is too limited. Many will argue that with their market share of about 60% to 65%, these leathers can never compensate for the decline of upholstery, and of course we cannot forget garment leathers.
It’s important not to give up right at the beginning. The basic use of shoes globally will definitely not decline by much. Of course, if people are unemployed or their family budget doesn’t allow extra spending any more, they will not be tempted to buy more than they can pay for. However, it is also true that a lot of disposable income was being absorbed a year ago by higher food and energy prices and has now become available for consumption again. Not to speak about lower interest rates. Nor should we forget that for every new car people decide not to buy right now, a decent amount of purchasing power becomes available for other products.
Turn to footwear
A lot of calculations have taken place to see if there is a realistic chance that the decline in upholstery production can eventually be absorbed by a rise in side leather production. Theoretically one could try to calculate how many hides are missing today in upholstery production and how many shoes they would make. We don’t think that this is the right way to look at the question.
We believe that fashion, quality and a higher penetration of leather in shoe production—for reasons of price and comfort—could create tremendous leverage. If a return of handbag and accessory fashion happens too, it is definitely not so unrealistic to believe that, within a timeframe of one or two seasons, side leather could make up a lot of the losses which we must expect for some time in upholstery.
We have to leave it in the hands of the brands, designers, retailers and manufacturers. If they can pitch leather successfully against rival materials, then—despite unfavourable retail conditions—leather consumption and sales of leather products can rise against the trend.
This might all sound a little bit like wishful thinking, but we are seriously convinced that there is a fair chance that this could happen. In times of crisis, consumers like to spoil themselves with small pleasures, such as fashion and quality consumer goods as well as cheap forms of entertainment such as cinema, music and so on. There have always been the winners in difficult times, but only if they are presented well and catch the imagination of the public.
Quiet times in the market
Market activity over the holiday season was definitely limited. In December, most markets enjoyed a large flurry of interest and sales. Productions and manufacturers had delayed the replenishment of their pipelines by so long that a number of them decided the time was right to act. They felt the raw material market had fallen far enough and that the chance of any further substantial reduction was limited.
In the end, a number of tanners we spoke to also admitted that raw materials prices were no longer the key problem for them. They have more important matters to deal with such as the revaluation of stock and a lack of orders. On the basis of today’s raw materials costs, the problem is no longer calculating the price of the finished product.
In all the optimism we are displaying, we do not think that we have completely passed through the valley of tears yet. The cleaning up of the damage caused by the crisis is not yet over and we would say that there are still a few earthquakes to be hit before things really calm down. All the positive statements we have made above remain untouched, but the real restructuring in the tanning industry has actually not yet taken place.
Closures to come
We should not forget, that apart from business problems we also are right in the middle of a financial crisis. What had been a problem for banks, hedge funds and other gamblers in the financial industry is today a problem for normal enterprises. Despite all the bail-out programmes of governments, the access to capital for normal or mid-size businesses has become, and will continue to become, more and more difficult.
In the vast majority of cases, 2008 results in the leather industry will not be very good. This sector is considered as a high-risk area. With the traditional high leverage and extensive need for external finance, one has to expect—particularly in Europe—massive problems between now and the middle of the year for companies to maintain their necessary financial base. Falling raw material prices are definitely helping as cash needs are reduced, but in many cases the low use of production capacity, and the massive cost of adapting the same is unlikely to be financed by banks. Consequently, we still have to expect a decent number of shutdowns and bankruptcies in the months to come. This is not good news for the raw materials market.
Secondly, credit insurers are tightening their cover almost on a daily base and if we are right with the above this is not going to get any better; it will probably become much worse. With tanners in Europe normally receiving up to 30 days in terms, this could become pretty difficult for many when no credit insurance cover can be obtained any more. It is quite unlikely that the missing finance can be obtained from the bank to pay suppliers in advance.
These negative influences on the market will have, in our opinion, a tight grip on the situation for some time. Only tightening supplies can actually support raw materials prices and we should not forget that rising raw materials prices will need even more cash, which could quickly deepen the problems of the manufacturers in the short term.
Hopes pinned on Asia
The only thing that could dig us out of this problem and could have a positive effect on the raw materials market would be the quick recovery of leather orders in Asia, and in particular in China. The high season of production for the export markets is now and in the months to come. So far, most producers out there are telling us that their domestic business is still okay, but they are missing export orders or any kind of serious commitments for volumes for their production from now into the summer.
Despite the big rebates given by retailers to attract consumers—in particular in the US—it seems that the physical clearance of stocks hasn’t been too bad. Measuring sales in money and not in units can be pretty misguiding. Maybe the retailer has not had the turnover figure or the margins expected, but the stocks have been cleared and need replenishing.
Courageous forecasts
Here we come to the critical point in our combination. Who is going to have the courage to plan and budget for same or even higher volumes for the seasons to come? Until a year ago everything was just set to grow and hardly anyone in companies’ management teams dared to project anything other than growth, preferably in double digit numbers. With the general economical forecast, the high uncertainties and the financial crisis not yet finished, most companies will play it safe, and one would not be surprised if the orders in the pipeline turn out to be less than they were a year ago.
With the longer lead times we have in the globalised world, we would need at least another six months if we miss the chances of the next four-to-eight weeks. What should be in the shops after summer must be ordered pretty soon. If we are realistic it is hard to believe that retailers and brand names will have the courage to commit themselves for large quantities and longer periods under the present conditions. So we can only hope that orders will be more for short term but with high levels of reordering to come afterwards. One way or another, the time until the end of February will definitely give us more of an indication as to how things are going to proceed because global buyers will have to make at least some minimum commitments in the near future. Nothing in the shops means still nothing to sell.
Split trading
The split market has also been in full holiday mood. We couldn’t trace much trading and, as cheap as hides have become, it is hard to see where splits can actually find a serious home in leather production these days. There is however still some market in specialty items, and also collagen and gelatine consumption remains at good levels with producers rather suffering from restricted supply due to insufficient soakings in the tanneries.
Hide prices in some areas of the world having become so cheap that a number of them are already going directly into collagen production, at least where the infrastructure allows.
The skin market is also heading into serious trouble. Goat skins can still defend themselves reasonably well because they have a reasonable role to play in fashion these days. In the present production season, kids and goats have found good homes in manufacturing and that is protecting their prices and selling activity quite well.
Lamb and sheepskins are having a pretty rough time. Things looked reasonably steady until the beginning of November, but since then the garment business has deteriorated even further. The wool market is also struggling because of global prices and a lot of material has got stuck with Chinese importers, for whom payments and the acceptance of outstanding contracts have also become pretty critical. Specialty items, in particular top-quality skins, are still doing significantly better but for the medium and lower end we have also come to a situation in which, in many cases, the collection and processing costs of skins are no longer covered by the return for their products.
Low gear
For the coming two weeks or maybe even more the market activity will be in low gear. The Chinese productions are preparing for their holiday break, which is going to be as extended as the holiday break in Europe was. A shut-down of two weeks is the absolute minimum, and we would say that the vast majority of factories are closing down for three weeks. Managers and owners might take just a short break, and for the rest of the period they will be busy either receiving clients from overseas or travelling to try to sell or to get better information about what they have to expect for 2009.
At the end of this month we have the IILF leather show in India, which traditionally opens the fair season. The show might come a bit too early this year, but it may also be exactly at the right time because, as we have mentioned above, the leather pipeline desperately needs a clear indication of what retailers and brand names have put in their budget for the seasons to come.
Let’s hope that designers are doing a good job in creating fashion trends that will be appreciated by consumers. The normal rules are that in periods of crisis more quality and classical fashions do better than challenging experiments. Raw materials markets seem to have settled down for the moment and we would not bet too much on massively lower prices.
The statement that we have heard quite frequently over the past week is that the market has bottomed out, but that there is little chance of any significant rebound and it will consequently just bounce around the present levels. This seems to us quite sensible and we tend to agree to them. For individual players, it remains definitely advisable to watch the currency markets.
Again a very happy, healthy and prosperous new year and let’s hope it is going to be better than it looks like today.
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