A shift in carmakers’ attitudes to price rises begins to emerge
19/02/2014
With the dominance of Asian production, the influence on the general market is increasing every year. This year most people outside China were pretty much alone and this displayed once again how small the leather business has become outside the Far East. Of course, beef production continued and so hides and skins were being produced but as far as activity in the supply chain is concerned, things are really very quiet when Asia is taking a break.
This can also be seen when you look at shipping schedules. The break strongly influenced shipments inbound and outbound with a lot of services reduced or even cancelled. This caused quite a headache for those who have regular shipments and where the pipeline needs to be continuously filled, because not catching one boat means possibly a delay of two to three weeks until the next opportunity arises. It might be well into March until everything is running smoothly again.
The situation is hitting raw material suppliers in particular as they are not the preferred customers of the shipping lines for various reasons. Hides and skins fill containers up to their full weight capacity, making them one of the most expensive products on the boat, and they also run the risk of spoiling the containers by leakage - although protective measures are taken. So, if there are other options for the shipping lines they will take them, and this is even more of a problem when shipping capacity is not sufficient. When you have to meet timeframes dictated by the customer and his production schedules or by letter of credits, this problem has to be considered.
The general tranquillity of the market might have caused a few worries, but one could nicely see this year how little the volatile raw material markets are actually affected by two to three weeks of almost no or very limited activity. In the ‘good old’ days many producers and traders were scared by periods of low sales. After the general firm market for the past four years, with every decline just marking a correction and not a new trend, the supply chain has become pretty relaxed about periods of reduced demand and activity. All forecasts and projections are seeing continuing shortage of raw material and the price trend knows only one way: up.
The forecasts of many leather-consuming industries for the current year are optimistic and so suppliers are generally just leaning back and waiting for customers to knock on the door again. The further down the supply chain you go, the more people are comfortable with the situation and for them, nothing is better than when prices are continuously rising. This means that stocks are not facing any market risk and when the market is higher customers are also much more willing to take and pay for the material they bought some time ago.
So far so good on the surface; but we all know it is far more complicated. It seems fair to say that as you go further down the supply chain, the potential to raise prices becomes more limited. This means that margins further down are squeezed and possibly become negative at a certain point. We are still missing the news that leather prices can be raised sufficiently to cope with the increased raw and semi-finished material prices.
While this is possibly still something what can be handled, as long as turnover runs smoothly, there is the possibility of another bottleneck, which has to be watched carefully. Its boils down to finance and as cheap as interest rates may be and as much liquidity as has been pumped into the financial markets, there is really little available for those who require finance from banks. To expand credit lines, in particular in countries where the economy is struggling, is barely possible. This is not so much of a problem for the big and strong companies, but for the traditional medium-size family tanner this has been a serious headache for some time already. You can free cash by reducing your inventories, you can sell your invoices and you can possibly even find some private money, but in general everything is nearing the limit.
In the bovine business this is not so obvious, because there are many factors which have helped. Cash could be raised by selling splits at constantly higher prices and for quick money, the ongoing price rises made it easier to attract private investment and the supply chain for finished leather has had much less seasonal influence than the ovine sector, for example. However, in the end, the same rules apply.
We mention this because we are getting increasingly worried about the situation in the skin business. We had a very warm winter, sales for double-face garments and winter-related leather jackets were far from good. The expected rising demand for cheaper lamb nappa did not come and so we are confronted with reasonable stocks of skins, leather, finished jackets and unpaid invoices.
Prices for average-quality skins have declined and the break due to the holidays in China hasn’t helped either. Some of the big players with strong financial resources tried to stay in the market and defended against further price reductions. In the end they are using the same strategy as the bovine sector, trying to average down their cost price of the raw material inventories and hoping for a strong recovery in prices as a consequence of the general upward trend.
However, if the turnaround doesn’t come soon you will need very deep pockets to handle this and some may remember that the skin market has different rules and it is not too long ago that we saw a big slump after a strong rise.
The reason for this, as we all know, is the very seasonal business where raw material production and finished product demand are never really running parallel. People have to buy raw material when they have no clear picture about what the finished product demand is going to be, while shoes are a bit more independent from seasons - if the weather is not extreme.
What worries us is that we are getting more and more reports where people are stating that leather is increasingly sold on credit terms. In particular, from China and Turkey this hasn’t been heard for many years. Where leather is based on structures, a lot of shipments and a lot of production is based on extended payment terms or payment after sale. As long as this is not exceeding a healthy ratio of the total business it has always been part of the game, but the portion of this kind of credit business is on the rise and that has never been good news. There is always the chance of a strong performance in retail and that will solve it again, but it needs less and less in some parts of the market to cause serious trouble.
Although the activity in the last two weeks has been reduced, the leather pipeline was still discussing the future of the business in the months to come. In particular, in Europe, where automotive leather production is playing such an important role for the raw material market, many were unhappy about the automotive industry which is making it so difficult to raise leather prices to adequate levels. Auto sales, in particular in the premium segment, are doing extremely well and leather as a superior option can be used to promote the luxury lines. It is no secret that a leather interior is still making good profit for the car industry. However, it is the simple question of power - in at the end, the suppliers are blackmailed until the very last moment to squeeze their margins as much as possible. Although it has worked pretty well for a number of decades it is becoming more difficult because big companies have been established at the beginning of the supply chain, and they also want their share of the added value.
The biggest problem is that the prices have to be fixed for a long period and this is making life increasingly difficult for suppliers. With the general opinion that raw material prices will continue to rise, and considering the fact that prices in the first quarter of 2013 versus the first quarter 2014 have risen between 20% and 25%, one can easily understand how difficult such kind of negotiations are when you have to estimate today the raw material price increase of tomorrow. Previously, tanners were thinking of price reductions in cycles within the contract timeframe, but they burnt their fingers so badly that they are not ready to challenge their fortune again.
In the end we understand that some agreements have been reached, with some of the brands finally surrendering and accepting price increases. Others are not there yet and we have no serious and reliable information about whether leather suppliers are happy with what they have achieved. However, market activity in the coming months will tell us, but one thing is certain: even the premium tanners are sourcing more economical raw material to find a mix that will allow them to operate.
Another thing can be concluded after the review of opinions and company strategies. Wherever possible, the industry is shifting to more economical raw materials in their product mix. One can see that already with prices of so-called cheaper origins rising far more quickly than the traditional average standard raw materials. In the coming months it is going to be interesting to analyse if this is the continuation of the step-by-step, market-by-market raw material price rise or if we are really hitting a price ceiling with more leather substitution seen. For the moment is pretty clear that the luxury side is still doing quite well and while they are concerned about prices it is the exclusivity that counts.
The skin market was exceptionally quiet in the past weeks, of course because of the Chinese holidays but also other markets like Turkey were suffering from weak sales and trying to sort themselves out before the new season begins. Prices for Nappa skins are seriously under pressure while top quality is still running significantly better. Fortunately, there are still some big players in the market continuously purchasing at the lower price levels, so that no serious threat of a collapse has developed so far. However, it seems that we will need a flurry of activity pretty soon to keep the pipeline flow intact.
In the next two weeks, general activity needs to resume to normal after the holiday break. Suppliers will do almost anything to keep the market steady, at least until the big breaking point which is the APLF [Asia Pacific Leather Fair] in Hong Kong at the end of March.
As far as cattle hide suppliers are concerned, it seems they have the better cards in their hands and are controlling the physical supply of raw material quite smartly. Tanners can’t expect to win this battle in the short-term. However, the money side of the game has to be watched too and rising raw material prices are leading to cash flow problems, not only for the tanning industry but also for suppliers where risk is rising and capital resources can be burdened quickly if money from their customers is not coming in on time or the credits are not opened quickly enough. If this is the case, there might be a good chance for those with deep pockets to do some successful fishing. Fundamentally, there is no reason why in the weeks to come there should be any serious price reaction in the market.
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