An argument against reducing hide prices for now
04/03/2014
Why are we saying this? Normally, we are considered to be more on the side of the leather industry than supporting the ideas of valuation the beef industry has for its products. We favour a fair market value and the possibility for the leather industry to operate profitably. However, there is at this moment in time no conflict in our position that a major correction in the market would not be good for anyone. As we stated in our general economic section above, we believe that the global economy is possibly more shaky than many people think. The political unrest we see and the high levels of uncertainty about the shadow banking system in China could become a problem for the commodity markets more quickly than many people think today. We are in the high season for leather production and it would not be a very good idea if serious problems were to end in a substantial decline in raw material prices because we all know that this would have a lot of side-effects in the leather pipeline, which nobody can really want.
Looking at the leather business at the moment, looking at the results of the trade shows and the recent trends in the raw material market, it is fair to say that many of the concerns and projections we made some month ago are beginning to materialise. We see a major shift from medium- or higher-priced raw materials to lower-priced alternatives because the finished product manufacturing sector remains price-conscious and is not willing to raise the price per square-foot of finished leather. These companies want new developments in leather articles and new leather trends and may allow more defects to show in finished leather rather than make concessions on price. This can be seen in the extremely firm market for splits, but also in the sharp rise in prices from the more economic raw material sources such as South America. Asking prices have been jumping in the first eight weeks of 2014 by up to 20% while at the same time the demand for the medium-to-higher quality materials is beginning to struggle, although no price reactions have been seen so far.
In the end all this is pretty logical considering that most of the big brands, as well as the automotive industry, have been optimistic about sales for 2014 and, consequently, their purchasing budgets and consumption looked as though they would remain pretty much around the levels of 2013, or possibly even slightly higher. With a pipeline today of six-to-nine months from production to final consumer, it has to be filled and productions have to run. Within the current season it is never really very positive when raw material prices fluctuate too much. Tanneries have little chance to raise prices within a contract period, and leather buyers have a pretty bad attitudes to price concessions if they smell that the tanner has an opportunity to save on raw material cost.
So far so good, but there are still a number of worrying signs this year. In particular the situation in China for small and medium-size operations continues to be pretty fragile. Pollution controls and financial issues are dominating the scene at the moment and becoming a serious threat to many of the small and medium-size companies in the business. The tanning regions in Hebei are in the limelight because of pollution controls there and this was where many producers ‘escaped to’ last year when controls were tight in the south of the country. The massive problems with pollution in general this winter has forced the government to take serious action, because the public is starting to become angry and expects those responsible to act. Many believe this trend supports the large tanning enterprises and kills the smaller ones. Although many of the large ones are not working properly either. There is no serious control of emissions or effluent for small or for big companies. However many of the big ones are definitely showing better infrastructure and can adapt more quickly to the regulations if they have to. Any serious change would quickly inflate the cost of production in China and, as long as leather prices seem to be capped, any rise in cost would need to be absorbed somewhere and the first ‘victim’ would be raw material costs.
The problem of shrinking profitability, which began to emerge in 2013 with a generally unbroken trend of firmer raw material prices and only small gains in leather prices, has started to force action in the industry. In particular smaller companies in Asia have no choice other than to reduce production, because their position is continuously weakening. Investment in expensive effluent treatment cannot be justified for small production volumes and generally the finance is not available anyway. Most of the larger enterprises smell an opportunity and have decided to keep on going and to hold out as long as they can in the expectation that their position in the market will become stronger eventually. They are supported by the large suppliers, who are willing to make moderate price concessions if volume and safe payments are guaranteed.
For suppliers, the question is if the decline in demand from smaller leather producers deciding to cut production can be absorbed by growth among the larger ones. This might be the most important question when it comes to the discussion about raw material prices in 2014. The beef industry in general is quite positive about its position because of the fundamentally positive outlook for the current year. However, we still believe that there are traps on the question of finance and if the industry is really cash-positive enough to keep pace with raw material purchases and shipments and strong enough to support the ambitions of suppliers.
The split market continues to be extremely strong. It is generally a bit like the hide market in 2012 and the beginning of 2013. There is too much demand and simply not a well balanced supply situation. If the tanning industry reduces production, the number of splits available will possibly decline. At this moment it seems that splits are still one of the escape lanes against the rising raw material cost. If many manufacturers of shoes or other leather items continue to go for cheaper alternatives, we could actually see split prices continuing to inflate while full hides may stall in their price development. Looking at the last level of prices for premium splits, one finds it difficult to see how they can remain price competitive. It is also interesting that the prices for splits used in leather production are beating the levels obtained in collagen, which has barely ever been seen before.
The skin market is suffering still from a warm winter in Europe, and also from effluent controls in Hebei in China, where most of the fellmongering of skins takes place. The market hasn’t picked up after the Chinese holidays and skins have begun to pile up in serious quantities. The first rumours about renegotiations of pending contracts have been heard and prices in Europe are still falling. It’s a good thing that we are in the winter season and skins are easier to store; they are large and carry good amounts of wool, which helps protect them. Top-quality articles for the luxury markets are still standing up much better have fewer problems as far as sales and prices are concerned.
There are just about four weeks to go until the trade gathers again in Hong Kong for APLF. Some will visit the Lineapelle show in Bologna first, which is good for the fashion side, but on a global scale not of such great importance any more. Most of the sellers will begin to travel to Asia soon and we would not be surprised to see people departing earlier than usual. Despite all the talk from hide suppliers about decent sales and steady prices, we are quite convinced that total sales in 2014 are satisfying no one so far.
All know that it would not be convenient to meet in Hong Kong with the smell of a weaker market in the air. So, we believe that at least the large suppliers will try everything to get together with their big clients and to convince them to make larger bookings prior to the APLF fair, but we would be surprised if that proves possible at present price levels. We believe that we will see a similar scenario as we did prior to the All China Leather Exhibition in Shanghai last year: in private, larger sales were concluded, giving major customers room to breath and the sellers the opportunity to sell enough product to arrive at the exhibition with not too much left in their pockets, so that the market and the price levels were safeguarded for some time.
For anyone not in the club, a difficult time could follow, with smaller sellers finding their customers already well covered and small buyers finding that not much ‘cheaper’ material is left for them. All in all, it seems that the prices have really hit the ceiling now, but how much of this is going to be seen in the price reports will be interesting to learn in the weeks to come.
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