The Leather Pipeline - 08.09.15
08/09/2015
Anyone who needed a bit of entertainment on the financial markets after the very quiet summer months has been richly rewarded in the past two weeks. The last issue of the Market Intelligence had just been published when the stock market in Shanghai plunged and uncovered all the worries and concerns about the Chinese economy.
This has dragged most international stock markets deep into the red and the commodity markets have followed the trend. The week before last was definitely not one for investors. Unless of course they had been betting on value declines.
Apart from the stock markets, the steep fall in oil prices was also a matter of major concern and the price per barrel fell well below the $40 mark, always considered the target and possibly the low end of the trading range for this year. However, as is very often the case in the financial and commodity markets when the target has been reached and the sell-off is over, the rebound is already on its way. We saw another ‘V’ trend for oil prices, seeing them jump by more than 25% in just two days. Consequently, we are getting back to levels of around $50, still cheap but enough for the moment for total catastrophe to be avoided.
The markets have shown their highest volatility for a long time. Daily changes of 5% or more have become pretty common, showing how nervous investors are and that the bulls are fighting the bears at the moment. Who the winner will be is not yet clear, from our perspective. However the low oil prices will definitely have serious consequences in many of the oil-producing countries: they will have to prepare for serious financial problems on the road ahead. Even a country like Saudi Arabia is dealing with a $700 billion deficit and needs desperately better oil prices to manage the debt in the long run. In other raw material-dependent countries, low commodity prices are also negative for national budgets and for the spending power of the population.
What is bad for some is good for others. Whereas before high prices were taking money out of the pockets of consumers in importing countries and spilling it into the budgets of exporting countries, we now have the reverse; many consumers around the globe can be happy about having significantly more money in their pockets because of much lower energy and petrol bills.
The situation in the Chinese economy is the most discussed issue in the global economy at the moment. The impact the second largest economy in the world has on many countries, for various reasons, is extremely important. No matter what the Chinese government is trying to do at present one has to assume that the economy is growing far less than the official expected rate of 7%. Many may say that smaller growth is still growth. It is pretty clear that the time of the ‘endless’ boom is over, which is showing up a lot of fundamental and structural problems in China.
From our point of view the main problems are the overcapacities in production that have been created (in expectation of a never-ending expansion of the economy) and serious cash flow problems in many sectors of the economy. The overcapacities have created significant stocks of finished and semi-finished materials and these are binding up a lot of cash along the supply chain. The rising labour costs have made a lot of export orders disappear and move to other, cheaper countries. This might be good in the long run and the government’s attempts to stimulate local demand and the service sector might one day prove successful, but for the moment things look pretty ugly.
China would not be China if one could really predict what is going to happen next and we have to watch closely for the government in Beijing to decide its next move. For the moment it seems to be suppressing any kind of criticism and trying to intervene in the markets as much as it can. This definitely is one of the very interesting aspects, seeing if the markets really can be controlled and manipulated or if they will find their own levels sooner or later.
We don’t want to extend this section by too much: it just needs to be noted that the US and Europe are delivering a mixed bag of economic data too. Overall, things seem a bit more negative than positive.
Market Intelligence
The situation in the leather pipeline is as exciting as that of the financial markets, with real excitement felt before the All China Leather Exhibition (ACLE) in Shanghai at the start of September.
Many sellers of raw materials had already spent a week in Asia to visit their main customers and either to sell raw material or just gain some impressions about the situation in the week before the show.
The fair in Shanghai is mainly an event that is oriented towards mainland China. The international scope, which one still finds at APLF in Hong Kong, is limited at ACLE, at least as far as the tanning industry is concerned. International suppliers might be pretty much the same as in Hong Kong but the target customer group and the number of visitors from many countries is substantially less and has declined in recent years. There are many conflicting opinions about the show in Hong Kong, but as a meeting point in the marketplace for the whole of Asia, it works much better than ACLE.
No matter what the official statistics say, the number of exhibitors was down and the space not covered by stands was significantly higher than in previous years. Empty spaces and wider aisles were seen in all the different halls. Although the show had very busy periods, the number of visitors seemed to be down, although one can’t really complain about traffic and the activity on stands and along the aisles across the three days.The last day, which is normally pretty deserted, showed that quite a number of people and stands were busy even after lunch.
After more than a week in China, we cannot help but be concerned about the situation in the leather pipeline there. Business might be good or bad, but the fundamental, structural problems are serious. With a slowdown in the economy and a reduction in leather demand globally, the brutal reality with regard to the overcapacities that have built up in China over in recent years has to be seen and accepted. One is reminded in a way of the situation in other tanning centres in the past when the expansion of capacity was much faster and bigger than the potential of the leather and retail markets.
The pipeline has come up with explanations and excuses and mainly the growth in the automotive industry justified rising raw material prices until April this year. At the same time, many players made the declining kill in some regions around the globe the justification for the price levels we saw.
Today one has to accept that leather demand has been shrinking, despite the positive conditions in the automotive business. A lot of raw material demand was related to expanding capacities and attempts to reduce production costs. Increased production capacity did not find enough of a market and led to shrinking or even negative financial results. Since new investment and expansion did not lead to any success, tanners had to cut production by mid-year at the latest and this is reflected today in the raw materials market.
The hardest hit is definitely the low end of the quality range, which has been obvious for quite some time from the situation in split market. Low-grade materials and commodity leather production are suffering most from the declining demand in the consumer markets globally, even more so because of the high prices seen until early this year. Substitutions have taken place. Just walk around and have a look at the feet of people; everybody will understand what has happened on top of the general declining consumer demand in various parts of the world.
Somewhat unclear is the information one can obtain about the automotive market. Although there are still some people predicting a pretty steady if not growing consumption of leather in vehicles one has to be a bit more concerned after travelling in China and talking to people close to the business. The US market has seen a very strong performance, but the driving force in the market was always China. The sheer size of the market makes changes much more evident than in any other region of the world. Car sales are definitely down in China, by how much we will see from the statistics to be released in the coming months. Problematic is, however, the volume of cars that are already produced and are now looking for customers; this will also cause a necessary revision of production plans and demand for the coming year.
This is the most worrying issue altogether. Spending almost two weeks in China we did not meet a single person expecting any short-term improvement in the economy or in consumer demand in China. Since this issue is mainly dealing with the issues around ACLE, we will also stay a little bit with the situation in the second-largest economy of the world because the boom there has fuelled the global economy to such an extent that a little cough in China can be contagious and affect the international situation.
The situation of Chinese businesses is extremely difficult with quickly eroding export orders because of cost and, at the same time, lagging domestic demand. While this could still be managed under normal conditions it is extremely complicated this time because we have a vicious combination of inflated inventories and serious cash flow problems. Unless the inventory of raw, semi-finished goods and consumer products at retail level is cleaned up, there seems to be very little chance of any real improvement. Many people we spoke to, people we consider to be rational thinkers and well-informed, are not expecting this to happen until the first quarter of 2016 at best and this is why nobody is expecting any real sign of improvement before some time in the first half of 2016.
Not everything is bad. The business for medium- and higher-end leather products might also be hit by reduced consumption in China but the extent of the problem is definitely much smaller and could possibly be handled by lower prices, which we have already experienced in the last months and a lot points towards that particular trend not being finished yet. Better margins and profitable business normally encourages more optimism. The Lineapelle show in Milan this week, which is more dedicated to this kind of article, will show us if this assumption is right.
Summarising, people will have returned from China reasonably disappointed. The meetings with customers and the situation in the country did not offer much reason for optimism and for the time being it might be better to remain cautious and prepared for more bumpy roads ahead. Those who have been pointing at increased raw material sales in August should be advised that many of the tanners just replenished inventories and many of them regret doing so already, claiming their raw material needs are now covered for a pretty long period ahead. It will take quite a bit to get the stocks moving and turned into cash (even though frightening losses will occur when the stocks are turned into cash at today’s prices). Consider a stock of only 100,000 hides with an average size of 50 square-feet with a price loss only of $0.50 per square-foot. These numbers are still quite conservative considering that there is barely a buyer for this kind of material at any price today.
The split market, which is another very important factor, is not showing any kind of recovery yet. Plenty of splits, plenty of low prices quoted, but no recovery of any demand for split so far. The leather industry can’t expect any short-term improvement in the situation. It is also pretty difficult to see why PU-coated split leather should actually see any short-term recovery considering any artificial product today will serve a similar purpose.
The skin market is as dull as any other, but at least here we could see a little bit of a chance for a silver lining somewhere on the horizon. More articles made from lambskin are appearing and, as cheap as it is, it might really become an interesting alternative in particular in sectors such as linings and bag leather. We have seen some beautiful products, in particular chrome-free, and this might be the sector that sees the first recovery after the drama. At least suppliers from Europe have been reporting sales, with some even claiming to have obtained a little bit more money, which is not too impressive considering how low prices have fallen. In many cases the selling price, after deducting transportation and other related cost, is barely covering preservation, selection and storage.
We are now moving from fair to fair and after Shanghai is Milan, and after Milan is Paris. With each of these fairs we climb up the quality and price stairs. We know now that the commodity sector is presently not doing very well and the outlook for a short-term improvement is quite negative. Leather as a material has lost a lot of its market potential and we definitely need a boost from fashion and marketing campaigns that put leather back into focus. The loss of market share in the material mix is, from our perspective, the real and fundamental problem we have to deal with.
We have to hope for a successful performance for leather at the medium and higher end of the fashion and price range. If leather is successful here it becomes attractive again for the average retailer and department store. Although it always needs a few seasons for a change, the sooner it begins the better. Let us hope that the Italians, who are masters of invention in fashion, surprise us with beautiful and attractive new articles in the coming week. In addition we can only hope that the luxury business, so dominated by China, is not going to suffer too much and the top brands can balance the decline from China with interest from other wealthy people from other parts of the world.
All in all we think that the price correction is not yet over. However, the pressure will not be evenly spread and we think that in particular the cheaper end of the raw materials market might continue to face the strongest headwinds. It remains a balance between supply and demand and there is still not too much high-quality raw materials available.
September is traditionally a month when most of the directions are set and it might still be too early to draw the bottom line after the trip to Asia alone. Consequently, we will wait for the outcome of the shows and meetings, impressions and negotiations in the coming two weeks to get a clear picture of what we have to expect for winter 2015-2016. At this stage, and believing that this business is always running in cycles, we have to admit that we think that the downward cycle has not yet reached the bottom.
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