The Leather Pipeline - 27.06.17
27/06/2017
There was only minor activity in the world of economics and politics in the past two weeks. Unfortunately, we continue to be faced with terrorist attacks all over the world; they have become so frequent that that they now barely make the headlines or are quickly forgotten.
The past two weeks were dominated by more terrible incidents, like the tower block fire in London, the forest fires in Portugal and the landslide in southwestern China, which all caused lots of casualties. The death of US citizen Otto Warmbier after his release from a North Korean prison also belongs on this list. Extreme weather, like the rainfall in China and droughts in Italy and Spain, has drawn the climate policy of US President Donald Trump back into the limelight.
In France, President Emmanuel Macron’s ‘En Marche!’ party won the elections for the National Assembly. He now holds a clear majority and so has the tools to carry out his reforms and political ideas. He is getting strong support for his ideas from various EU partners, in particular from Germany.
Tensions in the Middle East continue and might even intensify with the two sides not showing any interest in softening their positions. Generally, one would have expected oil prices to benefit from such tensions in this region; in the past, oil prices would have surely reacted. However, at the moment, neither the production cuts from OPEC or any kind of dispute in the main producing region are capable of impacting oil prices. In the US, oil production continues to rise and there is definitely no shortage in the market right now. This had led oil prices to slide; they have fallen well below the $50 level and have reached almost eight-month lows.
The US Federal Reserve increased its interest rates, a move so expected by the markets that it didn’t help the value of the US dollar.
Stock markets continued to trade at pretty high levels. The number of investors talking about a housing bubble continues to increase and several people are afraid that potential bubbles could deflate quickly if interest rates continue to go up. However, those who disagree with this point out that there are few alternative investment options at the moment.
Gold prices continue to trade in narrow ranges and the bullion continues to be priced between $1,200 and $1,300.
Market Intelligence
The leather pipeline is shifting more and more into holiday mode. We are now at the end of June, meaning we are nearly at the halfway point of 2017. We are also into the summer time, when the busy winter period of leather production ends and preparations for the coming season are made. As we all know, the leather industry does not follow the calendar year; it instead runs from September to July, with the holiday break taking place from mid-July to the end of August.
Leather can maintain its position as a preferred material in the automotive sector and wherever it is part of the DNA of specific products and brands. On the other hand, leather as a basic material in footwear, upholstery and leathergoods is losing its market share and continues to be pushed into the background. Nobody likes to hear this, but we have to deal with the facts. In Western Europe, we are also dealing with the anti-beef campaign, which is slowly but surely affecting consumer spending.
The automotive sector is a special case; leather consumption depends on the general production and sales of cars, rather than on any discussions about the material. A lot has been said about automotive brands considering reducing the amount of leather in their vehicles, but no real action has been taken so far. For the coming model year, not too many changes are expected. In this field, we have to deal much more with how the consumer is reacting to issues like the diesel emissions scandals, traffic jams and the future of engines, and if this might impact car sales in the short-term. It is unlikely that we will see any major changes within the next five to ten years because it will take a long time before new mobility concepts and innovations hit the roads and have an impact on spending on cars.
Having said that, we should not ignore the writing on the wall. It is common knowledge that a number of companies are investigating the ideas of consumers to find out if there is a rising demand for leather-free vehicles. Looking at the general behaviour of consumers, it seems likely that all the anti-leather campaigning will only reach the usual minority, who will make quite a bit of noise, but will not have any serious effect on leather consumption in cars. It is generally accepted that leather will remain an important interior material for the foreseeable future.
Although the prices for bovine raw material are still in the middle of the historical range, we have to acknowledge that the mathematical average is not fully representative of the reality. The spread between the prices of different qualities has widened more than ever before and the substitutions we saw in the past, which saw expensive high-quality hides drag up the prices of alternatives, do not happen anymore.
In a simplified analysis, we can say that we are currently dealing with three major segments in the market. One is the top-end, luxury level, which is supported by a rising number of wealthy people around the globe looking for premium brands and materials to distinguish themselves from the rest. For this part of society, a designer bag or handcrafted shoe is a takeaway expenditure rather than an investment. As long as this wealth continues to be there, one has to remain positive for this segment, and consequently for everyone in the supply chain related to it. If anyone needs confirmation for this statement, they just need to read the reports and plans of the large luxury groups.
The second segment is more of an industrial highway. There are still large brands in the consumer world consuming big volumes of leather for shoes, bags and upholstery. In these cases, the typical tannery-end user relationships do not apply. These are big industrial conglomerates that have the size and organisation to meet all the codes of conduct and to finance and manage the volumes required; this only applies to a small number of players. The most obvious example is the automotive industry, where such arrangements and connections in the supply chain have been common for a while.
Timberland, Tod’s, Coach, Michael Kors, Apple and many more global players need suppliers of leather who have the production and supply chain capacity to meet their requirements in terms of volume, standards, traceability and price. They also must be able to play according to global rules. In short one can say this is just a case of big-meets-big. They are tightly connected, so much so that, from the meat packer to retail shop, the levels of flexibility have become low. This is why we refer to the flow of product in these supply chain environments as an industrial highway: the traffic is so fast and dense that hardly anyone can get to an exit during the rush hour.
Last but not least, we are left with those that do not really fit into the above segments. These include the small companies, the ‘no-names’ and the ones that only qualify for the lower end of business. Here, price is virtually the only influencing factor and this is where leather is seeing the strongest headwinds. The total size of this market should not be underestimated; in aggregate volume, it is still extraordinarily large. However, it is very difficult to meet price and standards with all the parameters related to leather. It is obviously much cheaper and more flexible to use other man-made materials, as long as the consumer is not insisting on the use of leather.
When we look at what has happened recently in the market, one can also understand that it is getting increasingly difficult for leather in mass production. The small leather-producing facilities are disappearing at a quickening rate. In many cases, this if for good reasons like environmental issues or questions about labour safety. In China, the government is ruling with an iron first when it comes to environmental questions. However, simple economics is also playing a role. Rising labour costs and other costs in the tanning industry are making life almost impossible for smaller and non-licensed operations, which is forcing them to close.
In India, there is a completely different issue threatening the country’s small enterprises. A massive campaign from the government against cow slaughter has had a very negative effect on beef production, including buffalo. This has and is tying up the local supply base for small tanneries and manufacturers, which are still plentiful in many parts of the country. They are not getting enough raw material and they will have to close if this does not change very quickly because it is impossible to buy and deal with imported raw materials.
Apart from these theoretical issues, we did not see too much activity in the leather pipeline in the past two weeks. The flurry of business we had observed cooled down, with many tanneries, particularly from the first two segments previously mentioned, having sufficiently replenished their inventories.
For the trade, the news of the arrest of importers and tanners in China for illegally importing hides produced in countries without trade agreements was quite exciting. Many will remember that we had a similar situation in the south of the country a few years ago. The government in Beijing has made it very clear that it is not willing to tolerate the smuggling of raw materials into China. These hides were looking for new entrance doors, which they found in Wenzhou and related ports. For the moment, it will definitely hit individuals and enterprises on the supply and on the import side. A lot of deposit payments will be lost. The hides that were seized are expected to be destroyed, which will be another financial loss for those who are most likely in jail at the moment.
The main subject of discussion is if these hides, which were coming predominantly from Central and South America as well as Africa, need to be substituted. Many are of the opinion that this is a minor problem because the market for these hides was not particularly good and what is needed in the future can and will be imported in wet blue or can be easily substituted from other legal origins. We tend to agree because there is definitely not a shortage of raw material in the market at the moment. If there is any problem, it might be the price.
The split market is showing no signs of improvement. This is not really a surprise because it is also the summer break in this part of the industry. We will start a new season of leather production after the summer holidays and it will be interesting to see if splits have a greater role in production. A number of pundits claim to know that the automotive industry is planning to increase their consumption of splits. The consequence of this, of course, is that less grain leather would be needed. There might be room for greater consumption of split leather in shoes and automotive, but we will have to wait until September or October to see if there is any truth in the optimism.
The skins market is showing a similar trend to that which we have seen in the bovine market. In Europe, there is good demand for but limited supply of new season lambs suitable for lightweight, double-face garments. With prices fluctuating around the €5 level, we have returned to a valuation that is adequate for both sides. Material that is only suitable for nappa leather remains in the same catastrophe as before.
The next two weeks should lead us even further into the holiday period. From mid-July, the western world will take its annual holiday break; in particular, the first three weeks of August will see hardly anyone at their desk. The mechanics will have to work hard because this this is the time when most of the tanneries carry out their major renovation or maintenance operations. It seems that the leather pipeline would be quite happy for things to stay as they are, leaving new directions and decisions on price until September.
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