The Leather Pipeline - 5.9.17

05/09/2017
Macroeconomics

Over the past two weeks, politics has been high on the agenda, and Hurricane Harvey dominated headlines. Vast parts of Texas were flooded and the storm claimed at least 60 lives.

North Korea’s rocket test over Japan proved another challenge - even China is beginning to consider imposing sanctions - and it will not take much for the big players to lose their patience.

Many of President Trump’s promises to the US business community have not come to fruition and the markets are reacting accordingly. With missing stimulus to the economy and continuing changes in the administration the dollar is suffering, and has crossed the 1.2 level against the euro.

The European Central Bank has not yet begun to intervene in the markets, but it can be assumed that the negative effects on European exports and a further rise of the euro could trigger action.

Political tensions have made the price of gold rise and the oil price jumped due to interruptions in Texas caused by Hurricane Harvey.

Stock markets continued trading in narrow ranges while the general trend was somewhat weaker.


Market Intelligence


At the close of the Shanghai-based All China Leather Exhibition (ACLE), some exhibitors and visitors expressed disappointment. However, as we have stated many times, the problem is not the result but the high expectations. 

The organisers will no doubt draw a positive picture, but those who attended noticed that in many halls the number of stands and visitors was significantly reduced. However, the number of visitors is not as important as the quality and the amount of business concluded. People went home with mixed results, depending on which part of the business they came from.

On the positive side, we met people from the machinery and chemicals sectors who had been impressed by the number business discussions they had. The leather industry is still interested in innovations and improvements in production and processes. As we have seen in the past, sometimes the difficult periods are better for these industries because companies have time to think about innovation and changes.

The large Chinese tanners exhibiting in Hall E4 did not seem as depressed as many reports tell us. We are in a period of major transitions in the world’s largest leather market. The Chinese government is managing the sector with an iron fist, which means tanneries that do not meet environmental standards are facing problems. The stories of government officials closing tanneries with no notice are true. 

Local governments that control some of the major clusters have tried to find solutions by setting up centralised beamhouse operations and wastewater treatments to serve the smaller units. This is a similar situation to before, except the wet blue production that had been done cheaply ‘in the wild’ now has to be done officially and under controls. This has major consequences for cost, at a time when price pressures already make things difficult.

The situation in China reflects the global leather business. Automotive tanneries complain about margin issues, uncertainties about the future and difficult negotiations with the OEMs, but not about volume.

Tanneries producing for furniture upholstery and bags are generally quite content as well. Business might not be brilliant, but generally we feel that there will be no significant drop in orders for the winter season. 

The major concern is prices for finished leather. Leather buyers have access to market information and obtain a generalised view on raw material price developments. If a leather buyer monitors the international price information he or she will get the impression that raw material prices have dropped significantly over the course of this year and this will make them take a tough position on discounts. We have had major corrections, but not across the board. 

The shoe sector remains in the doldrums. Raw materials suppliers need to accept the situation. I agree with one of my sparring partners, who said shoe leather still uses the majority of leather production, at least 50%. The rise of athletic and casual footwear has hit leather demand significantly. Leather consumption for the manufacturing of shoes has declined more than 10%. Estimations of well-informed sources put the figure closer to 20%. This means a reduction of 10% in terms of total leather production. But it doesn’t matter if the number is 5%, 10% or higher, it is a substantial amount.

The reduction in demand is not hitting every material to the same extent and it does not mean that each tannery has lost 10% of business. It could even mean that for some, business might be better, if they have access to cheaper raw material. It does mean, however, that the total raw material supply cannot be fully absorbed. The split market is showing evidence of this: falling demand cuts around the edges of supply before it hits the centre.

When demand falls, so does the average price. It starts with the lowest quality material and then creeps up the quality ladder. It has not reached the top yet, but it is on its way. The biggest problem now is the affect it has on leather prices. Raw material markets react and move quickly, but leather prices are far more inelastic and generally only change in seasons. 

This is becoming one of the biggest complications for tanneries that are still enjoying a decent order book. Higher production costs and a less-than-average decline in the cost of their specific raw material makes life difficult when their clients insist on market-average declines for leather prices for the next season. 

We are in one of the difficult and fundamental market changes which happen within the long cycles and the only defence would be an improving leather demand.

For the day-to-day business in the show, it meant raw material and wet blue suppliers were struggling to generate the sales they wanted. Although there were Chinese customers passing by, the number of customers was low, and very few were willing to discuss serious business. 

That left a lot of room for gossip and rumours. This time it was mainly about emergency sales and ‘low priced spot deals’. That left quite a few who were obviously not prepared for the reality in shock and several did not bother to attend the show on the Friday. Several suppliers said they feared contracts could be cancelled and most just pushed to get payments and shipments effected. 

There was also a general feeling warehouses in some parts of the world are congested, because shipments are not matching production and sales.

Most sellers take quite a bit of homework home. More than ever, a realistic analysis will be needed to avoid surprises. One can hope for relief in some sectors due to the seasonal upswing in winter, although the anticipated shortage of inventory has not happened.

SPLITS AND SKINS
Those hoping for an improvement in splits were probably most disappointed. Splits are not the main focus at the fair, but we could not find anyone who reported any improvement in split demand, except the usual specialties suitable for high-quality suede or heavy veg-tan material.

The skin market hasn’t changed either. A number of lamb and sheepskin tanners were around in addition to those who were exhibiting in hall E4. Double-face garment is back and this means there is good demand for suitable skins. Fine and dense wool skins are also finding decent interest. Nappa remains a problem and we could not find anyone who was predicting any improvement. We still cannot understand the pipeline. There is quality raw material almost for free. It can be used in many different products but nobody seems to be considering this natural and sustainable material anymore. 

It is not easy to predict what is going to happen next. The leather fair proved that, at least for shoe leather, demand does not match supply. The price structure for leather and raw material is in the process of a complete redefinition. The leather pipeline has become more inflexible, and the big brands and manufacturers are requiring technical specs that have been set due to specific regulations and have limited flexibility. Leather might not be invented by the tanner anymore, instead set by a product manager somewhere else, but the realities of cost and return still exist.

The price structures and the spreads between the various raw material options have become far too wide to be acceptable. New parameters might redefine the values. However, until this happens we have to expect price adjustments according to market conditions. What this means is there is a lot to do to get everything in line again. For some cattle hide types it could become pretty painful if leather demand is not going to expand above the seasonal increases.