The Leather Pipeline - 20.2.18
20/02/2018
There are periods when the financial markets and the political arena are boring. This makes it difficult to collect any kind of interesting information which is exciting or important for this publication. The current situation is the complete opposite.
As far as politics are concerned, there is nothing that can be considered super exciting, but there are a lot of issues here and there which, although small, could still have significant influence in the long term. This is not the place to go into detail, but we should all watch the progress of Brexit, which could mean a lot to Europe’s future.
US President Donald Trump continues to deliver almost daily private and also public news. If we leave the private ones to one side, we would just mention the tax reforms and the budget, both of which have a great impact of the market.
Last but not least, the President of South Africa, Jacob Zuma, was forced to resign following allegations of corruption. This is a pretty common subject at the moment, with politicians in Israel and China facing similar situations.
The financial markets have been on a rollercoaster ride in the past two weeks. In particular, the US markets were triggering several movements and the currency market has been shaken. The US dollar lost more than three cents against the Euro within a few days and daily movement of almost two cents has been common.
Most of the movement was triggered by the consumer price index (CPI) data, which exceeded expectations and raised fears of a return to inflation and quick interest rate hikes. This would normally support the US dollar, but, after a short spike, it actually depressed it. The economic community has failed to explain this, again leaving room for conspiracy theories.
One of these is that the Federal Reserve, driven by President Trump, is doing everything to weaken the dollar in order to support commodity prices, especially oil. This would help a number of exporters, one of which would be the US if oil production levels continue to rise at their current rate. At the same time, a weaker dollar is bad news for other exporting countries, which is a preference of President Trump.
Despite the weaker dollar, oil prices took a beating, with production exceeding consumption by quite a bit. We now wait to see how OPEC is going to deal with this issue. The price level is still around $60 per barrel, which means there is not really a serious problem for net importers of oil, especially when you consider that the weaker US dollar is reducing the import bill.
The 2018 Munich Security Conference took place from February 16-18 and several statements suggested present global stability is fragile. We have been used to peace for such a long time, so we should all listen carefully.
Market Intelligence
A large chunk of the leather pipeline went into a lower gear in recent weeks. In the Catholic parts of Europe and in Brazil the Carnival week dominated and meant companies had a few ‘semi-holiday’ days with just emergency staff working.
In China and in various other Asian countries the Chinese New Year break was prepared and most business life closed down. We would take this opportunity to wish our readers in that part of the world all the best for the Year of the Dog.
As expected, business activity slowed down, particularly in Asia, with the exception of a rush to open letters of credit (LCs) and to send deposit payments to facilitate smooth shipments from origin during the holiday period. Most suppliers we speak to are reporting fast and smooth receipt of payments and LCs for outstanding contracts. Not a single one complained about any delays. Another piece of proof is that tanneries with existing orders and production plans are neatly planning their raw material needs and speculative demand has further decreased.
Industry issues
With the reduced trading activity there was a bit more time to discuss with some of our sources in the trade how they felt about: the present raw material situation; the position of leather as a material versus its competitors; structural changes in the industry and pipeline; and, if they expect changes, how these will influence the leather pipeline or their individual business.
It is no surprise that there was a plentiful variety of answers. Many reflected the present and common opinion, but a few were also provocative and completely left the common tracks.
The majority confirmed the general opinion, based on their individual experience and business situation. The higher you climb in terms of quality in price, the more successful and stable the position of leather is. The main concern mentioned was the availability of adequate raw material. As usual, price matters, but it is not top of the priority list. Analysis of these conversations made it clear that size matters even at the high end.
What are they complaining about? Some are worried about the simple problems that almost every business has to deal with. Many of them are small and are run by the owner and a handful of employees. Who is taking responsibility when the ‘brain’ is unavailable? Where do you get qualified labour willing to learn what is needed to save and develop the know-how required in specialised production?
Where these problems can be dealt with, other issues are frustrating successful companies. When you are small, in the tanning industry this is already quite big numbers, you have to handle the problem of critical size. Critical size for supplier, critical size for transport of raw material, critical size for wastewater solutions, critical size for chemical suppliers and their support, critical size for machinery suppliers, critical size to handle bureaucracy or administrational demands from authorities and maintenance requirements.
In some cases, it is a problem of getting the service; in others, it is the cost, which has increased more than ever when volumes are small. As a result, small units are successful with their products, and in many cases are even in a position to operate profitably. Nevertheless, they are either underserviced or are challenged by requirements which simply exceed their capabilities. In simple terms, they have to meet almost the same standards and requirements as the big operations. This simply cannot be done.
The challenges facing small and medium-sized units in Europe and Asia are different, but the end results are the same. In Asia, the problems for smaller units are mainly related to wastewater treatment and other environmental subjects, while the ones in Europe mostly suffer from underservicing and excessive administration. The common concern for smaller operators is not demand for leather, but the above challenges.
All eyes on GST
There is a different picture for the bigger units. Although a lot of concerns are mentioned in the automotive supply chain, the orders and business situation remain completely intact. The bankruptcy situation of GST AutoLeather is almost resolved and the trade now awaits the next decision of its new owners. Several other operators are already in place to handle supplies in case of failure and several ‘plan Bs’ have either been implemented or are being prepared. It is unclear if the OEMs are going to return or if they will stay with the suppliers which have taken over some of the supplies of GST.
One thing is certain; the number of leather seats manufactured for cars is not planned to increase in 2018. This means there is no need for any increase in production capacity. Several competitors have already started to ramp up production, and this might need a rebalance.
Price pressure
The biggest concerns are raised from the furniture upholstery and shoe sectors, although statements from here are also pretty mixed. Price is the main issue and problem everywhere. Leather prices are under serious pressure, quality requirements are high and consumption of leather is generally declining across the board. The high-end producers are not complaining despite all the concerns. They are also insisting that their order outlook for 2018 remain positive.
Tanners that were able to manage their raw material use in 2017 also report quite positive results with good margins when they were able to take full advantage of the decline in prices of various raw material origins and, in some cases, also the currency swing. Some of that might be called windfall profits, but they still believe that a flexible raw material use and high technical skills will enable them to perform well as long as they can hold production levels stable and have stable orders from their customers.
Those tanners operating in the price sensitive volume sector continue to display the biggest concerns. To remain competitive and to control costs they need to run their factories at full capacity. Tanners in China in particular, but also some in Europe, seem to be the victims. Bulk, industrial buyers raise the specs and requirements for resources, standards and capabilities that can only be handled by the large, strong performers.
So, has the shrinking demand for leather been unevenly spread? Is it not news that a number of tanners in China have taken a longer holiday break and that several had already been operating at reduced capacity for a while. At the same time, we learned about several large and well-established players which run at full capacity and beyond because they are favoured by the big brands and retailers. These buyers prefer fewer and larger suppliers, which can be more easily handled and are more likely to comply with their specs and regulations. The net balance is definitely negative when it comes to mass production.
A boost for leather?
Another subject being discussed along the leather pipeline is waste management. This time it is less about the waste management of tanneries and more about the restrictions the Chinese government has placed on the import of waste or low added-value materials. One example is the leather scrap produced when leather is cut for automotive seating or for upholstered furniture.
A lot of this material has been exported to China. The cutting yield range is between 50% and 80% and so a lot of this kind of material is produced around the globe every day. This product will certainly find new outlets and destinations, but at the moment we hear about a back-up of the material and the collapse of the return for this by-product of leather cutting. This is weighing on the calculations of tanneries and cutting plants.
When we talk about plastic waste, we should realise that this is probably good news for the leather industry. The massive shift towards oil-based alternative materials and fast fashion production has significantly increased plastic waste of every kinds. Almost everybody is complaining about plastic pollution in the oceans and about the general management of waste plastic.
The fact that a number of retailers and brands are using recycled materials is a nice marketing campaign, but the truth is that barely 10% of total production is based on recycled products. This is possibly the best marketing argument for leather as a material for a long time.
Contrasting views
As far as regular business is concerned, the past two weeks have been fairly uneventful. Trading slowed because of the Carnival season in several parts of the world and the Chinese New Year holidays in Asia. The supply chain obviously completed their homework on time and we did not hear from any part of the world about any hectic activity. Most suppliers were confirming regular shipments and timely payments so that the product flow in the pipeline was not negatively influenced.
The subject of discussion remains how well the tanning industry is covered for the second quarter of 2018. Raw material producers strongly believe that the inventories of the tanning industry are very low as a consequence of the slow business in 2018 so far. In Europe, a regular purchasing program is common and tanneries are generally planning four to eight weeks ahead. This means that one gets a pretty clear picture about the activity and the situation in the tanning industry on a regular basis.
In Asia, the situation is a bit different, because it is still common to take positions to beat the market and to achieve better than average inventory values. The optimists are convinced that the industry in Asia has been bluffing, with negative information about leather business being released in order to force suppliers to reduce their asking prices. The general belief is that the Asian industry will come back from the holidays with a great need to replenish stocks and will finally be forced to pay asking prices.
The pessimists have a different interpretation; they believe leather orders are seriously down and that the negative trend we have seen for more than 18 months is continuing. They point to the poor sales figures in recent weeks and insist that tanners already covered their needs in the last quarter of 2017. This was also an attempt to avoid winter hides. They expect suppliers to be disappointed with the demand in the coming weeks and see the APLF exhibition in Hong Kong as the next breaking point for further significant reductions in the price of commodity raw materials.
We see that both sides have pretty convincing arguments, but we must admit that we continue to be on high alert for the raw material prices in the medium and lower quality range. We are aware of too many raw materials that barely move any more regardless of the price tag they carry.
Splits and skins
The split market continues to reflect the hide market. Specialties and niche materials are doing so well that there might not be enough suitable splits around to satisfy the potential demand. However, when it comes to the standard items, which are traditionally used for cheap products, the situation does not look good. There might be many more splits in stock than many are willing to admit.
The skin market is a bit unclear. It is true is that skins that are mainly used for nappa garment leather remain almost unsellable. In many parts of the world they are either collected free of charge or the producer has to pay to get rid of them. This has been the case for quite a while and we should really monitor the situation because what once seemed unbelievable is now a brutal reality. Raw materials, namely skins, are being thrown away and this should be realised by the players in the bovine sector. The impossible has already become possible and we must hope that this is not happening again.
What makes us a little more positive in spite of all the trouble is the slow recovery of coarse wool prices. There is still plenty of cheap clip wool available, but if the demand remains when the stocks are cleaned up it would make the wool recovery from skins attractive again and immediately change the calculation. It might still take a while, but we will watch the wool market closely to see if this could be the trigger for the recovery of skins as well. Other skins, such as specialties with either fine or dense wool, super grain quality or simple beauties for decoration, continue to perform very well and sellers cannot complain about the prices.
Crucial period
The next two weeks will be quite exciting. The Lineapelle exhibition in Milan will offer us lots of information about fashion and trends. There might be fewer Asian visitors due to the holidays, but it is still likely to be a very important get together.
The following week, most of the Asian leather industry will return from their holiday break. This will give the first indication of who is right – the optimists or the pessimists. We think the period between now and the APLF exhibition in Hong Kong will be decisive for the trend of 2018. At the start of April, we usually enter the low season of leather production with declining demand. Only a major turnaround in fashion and material mix can reverse this trend.
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