The Leather Pipeline - 01.05.18
01/05/2018
In the past two weeks, politics were no longer the main driver of the public attention. It is not that anything has really changed, but it seems the main actors had to take a little break. We saw the North Korean leader, Kim Jong-un, travel to see his brothers in the South; one wonders if this is a direct result of the secret trip he made to China recently. Nobody knows what will happen next with these sorts of characters but it nice to see that there might be some sort of de-escalation in the region.
The main European leaders travelled to the US to meet President Trump and to discuss the critical topics in the relationship between Europe and America. Climate change and trade wars seem to have been the two big topics on the agenda. Since Europe is no longer completely united and the ‘Brexit’ has separated the UK, President Trump is playing different cards with various European nations.
There were no big changes in the financial markets. Despite small slowdowns in growth in Europe, the US and China, the economies of the big players remain on track. This comes in spite of the concerns and worries we have seen since the beginning of 2018.
The stock markets continue to be at steadily high levels. Corporate earnings were pretty good in most cases in the first quarter; this means most people are not seeing any clouds in the sky. What might become a major factor are the different trends in interest rate on either side of the Atlantic. Yields in the US have risen to more than 3%, while interest rates in Europe are kept low. This means the spread between European and American yields continues to widen.
Under normal circumstances, this would be pretty positive for the US dollar. Indeed, at the end of the period the greenback broke out of the stable range which we had seen for so long. The Euro was easing, and we ended the period around the level of 1.21 against the dollar. Some analysts see good potential for an additional rise, but some major banks have changed their forecasts in the expectation that the dollar will trade below 1.20 in the coming months. Trying to predict currency exchange rates is even harder than predicting the weather.
Oil prices remain firm, although this is hard to explain. Only the tensions in the Middle East can really justify the price levels reached. Oil trades on a healthy level, around $70 per barrel, while there is definitely no shortage in the market. The US continues to pump more oil than ever.
Although we don’t usually deal with specific industries in this section, we think it is important to mention the extremely positive results of most of the big automotive brands in the first quarter 2018. There have been no scandals, no concerns about the environment, no questions over general individual mobility, and car sales are strong in most parts of the world. Their forecasts for the rest of the year suggest that a downturn in car production or sales will not take place in 2018. We can rely on the strong performance of this industry for at least the rest of this year.
Market Intelligence
It is a difficult time for a great part of the industry at the moment. It is also difficult to discuss the issues of the leather pipeline because what has once one pipeline is now at least two. There is a clear separation between the premium sector and the commodity one.
We have been dealing with this trend for a long time already and now we must deal with the consequences. For the premium segment, it is pretty simple. The first quarter results for the luxury companies were all positive. They reported more turnover and more profit, with leather-related divisions outperforming other divisions.
It comes as no surprise that the leading luxury accessory and handbag brands are planning further expansion as they see there is more demand out there. Production capacities are expanding and so the demand for leather will also grow. The only question is what their raw material base will be when all these plans become reality. Their main focus has always been on superior quality veal skins from the dominant origins in Europe. If the numbers attached to their expansion plans are correct, the requirements for premium leather will no longer be able to be met by their favoured raw material source.
This might be a bit premature, but the question of what comes next must be raised. It is fair to say that there is an unknown raw materials sector which could be the beneficiary of the success of luxury brands. We are sure our readers would love to get a hint about what it may be, but we must admit that we do not have a clue. We have plenty of ideas and could make plenty of guesses, but we remain completely in the dark over what designers and product managers will eventually choose. It doesn’t matter as long as the success story continues. More leather demand will stimulate activity in the premium section of the leather pipeline.
We could now switch to the automotive industry, but that isn’t really needed at the moment. Everybody waits for changes in the auto leather market and many were expecting a downturn in leather consumption for various reasons. Regardless of the number of cars being produced, there is a lot of talk about new developments and the interest in the automotive industry to walk away from leather. So far, there is no indication that this will happen within the next two years. Fears that public pressure would force the car industry to reduce or eliminate leather use have not materialised, despite all the media hype.
Commodity headache
This leads us to the section of the leather pipeline that is providing the biggest headache. Although it is painful, we have no choice but to discuss what the future holds for leather and what it might mean for the hides and skins being produced every day. One must acknowledge that the supply of hides and skins will not decline in the foreseeable future. Beef demand and consumption continue to rise and so the supply of hides and skins is unlikely to fall in the next five years.
If we accept that the situation on the supply side is pretty clear, we must now deal with the fact that for the past two years the commodity segment has not been consuming as many hides as are being produced. It has never been a linear development or trend, but it has been obvious for a long time that demand for commodity leather has been stagnant or falling.
As we have said in previous issues, the problem is not that there is an anti-leather trend, rather that the material is technically difficult to handle for producers of consumer goods. Industry 4.0 is the real enemy of leather; more machine manufacturing is pushing brands and consumer product manufacturers towards uniform and easier to handle materials. The consumer is accepting these decisions and profits are higher for brands, so the benefits of leather are no longer an important factor in purchasing decisions. The real enemy is plastic, but the industry is yet to unite behind a common strategy to safeguard the use of leather wherever possible.
It is true that the demands of eight billion people around the world could not be satisfied by leather, rather than by alternative materials. However, if we include all kinds of hides and skins, including splits, there would be significant volumes of materials available for use in production.
It is frightening to learn how many hides and skins at different stages of production and preservation, as well as how many splits, have accumulated in warehouses around the world. This doesn’t include the number of skins which have been destroyed over the past two years due to their inability to find a market at adequate prices.
The low interest rates and the easy access to finance have camouflaged this congestion for quite some time. The recent decline in raw material prices is creating another substantial problem. One day, these inventories will have to be correctly valued and this could mean quite a lot of trouble for their owners. The vicious circle continues and only a rise in demand for leather will be enough to rescue the situation and prevent serious consequences.
A matter of time
As far as we are concerned, the most serious problem at the moment is the factor of time. With a reduced number of trading operations more of the hides and skins pressing on the market are now in the hands of their producers. These companies are reasonably strong financially and the by-product is only part of their business. A similar situation 25 years ago would have been far more dramatic.
Nevertheless, we need more demand for leather if this product flow is to return to normal. We must consider that either more hides and skins are going to be destroyed or that they will be shifted into non-leather production. Every problem has a solution, but this would not be a good one for the leather pipeline.
The problem of time remains, however. Although there is no indication that leather consumption in consumer goods is going to rise, even if it did it would take a minimum of six to nine months before we saw a real effect on the supply pipeline. The decision of a shoe company today would need quite a few months before it filters through the system. This is without considering the large buffer stocks which would need to be cleared first.
We are fully aware that this is not a popular discussion and that a lot of people are not willing to consider such scenarios, but one cannot escape the fact that this might be one of the most serious problems we have today. Neither the beef industry nor the tanning business have ever considered such a situation. In the eternal logic of the trade, raw materials only need to be cheaper in order to find more demand. They believed this to be an endless cycle.
In the end, it leads us once again to the same topic we have discussed a number of times; how can we stimulate demand for leather? It is quite simple; if natural growth in consumer demand is not enough, leather must regain its market share. It must become an attractive choice again. It should be noted that, although the situation is bad, leather demand does not need to double or triple.
Contrasting fortunes
The reasons why leather has lost its market share in footwear have been discussed, but the issues facing leather in the upholstery market are different. In our opinion, the tanning and furniture industries have not managed to find a fair compromise between maintenance and care, and beauty and comfort.
With a few exceptions, there is no particular reason why a person should buy a leather sofa. The benefits leather offers may be a factor in heavy-use items like office furniture or items located in a public place, but this is less relevant in a normal living room. Here, the industry is simply looking for large volume and uncomplicated manufacturing. The opening of markets in Asia, especially China, has made it pretty easy to win clients off the back of leather’s good image. There are big numbers, but there is nothing to make customers buy again and so sales stagnated once the massive growth in China came to an end. Manufacturers are only worried about making things more cheaply in order to compete with alternative materials. This has led to flat sales performance in recent years.
In the more creative segments of shoe and bag leather production, there are a number of interesting ideas about how interest in leather can be rebuilt. In general fashion, there are fewer flawless and uniform surfaces and more combinations of material, textile looks and artificial surface design. This actually plays into the hands of leather. It would not be a surprise if some of the big brands decided to opt for the higher comfort and greater durability that leather offers. However, as long as the mass producers among the big brands are unwilling to promote the material and ask their designers to use it, it is going to be a very difficult task.
Amidst all the misery, the luxury industry remains the most positive spark. The leading luxury brands remain loyal to the beauty and image of leather in spite of the anti-beef and anti-leather campaigns. They are still the market leaders and exert real influence, so it would not take much for their success to spill into mass consumption too. All that is needed is someone to trigger it.
Splits and skins
The split market continues to face the same problems as full hides. Niches are still doing well and there is good performance from high-quality suede, but there are serious problems for everything else. We have heard about further rising stocks of lime splits in China and other Asian countries. This is because the import of wet blue split bellies and shoulders is no longer allowed in China, meaning a lot of containers are getting stuck with no immediate alternatives available. There is no imminent solution on the horizon.
There is little news in the skins market. Top quality skins suitable for the luxury market find their customers on demand, fine and dense wool skins have their customers, and new season lambs in Europe also have enough takers. This is because they are only available for a short period of time and are needed for certain specialty productions. The situation remains the same for goat skins. Low grade nappa sheep and lambs are in the same trouble as before.
Rising danger
We are now at the end of April, which means the long spring and summer is still ahead of us. In general, this is the low season of leather production and so it is unlikely there will be any increase in demand.
We are getting closer to a very dangerous junction. As long as the beef industry and hide suppliers are still hoping for the better and don’t panic, the raw material market will not collapse. However, with all the stocks beginning to get stuck, the danger is rising. Fortunately, the beef industry is still in control and several supply pipelines remain intact. The successful companies should enjoy their success, but they should not make the mistake of believing that the situation is okay and that they can avoid the problems.
Leather prices and the raw material markets continue to see negative trends. Prices will continue to decline; the question is by how much. We should not ignore the fact that the price of a number of raw materials is getting very close to the processing cost. This skin segment has already given us a taste of what can happen, with certain low-grade skins still being destroyed rather than being used for leather production.
This could eventually happen to low-grade cattle and similar hides. The minimum price for leather is pretty easy to define – it is the cost of production minus the amount the industry would be willing to pay to get rid of the hides and to cover the processing, transport and administrative charges.
From our position it is impossible to make any predictions. The market conditions are clear and have been explained above. There are plenty of positive options, but they have to be taken. If the tanning industry can work with its customers to find the exit door from the vicious circle, the situation will eventually change. However, it will require discipline and optimism, as well as warehouse facilities and sufficient finance, to keep things in the commodity segment under control.
Share this story:
