The Leather Pipeline - 19.03.19
19/03/2019
After a long period during which there was a lot of financial and political news each week, we have entered a certain type of a break in the past two weeks.
First of all, we have to mention the tragedy in New Zealand. Our thoughts are with all the casualties and their families. Unfortunately, it has become clear that nobody and nowhere is completely safe anymore. The incident in New Zealand, a peaceful, beautiful and tolerant country, shows everyone that there are more important things in life than money and politics.
Turning to less important subjects, we must again mention Brexit, which has begun to feel like a TV series or soap opera. It would be a very entertaining weekly event, were it not so important for the people in the UK and Europe. The most frightening things is that nobody seems to have any idea what the final consequences for daily life will be. Those in favour of Brexit seem to believe it will be business as usual, while those who are concerned about the UK leaving are predicting something catastrophic. One thing we can be sure of is that the politicians will not take responsibility for their actions.
Nothing else of real importance happened. The German economy is slowing down, dragging down the rest of Europe. China’s imports and exports sharply dropped in February. This could be due to the Chinese New Year holidays, but it is certainly proof that things in China are not as bright as they used to be. As one of the main drivers of the global economy, this situation will quickly spread unless it is turned around.
In Europe, the European Central Bank (ECB) has said it will pump more money into the markets to defend against any negative trend. We should have learned by now that low interest rates are no longer enough to push the general economy. In the US, there are some indications of a slower economy, with the labour market only adding a few more jobs.
The financial markets remain pretty relaxed, with stocks only being shaken by individual incidents. The same applies to precious metals. Most impressive is the stability of oil prices in view of general developments around the globe. Most analysts remain focused on supply, which makes means most investors are still happy to invest. It will be interesting to see if any stabilisation in Venezuela brings more supply from that country back into the market.
Market Intelligence
In our last issue, we reported about results and impressions from a trade fair and now yet another one has come and gone. The main players in the leather supply chain met last week in Hong Kong. For more than 30 years, this exhibition has marked the end of the winter season and the end of the busy time of leather production around the globe. Those who consider this to be an important milestone for the summer half come to the show. Many countries have a good number of exhibitors, who feel it is worthwhile to spend money on a booth.
This applied again in 2019 and we understand that leather, chemicals and machinery exhibitors will move up one floor in 2020 as several large chemical companies are looking to return. This means more space is needed. This year, most of the available space was well covered, although we saw areas that were left empty, possibly for design reasons. The aisles were not too wide, which means the space was being used.
Starting with the basics, there is always the question of whether the attendance is good or bad. We don’t think the usual headcount is of any real importance. What is important is what happens on the stands and if productive conversations are held. In a perfect world, new business and possibilities are seriously discussed as well. As far as attendance is concerned, we don’t yet have the statistics, but our general impression is that it was at least as good as in previous years. Let’s not forget about Hong Kong’s famous ‘second shift’ during the night; it is possible more business is discussed in the city’s various bars and restaurants.
Between 10am and 4pm, we saw many people around. Most stands were well attended and staff were busy. Those in the aisles gave the impression they were trying to keep to their schedules rather than taking an easy walk around.
All this means very little. Although APLF is not a fair where leather business and leather orders are really discussed, it is still an important meeting location for those with customers in Asia. For overseas exhibitors, in particular those from Europe, it is also an opportunity to attract new customers and to figure out if their articles and collections are catching the interest of those in the region.
Talking to various tanners from Europe, we got the impression that this was achieved once again. Having said that, it is also true that we are talking about the tanners making specialties or high-quality leathers. None of them were especially disappointed with the number of visitors they received. Despite the negative trend in the industry, this group of leather manufacturers still has the best performance.
Focus on automotive leather
It was quite interesting that several of the large automotive tanners were directly or indirectly represented at the show. Usually, they just pop in for the day because they know their suppliers from around the global are there. This time, it seemed to be different, reflecting the changes we see in the industry.
Things are very different compared to a year ago. It is not that long ago that automotive leather production seemed to be an endless success story, with the volume of automotive leather going from record to record in terms of market share and the entire cake of leather production continuing to rise.
The break came in the second half of 2018 when global car sales suddenly dropped sharply for various reasons. It is not important to discuss why, but the consequence was that the long supply chain in automotive leather and seat production was overloaded. Decisions must be taken to sort this out. Some producers made the subject public and others just reacted. Congestion was created and a massive pushback occurred, from finished product via semi-finished product to raw material. This was a blow to the market because for some time automotive had been compensating for the reductions we had seen in garment and shoe leather.
The system in this industry means that we either produce too much or too little. The situation was already clear long before the supply chain act. As a result, inventories were created, with the response being exaggerated production reductions in an effort to level things out.
The decline in soaking in the past four months has been anywhere between 30% and 50%. Looking at car sales, it would be fair to say they have dropped on average by around 10%. Without a further collapse of car sales, and using the general forecasts for sales, we might come to a balanced reduction of somewhere between 15% and 20%. This seems to reasonably reflect the situation in the global vehicle market. As a consequence, some signs of normalisation in the automotive leather production pipeline cannot be that far away.
Given the long cycle in the automotive industry, what happens in the next six months is not of much interest as most of this time has already been planned for. Far more interesting is what happens next in the industry. What is going to be the position of leather in the interiors of the models that are being designed now and will go into production two or three years from now? Will the rise of alternative fuels and mobility concepts change the demand for leather in cars?
From a manufacturing point of view, leather is definitely not easy. Everyone is aware that car manufacturers would like to eventually get away from leather. They will do so as soon as leather no longer generates the extra margin it has done for so long. The quality and technical specifications that automotive manufacturers have been demanding over the years mean leather is not as attractive to sit on as it used to be.
As with the shoe industry, the automotive sector does not sell leather. They sell their product and it is selling more and with a better margin that is important to them. If it does not offer a commercial advantage, they dump it. Based on the discussions we have had since summer 2018, we believe we are very close to the final decisive junction in terms of what it going to happen with leather in automotive production.
Like in shoes, it will never completely disappear. Leather still makes money and if it continues to meet the expectations of the buyer it still has a strong community of fans which need to be supplied. However, this does not mean it will be used in mass production. Those who have been in the business a little longer will remember that 20 years ago only a small percentage of luxury cars in Europe were actually equipped with leather.
We would not bet that the young generation of vehicle buyers will miss leather in cars if it were replaced by something else. This has nothing to do with the anti-leather and anti-beef campaigns. If the combination of production, usability, maintenance and appearance favours other materials, it could become a tough time for leather in this segment too.
The end of plastic sneakers?
We have spent such a long time on automotive leather as we believe this sector will become the key factor in the overall balance of the leather supply chain. In terms of shoe production, we have already passed the situation. We do not believe there will be a further downward trend in shoe leather production.
The markets continue to be flooded with plastic sneakers of all kinds. There is no shortage as they can be produced quickly and cheaply, as evidenced by all the discounts that can be seen and the massive offer on display. When combined with their shortened lifespans, we cannot see much more growth for them. We would even go as far as to say that the consumer will eventually become a little bored with the same machine-made product. One never knows, but every market gets saturated eventually. We are not predicting the end of the plastic sneaker, but the day is not too far away when shoe companies will need to offer the consumer something different in order to encourage them to purchase more than they need.
We see a similar scenario in the upholstery and garment industries. There is no real need to return to leather unless plastic become the next evil. The use of leather in mass production has reduced so much that the chance of an uptick is much larger than the chance of a further decline.
No raw material recovery
We come now to the business essentials. For most of our readers, the biggest interests are the next market trends and prices. The usual suspects in terms of raw material suppliers were extremely realistic at the exhibition in Hong Kong. It is a tradition in the raw material trade to paint a rosy picture regardless of how bad things are. It is the logic of the seller to be positive and to give the potential buyer the impression that it is better to decide now rather than later.
However, in March 2019 it appears that the reality of the global surplus of raw materials has also reached the producers. Without panicking, the majority of people we spoke with came to Hong Kong to understand what can be done to bring the markets back into balance.
At this point, we must mention that not all segments of the market are entirely out of balance. There are some ‘islands in the sun’, where special types of leather require a special type of raw material. These are the niche and specialty sectors and do not reflect the general situation. For mass production of commodity leathers, the situation is different. There is massive competition between standard raw materials and the excessive low selections coming from more high-ranked leather production. This has created massive stocks of unsold material along the supply chain. They need to be cleared, which means either using them or destroying them.
We have been hoping for a recovery, but the demand for commodity leather articles is again disappointing. There is absolutely nothing on the horizon at the moment. The general downturn in the global economy doesn’t make things any better. There is no light at the end of the tunnel right now for bovine and grain leather use.
We have been surprised to hear a number of people mentioning good order volumes for split leather in China. Not just split leather, but also for lime splits suitable for gelatine and collagen production. There is also strong interest for cheap raw material suitable for garment leather production. We actually saw quite a lot of leather garments at Milan Fashion Week, but where the sudden interest, in particular from India and Pakistan, is coming from remains unclear.
The prices for this kind of raw material are so low that they don’t cover the cost of production and processing. However, you have to sell what you have in stock and you have to take whatever the price is. Only by clearing the unsold material can we pave the way for better times ahead. We will continue to observe and monitor this section.
Challenges to come
Most people left Hong Kong convinced that the markets and prices would soften after the show. This may or may not be the case, but the real question is what will trigger price changes. Most people now realise that even lower prices are not enough to win new customers or drive sales. Existing clients have business they have to cover, but who in April would be prepared to buy more material than they currently need. The days when low prices attracted buyers and triggered new demand and the development of new articles are over, at least for a while.
As a result, official price lists might not change very much. The real prices will be negotiated in private between those who still have a strong customer-supplier relationship and between whom there is mutual respect and need. It is difficult to see there being any surplus business.
We are now entering the summer season in the northern hemisphere and this is not helping either. Beef production now also shifts. While slaughter in Europe will decline and remain low until the autumn, it will remain high and will possible increase further in the US. This will stress the balance for several grades even more. Commodity hides will be available in plentiful supply, while there may even be a shortage of specialty hides of a specific quality for a period of time.
Whatever lies ahead, times will continue to be extremely challenging. After the massive fall of raw material prices since the beginning of 2018, big shifts should only be expected in some isolated segments.
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