The Leather Pipeline - 07.08.18
07/08/2018
It is clear that politics and economics have not taken a holiday. President Trump continues to entertain the world. To call it entertainment might be a bit cynical, but what else can one say about somebody who thinks their main duty is to tweet and to try and make the headlines at least a couple of time a day.
We have become used to the trade war with China, the disagreements with the EU and the questions over the role Russia plays in US politics. We know he loves summits and has now invited the Iranian leader, Ayatollah Khomeini, for one. We have also learned that relationships, partnerships and common organisations don’t mean anything to the President of the United States.
In Europe, Brexit is approaching and there has been no real progress in the negotiations. The political and business community is starting to seriously worry about what the end result might be.
Despite the events going on in the world, few seem worried about their impact on the global economy. There are some warning voices, but the headlines are that Apple has become the first trillion-dollar company rather than that the commodity indices have lost 10-30% over the past three months. Despite all the issues, gold is constantly losing value. Despite tensions in the Middle East, oil has retreated from the highs seen in spring.
In many countries, including Venezuela, Turkey, Iran and South Africa, currencies are losing their value and economies are tumbling. Worries are also rising in China and the government is having to take strong action to keep all the economical balls in play. Although the US economy is still producing strong data, it is unclear how solid it really is and how much it would be threatened should trade conflicts escalate.
Due to the large spread of interest rates and the strong performance of the US economy, the US dollar was able to gain further value and ended the period on the high side.
Market Intelligence
The start of August has brought the beginning of the holiday season. Not only in Europe, but also in China and other parts of Asia, business activity is slowing down due to globalisation and supply chains. Consequently, activity along the leather supply chain is subdued. This may be the best time to take a breath ad look at where the industry stands at the moment.
Even the most experienced pundits cannot remember a time when the industry had to deal with so many problems at the same time. We have had problems and we have had the crisis, but those issues were local or regional and there was always a clear light at the end of the tunnel.
This time, the majority of the leather pipeline believed that when we entered the downturn, history would just repeat itself and the same tools, actions and patience would sort it out. The bigger the company, the more they believed in this concept. After almost 18 months of this downward cycle, as far as demand is concerned, everyone now understands that something is profoundly different this time.
Once again, we can exclude some of the smaller, more privileged sectors of the industry. Luxury leathergoods continue to outperform and, despite all the scandals, the demand for premium vehicles has not declined. This is not really a surprise as the growth of the global economy, rising corporate earnings, low interest rates, booming real estate values and strong stock markets have made the rich richer. Not even the decline of the Russian ruble, sanctions or other issues in various parts of the world have stopped the run on expensive consumer goods.
Everyone tends to focus on leathergoods and cars, but we shouldn’t forget about the premium upholstery and interior business, which has also had a good time and has been able to take advantage of the strong property market. All the prestigious villas and apartments that have been built require adequate interior design and furniture, and there have been many.
It was never correct to suggest that the whole industry has been in crisis. What is true is that only a small part is having a good time, while the majority are suffering. The pain is not evenly spread. The biggest issues have been for the tanners that are producing a standard commodity product and that are not part of any stable supply chain to brands and retailers. If they were also located in areas with major environmental and water treatment issues, they found themselves confronted with two of the most problematics issues a tannery can have. This meant production restrictions or a sudden massive rise in the cost of production, in combination with declining or non-existent leather orders. This is a pretty lethal cocktail.
Hard facts
Contrary to many times in history, we do not have a general consumption problem. There is no issue of insufficient demand for finished products; the problem is directly and specifically related to leather as a material. As much as people might talk about the decline of leather shoe consumption, the statistics show that general shoe production rose in 2017. The problem lies with the leather industry, and it is not just in relation to shoe manufacturing. It applies to all products for which leather is a potential material for manufacturing.
Being in August, during the break between the seasons, it might be the time to try to figure out what the future will bring. The hard facts at the moment are simple; leather production is shrinking due to falling demand. This applies to not just standard grain leather, but also to splits, skins, nappa leather and all the other sidelines related to the industry. The use of leather cuttings is another example.
The biggest problem is the boom and bust situation in China, which is making it difficult to analyse the supply and demand balance. If we look at the statistics, we can reliably say that the global supply of raw material has not declined and may even have grown by a few per cent in the past few years. General demand for consumer products has been rising and retail sales are expanding. Leather as a standard manufacturing material has been substituted. All efforts to quantify the situation have been extremely difficult and general statistics do not help much.
Let’s work from assumptions. Reliable data from Europe does not indicate any significant decline in leather output. Any variations are insignificant and are limited to certain sectors. We have rises in production and raw material imports in Thailand, Vietnam and Mexico. The official numbers from the Chinese tanners’ association do not show any significant decline in leather output, which is the opposite of the general industry sentiment after all the interruptions due to pollution controls and the significant decline of raw material purchases so far in 2018.
Without going into any deeper numbers in this issue, let’s focus on China, which by the sheer size of its market and its share of global leather production has the biggest impact on the situation. Raw material imports are down by 20-40%, depending on product and origin. Leather production is shrinking, but not to the same extent. It is also being moderately compensated by increases in production in other countries. This leads to the conclusion that, whatever the data may be, China has absorbed stock and reduced inventory.
This results in a classic market trend. Inventory congestion continually shifts from finished product stock to raw materials and vice versa, depending on the situation in the market. With the hype about growth, the low interest rates and the easy access to finance, it is possible that there was an overstocking of raw and semi-finished material in China up until the first quarter of 2017. At this point, it became clear that general leather demand was not justifying all this stock. Since then, the main ambition has been to reduce stock, which triggered the decline in prices. Shrinking leather demand accelerated this process.
Of course, we have no proof for this theory, but it is true that we are losing raw material supply due to the low price levels we have reached. Renderer hides and hides of very low value (in relation to their collection and processing charges) are no longer being saved and this trend will continue until prices recover. This is curtailing the offer, leaving just the congested stocks that are currently stuck in many places around the globe.
Nothing lasts forever
Hides cannot be stored forever. The longer it takes for prices to recover, the more the material has to be dumped into speculative hands, processed into semi-finished product by its owners, or absorbed by strong hand tanners who see it as a solid investment to purchase raw material below production and replenishment cost. All this means that leather demand will recover eventually. In any case, the raw material market will definitely return to balance. This will either happen due to the increased waste of raw material or due to an increase in demand.
One thing is definitely clear to us; the overstocked pipeline in the Chinese importer, trader and tanner ‘jungle’ and the excess of production capacity has already been significantly corrected. It is not so easy to determine if the excess has already been converted into a shortage, but this should become clear in the next three months.
At the moment, this big market is managed, with the exception of the large industrial groups, by a network of traders, importers and agents connected in WeChat groups. They are still in the ‘it will always be cheaper next week’ mode. They play it hard and offer no mercy to suppliers, but the more they push it down the more they pave the way towards a recovery.
The suppliers with stocks and shortage of cash will not like to hear it, but before it can get better it might get worse, at least for those at the beginning of the supply chain. It could still be a tough ride, but those who believe this one-way street will last forever are wrong. Markets always return to balance eventually, before the next cycle begins. It will not happen at the same time or to the same extent for all types, sectors and origins as the break-even levels are different. Trying to force it is not a good idea.
Without all the current political issues, which are not really a good base for long-term planning, we might have been further along in the process. It is highly probable that the implementation of tariffs will have an influence; if they come, they will hurt some and benefit others. This applies to both raw materials and finished products.
The currency markets in various countries, which play a role in tanning and manufacturing as well as in raw material supply, will also have a strong influence on the market. The summer might be a break time, but one must closely watch the changes in general conditions so as to be prepared for the re-start of the production season in September.
Splits and skins
There are rumours in the split market of trouble getting rid of all the production and by-products. Rising stocks of finished material are starting to become a burden, mirroring the situation in the hide market. As a result, the same logic for the future applies.
The skin market has passed through the European spring and summer hype and the same problems have returned after the failure of the new season lamb speculation. The Chinese have not returned as sustainable buyers and the demand remains focused on the same select items as before. The collapse of the Turkish lira and the problems in the Turkish economy have not helped. It looks like it will be a long, hot summer for skins also.
Brighter prospects
During the holiday season we will have to watch out for the consequences of droughts in some parts of Europe and in Australia. More cattle are being slaughtered due to the lack of feed. This is just adding to the excessive supply of cows and heifers, which could become a problem in 2018 because herds will not be replenished as quickly.
Although it is not directly connected to out general pipeline analysis, it would confirm our long-term outlook; more hides and lower prices in the short term, but the possibility of fundamental change in 2019.
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