The Leather Pipeline - 30.10.18
30/10/2018
There is no shortage of news and activity in politics and the financial markets.
In Turkey, an opposition journalist was reportedly murdered in the Saudi Arabian embassy, with suggestions that those in power had official knowledge of the operation. Such things have likely happened before, but killing opposition figures has become more common recently. The big difference is that such operations can no longer be hidden so easily. This event could be a serious threat to stability in the Middle East.
In China, growth is slowing. Official statistics still show a 6.5 % rise in GNP, but many pundits monitoring the country have questioned the number and the base on which the growth is built. There is still endless confidence in the government in Beijing, but many pundits are beginning to express worries in relation to the financial risks of the mega projects, as well as with regards to the financial exposure to the numerous state-owned companies which notoriously operate with losses. The trade war with the US is hitting export business and a general slowdown of the global economy would also hit the Chinese economy very hard.
In Europe, the endless Brexit negotiations continue to raise worries. Nothing is set, fixed or properly planned. Companies are making emergency plans and preparations. Industrial supply chains can be managed through temporary inventory management and local stocks, but in the case of almost all food and time-sensitive deliveries, it is becoming obvious that the new customs and import and export operations are without any kind of proper preparation due to the lack of clear decisions for day ‘x’.
The Euro crisis is back, although the financial markets are still not fully reflecting the situation. The budget of the Italian government has been rejected by the European Commission as it does not meet EU agreements. The government in Rome is not willing to respond, and adjusting the budget would create a massive conflict. If Italy does not change its position, sanctions from Brussels are inevitable.
The consequences are unknown. Credit spreads are widening and international ratings companies have begun to react. Considering that the Italian economy is the third largest in Europe and ten-times bigger than Greece, one can imagine what might happen if international investors are not willing to support Italy and international institutions are forced to bail the country out.
As a result of the general slowdown and rising concerns, stock markets tumbled. Many indices lost more than 2% in a week, with analysts predicting further declines to come. There is debate over whether this is simply a correction in a still healthy upward trend or if it is the beginning of a fundamental crisis and the next recession.
Oil prices have come down by an average of $5 per barrel. The outlook of the economy makes us believe that prices could continue to fall, but geopolitical instabilities, particularly in the Middle East, have kept investors’ concerns high and have protected prices.
The gold price got a little boost from the general conditions, but would have expected more than just the 4-5% rise in view of what had happened. The US Dollar continued to gain a little, closing the past two weeks at around 1.14 against the Euro.
Market Intelligence
The fundamental drama continues. If the leather pipeline is unlucky, it will get even worse and spill into the remaining strong-performing sectors.
The general situation in the leather pipeline hasn’t changed. There is no indication of additional interest for the coming season, beyond the basic demand, which is feeding the standard products, brands and manufacturers who are still using leather. We couldn’t trace any return of leather as a base material, nor could we see any signs of coming orders which would have boosted leather or raw material demand. As a result, everything is set for the current production season, which is beginning to get into full swing.
We are most disappointed by the performance of the upholstery sector. Winter is usually when production in this industry is strong and demand is rising. There might be plenty of dark clouds over the global economy, but for the time being most regions are still thriving thanks to positive conditions in the labour market, low interest rates and upbeat consumer sentiment.
The real estate and property markets may have gone passed their peak, but we expected more business and demand than what we have reported this autumn. We should not forget that leather in upholstery has not yet faced the same headwinds as we have seen in the shoe industry. As a result, the slowdown has to be explained by other factors.
We tend to believe that the tariffs and a slowing property market in China have wiped out a good part of the leather demand. A reflection of the situation in leather upholstery came with the news last week of serious financial problems for one of the largest and best-known Italian leather upholstery makers.
In the shoe sector, the decline and substitution of leather can be clearly seen in the shop offerings for this fall and winter. There are a rising number of shoes on the shelves and online which, although nicely described, are no longer made from leather. We are surprised that those who have worn a plastic shoe in very wet and cold conditions do not remember how much better it could be. Let’s see how this winter performs in the northern hemisphere. It is not about the number of shoes being produced and sold, it is the fact that leather is no longer used.
We have been concerned about automotive production for a while, at least in Europe. Car sales have been under pressure. The diesel emissions scandal and the cyclical decline after a long upswing were already enough, but this has been added to by side effects from politics. Last but not least, the budgets and expectations of the industry for 2018 and 2019 might have been too optimistic.
So, it is possibly not just a decline but also a longer-term adjustment to the market realities. The majority of cars are now leased. This offers the industry a little more security about demand for new cars, but is leaves the problem of where to sell the returned cars. In the US, higher interest rates might have a negative effect on pricing and options. Hopes are still there for the emerging markets and for China, but we doubt that the 2019 numbers for sales and production will meet the forecasts.
Fine margins
The last glance goes to the bag and leathergoods market. We will start with the good news. High-end brands continue to report record quarters, sales growth and, with a few exceptions, positive expectations. Despite this, the demand for premium veal skins has faded, especially for the heavier types. We understand the complaints that the hides are too big for cutting and the grain is not as fine as brands want, but if the volume rises, the raw material has to come from somewhere. We cannot find any market or origin which is reporting rising sales and is meeting positive budgets for the 2019 season.
When we get to bag leather and look at the labels selling in the mid-range price segment, we become worried again. Demand for finished products remains strong as middle-income women are still buying labels and remain brand conscious. The labels are obsessed with volume and their focus remains on growth and on expanded margins. The market is highly competitive and you have to preserve your brand image, which means increased marketing costs. To protect or gain market share means occasional aggressive pricing or sales, which squeezes gross margins. As important as their name may appear, the companies are just marketeers and do not care about quality, lifecycle or even second-hand value in order to establish long-term brand value. It is just about sales.
To protect or increase margins, material price and manufacturing costs are in the firing line. Price negotiations are becoming increasingly aggressive. Buyers understand their volume importance. Rough and tough negotiations in business are to be expected, but the price of leather is not calculated by simply adding the cost of the raw material to the manufacturing cost. These buyers want more than that, but are not happy to pay for it.
They are asking their quality suppliers for guarantees of secure waste management, for labour conditions they do not need to worry about, product and production controls, adequate audit conditions, etc. They don’t play fair, however, and blackmail their suppliers by claiming to have been offered cheaper material from other sources. This might be true, but not under the same conditions. It would be fair to say that the price for leather and raw material is being hammered down so much that the preparation of raw material and the production of leather is becoming uneconomical. We have already seen this in the ovine sector. This should not be the target and would not be in anyone’s interest.
Price trends have continued to be down in the past few weeks. The strong performers are also starting to suffer. Premium heavy hides and veal are showing cracks in their armour. Most of the material is produced in Europe, where we are at the beginning of the higher winter kill. This means higher supply is meeting with shrinking demand. If that is not enough, we also have to consider the holidays in Europe and Asia over the next three months.
Splits and skins
We could actually skip the split market section because there have been no changes. General supply exceeds demand, with the exception of the niches. Collagen and gelatine are not compensating. With the decline in prices of hides and the oversupply, there is little room left for splits. They have become a problem of waste management.
The skins market has already done its homework. The shake out of many raw materials has happened and the remaining skins coming to market have mostly found their homes and price levels. They still move according to season, but they cannot get any cheaper. Even premium skins are trading close to average and acceptable levels.
Tough times ahead
The coming weeks will tell us more about the situation in the European automotive sector. We fear that we will see production cuts. Various car brands have already cut shifts, slowed production or stopped for a week here or there. It has been easy to blame things like Brexit, but in November the truth has to come out and serious decisions have to be made.
Things will not get better. Those who have tight and reliable relationships with their clients are lucky. It is hard, if not impossible to find new clients these days. One does not get the impression that leather is going to regain market share at this time. It is important for each company to analyse its own situation and to take the necessary decisions.
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