The Leather Pipeline - 16.04.19
16/04/2019
It was not easy to pick some interesting headlines from the past two weeks. This is not because nothing is happening, but because it is difficult to select which events could have an impact on the leather pipeline.
We could start once again with Brexit, which is going into extra time. It would be pointless to get back into the details and try to understand if there is still a reasonable way to solve the problem. One thing can be said for sure: the politicians, who were elected to protect their nations and their people from damage, are definitely not doing their job. In terms of the economics, nothing has changed and the uncertainty remains. This makes commercial decisions difficult, if not impossible.
A number of elections took place without delivering any major surprises or big changes. In Ukraine, a comedian has reached the final round of the presidential elections; many politicians have become comedians so why shouldn’t a comedian become president?
The north of Africa is attracting some attention, with a local warlord taking up against the government in Libya, and ongoing unrest and protests in Algeria. The immediate effect on the global markets was the rising oil price, which is currently driven by political unrest, in particular in Libya and Venezuela. Oil prices have risen by more than 30% since the beginning of the year.
The major institutions continue to be concerned about the global economy. The World Bank and the International Monetary Fund are cutting their forecasts, with many national institutions doing the same. National banks continue to hold interest rates low, while the US Federal Reserve has indicated that it will pause the cycle of rising interest rates.
The US has again been critical of the foreign trading activities of the European Union, this time threatening new tariffs in retaliation for subsidies given to Airbus. Only China reported positive news, with reports of expanded lending and a recovery in the construction industry.
The financial markets continue to resist the global uncertainties. Stocks markets continued to move sideways at high levels, something we have been seeing for a while. Cheap money continues to bolster certain asset classes like stocks and real estate.
In terms of the currency markets, most of the major currencies continue to trade within narrow ranges. From our point of view, the normal private investor has to become more cautious.
The fundamentals no longer match the current market trends. An example is the higher oil prices, which are not really justified based on the basics of supply and demand. If they remain high or rise further, inflation will again become a factor. This could lead to the national banks being caught between stuttering economies and rising prices.
Market Intelligence
In our recent issues we have been mainly dealing with the day-to-day influences of the supply and demand situation along the leather pipeline. We have been discussing the trends in the various sectors, dealing with the campaigns that are influencing the industry, and trying to figure out if we are just within one of the cycles that have always been seen in the raw material trade and leather production.
Generally, we have come to the conclusion that leather demand is declining, a trend that started in 2015 or 2016, while at the same time there is a slowly expanding supply of raw materials. This has had different negative consequences on the various sectors of the industry. It all started in the ovine sector, shifted into bovine and, now, luxury goods is the only one of the larger segments that continues to perform well or is at least stable.
We also believe that the overperforming automotive leather industry may have peaked in 2018. There are strong indications that leather consumption in this sector is going to shrink for two reasons. One is the possible slowdown of vehicle production, which is purely cyclical. The second is the falling penetration of leather in the car interior. This means that this sector has stopped compensating for the shrinking demand from the shoe industry.
We have tried to explain that the use of leather is not greatly influenced by the aggressive anti-leather campaigns, as many promotional organisations would like and the leather industry appears to believe. It is too easy to simply celebrate and blame. The reality is that lower leather consumption is the consequence of business decisions. A consumer of meat and beef is a ready buyer for leather products, if he/she has a reason to do so.
It is too easy to substitute leather for another material and achieve better profits as well as making it easier to manage your production chain. The price of leather would have to be much lower than the price of alternative materials in order to regain market share based purely on margin decisions.
The mass production of leather has been mainly focused on raising cutting yields. The wrong battlefield has been chosen and the chance to gain a final win is now limited. A lot of time has been lost by fighting the ghosts; you can hit them, but you cannot hurt them.
Think about all the investments and efforts the leather industry has made to improve finishing technology, to reach exaggerated targets in terms of tech specification, to comply with environmental legislation, to boost productivity, to gain yield, etc. After all this, they find out they can never catch the carrot hung in front of their nose by the finished product manufacturers. The ‘be cheaper, be better and we will take more’ claims were not true.
Rocky seas ahead
The proof of this theory is that the noticeable drop in raw material prices has not led to any increase in leather demand. We see a lot of raw materials that are now being offered at prices that are lower than the cost of production and processing. Even this has not stimulated demand at all. The hide and skin producing industry in many regions has had to think about reducing losses rather than hoping for revenue. The beef industry in many parts of the world is losing income potential, but the profits generated by beef production allow for zero income to be made from its major by-product.
This seems to be an ongoing trend. We see falling leather production capacity, with some tanneries trying to manage the business with leftover production and others simply shutting down. In China in particular, the production of leather continues to fall, although the official statistics are trying to make us believe the opposite is true.
In the north of China, environmental restrictions are blamed for tanneries having been shut down, but it is actually the erosion of margins that is preventing companies from making the necessary investments. Even the large state-of-the-art operations have already shut down or are seriously thinking about doing so. This fight for the share of a shrinking cake has intensified the rule of ‘the weak goes and the strong stays’. This applies to all steps of the leather pipeline.
The situation has to be evaluated from both a short- and long-term perspective. In the short term, it is quite tough to find anything positive for those already feeling the pain. Automotive is the decisive factor now, with most OEMs predicting a recovery after a slowdown caused by a need to manage stocks. They predict better car sales in the second half of the year, with some even brave enough to predict full-year numbers similar to those from 2018.
This would mean an increase in demand for automotive leather of between 10% and 25%. For those who consider this to be great news and a solution to all the trouble; we have dropped between 10% and 50% since November.
At the same time, we have the seasonal slowdown in leather production. There are already large stocks of raw material and semi-finished leather, while global hide and skin production is still rising. We should prepare for rocky seas ahead in the coming months. The good news is for those who have already prepared their house. The risk of higher raw material cost is rather limited. The bad news is for those already struggling as there is a high risk that the order situation will not improve.
Survival of the fittest
There is one subject on the supply side that we should closely follow in the coming months. African swine fever continues to spread in China, Southeast Asia and even in Europe, where it has not been wiped out. The biggest problem is in China and reliable analysts estimate that pork production is down by 25-35% with no relief in sight.
As a result, Chinese animal protein imports have risen substantially and farmers in other parts of the world are happy to see their returns going up due to strong demand and rising prices. However, importers are not just replacing pork with pork; some of the gap is also being filled by beef and lamb. For some time, we will have to expect the supply of hides and skins to be stable, if not exceeding the forecasts for growth.
To draw a bottom line, there is going to be a rise in the already fierce competition for market and sales. Business rules and the free market do not know any mercy; it will simply be survival of the fittest. In other words, those with additional value to offer beside the price will be the ones who prosper.
This leads us to the long-term view and it means a return to the endless discussions and proposals that have been being made for a while. If leather cannot win the price battle, it will become a fragmented, niche material and will definitely be very successful there. It also means that for an undefined period of time, a certain part of this by-product material has to find an alternative use or be destroyed.
To avoid losing production capacity the industry needs to quickly find something that will offer manufacturers more sales and more profits. Don’t expect the manufacturers and retailers to help you solve the problem.
We will not use this edition to discuss the possible options, because many of them have already been named, but the efforts and investments to win the price battle should really be questioned. The singular strategy to target the consumer does not seem to be the winning road either. Without the manufacturer and retailer smelling sales and the potential for profit, they will limit their use of the material as much as they can. The first step is for leather to be clearly recognised again. As long as it continues to try and be the copy of the copy, it cannot expect higher margins.
Splits and skins
The split market remains difficult in the leather section and unclear in the collagen and gelatine section. There is no change in leather, with niches and cheap suede okay. But, why use it when grains are so cheap? In the gelatine and collage market, things are unclear. In China, cow lime split prices have fallen rapidly after seeing a massive flurry of interest and a jump in prices in February/March. Levels are still high compared to Europe.
In Europe, the reduced soakings during the winter have left their traps and supply is not sufficient. Last but not least, the market in South America, one the largest producing regions, remains depressed. Trade regulations, certificates, transport and market specifications for finished materials prevent a quick adaptation of regional prices from our point of view.
There is also a two-fold market when it comes to skins. Some articles enjoy great support and interest and seasonal production of several skin types has even led to a battle for raw material. Standard and commodity types are still being dumped. The price for specials is really high and in some cases we even see shortages for the coming season. The two markets have completely disconnected. The wool market for coarser types seems to have bottomed and there has been a moderate recovery, which may help the ovine market a little.
Summer struggles
We are entering spring in the Northern Hemisphere. This means higher kills and productions in the US, moderate declines in Europe, and a general fall in leather production all over. Since price is not a determining factor, the sellers of raw materials are playing their cards reasonably well. It doesn’t make any sense to offer volume to the market in public because it will not attract anyone to purchase more. Tanners are just covering what they need and will not take a single hide more.
Those that thought prices would be attractive and were willing to take in raw material have had their fingers burned. The more prices fall, the more this might be right, but, at present, confidence about a recovery in demand and of the market is extremely low. Looking at the seasonal pattern, there is no stimulus on the horizon and the next chance might by at the end of the summer when tanners sometimes try to secure summer quality hides. It looks like it will be a difficult period ahead.
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