The Leather Pipeline - 30.04.19
30/04/2019
Unfortunately the last two weeks have been dominated by the terror attack in Sri Lanka. Little is really known, just that the usual suspects have claimed responsibility or are being blamed. In the end we can only hope this is not the start of the chain of revenge attacks after the attack in Christchurch in March.
In Paris, the Cathedral of Notre Dame caught fire during renovation works. Plenty of donations have been made and the French government has promised to restore the monument within five years.
In the world of economics we are still dealing with a lot of uncertainty and unclear indicators.
The Chinese economy grew by 6.4% in the first quarter 2019. The number was welcomed as it was slightly better than expected. On the other hand Chinese statistics have always to be questioned and the figures are always too close to the targets (in this case of 6.5%) set by the government for one to have full confidence in them. In the US, GDP grew by 3.2% in the first quarter, which was significantly higher than all the forecasters and analysts had expected. This means that the US economy has actually decoupled from the slowdown which is being seen almost everywhere else.
Global trade shrank by almost 2% in the first quarter of 2019, which is considered to be a serious negative sign for the global economy. Sanctions against Iran, civil war in Libya, unrest in Venezuela, broken transport pipelines in Nigeria and more have helped the oil price to be propelled to levels not seen since October 2018. A barrel of oil reached almost $75 before seeing a moderate correction. The main drivers are the sanctions against Iran and the end of the special permissions for eight countries to import crude oil from Iran. The higher oil price has come at exactly the wrong time and we think that the global economy looks pretty vulnerable.
Europe’s leading economy, Germany, is also facing a lot of uncertainties. Problems in the automotive industry and a massive slowdown in export demand for industrial goods are still being cushioned by a strong domestic demand, building activity, a strong labour market and service sector, but the general concern is that the falling demand for industrial goods could hit back later in the year.
The gold price is not rising because of the political tensions that we see around the globe, but the US dollar is performing exceptionally well and has left the long established trading range against the Euro on the upside. With a different trend of growth in the US and Europe, the likelihood of a further rising spread of interest is driving the dollar up. The safe haven factor in view of the tensions is actually adding to the trend at the moment. For those who are depending on and influenced by currency fluctuations it might be quite important now to check if the dollar is likely to return to the range of $1.12 to $1.14 against the euro. Possibly a new range of around $1.10 or even lower will be established.
Market Intelligence
It is no great pleasure to write about the leather pipeline at the moment. Not that there is no interesting and positive news too, but it is fair to say that the negatives and problems are dominating for the majority of the players. In particular the tanning industry is struggling because, except in the case of a few successful sectors, it is extremely difficult for a tanner to find answers and alternatives to the challenges of the moment.
Being a tanner does not really offer a chance to use your expertise for anything other than producing leather. Those who are part of an integrated production and manufacturing chain have at least a few more options, but as we all know this is a small minority in the leather sector. As an example we can look at the automotive sector where most of the large enterprises have become integrated producers. Producing leather is only about delivering the material for cutting and sewing and actually having the expertise to produce cut and sewn components, or even the manufacturing of seats, leaves the option to focus on this part of the business and to use other materials too. It may be painful, but at least the declining demand for leather is not necessarily completely threatening to your business operation in future.
There are examples also in upholstery and shoe manufacturing, but the general situation is still that tanners buy raw material, convert it into leather and sell it to manufacturers making finished products.
Another extremely successful sector that is also completely integrated is that of luxury bags and accessories. These have become fully integrated in the past decade and produce from rawhide to finished product today. In a way, it is interesting that it is these people who are the most successful players in the field at the moment. Many pundits complain about their activity in tanning. They don’t consider them to be experts, and with the financial resources they have, their tannery management is regarded as being less than exceptionally efficient producing just what the finished product manufacturing division asks for. With such massive margins from their finished products, critics say making leather for these companies is easy.
This may or may not be true, but it is part of the business concept. Those who are complaining should not be jealous and could possibly learn from them. What they have achieved has not come free, but as a result of a long-term strategy of developing added value. What they have been able to do should be an example and possibly even a lesson for others to learn from.
Certainly not everyone can become a luxury brand generating sufficient profit to polish and develop brand value. However, the logic of expanding added value does not only apply in the luxury sector. In particular, with the collapse of raw material costs, there are today plenty of opportunities to distinguish leather from other materials and to create new markets and added value, to turn the temporary margin drama of many into a new success story.
What will certainly not work is for the industry to continue to try to compete on price or to consider this a strategy for the future. We have stated many times before that leather cannot just be considered as a material. It dictates a lot of the cost of manufacturing in the following steps. Anyone who thinks this about a price competition should be extremely worried about the future.
In all our discussions with people across the industry, many complain that we are just delivering theories and don’t understand that what we are preaching is not possible. Well, then you are in the same position as the manufacturer of the telex machine or the fax machine or paper-based photography, just to use some examples.
None of these changes have ever let everyone just convert and survive. Business is never fair and it remains the old story of the survival of the fittest, or in this case the survival of the most creative. We have to deal with the fact that there is now more raw material in the market then there is leather demand. This is certainly not short term and consequently we have to repeat ourselves: either the supply side drops its prices (unlikely), raw material will be destroyed (terrible waste of resources), leather demand is stimulated (possible, but it takes time) or we create new supply chains. We don’t want to go too much into detail, but we have to say that we have had quite a number of very interesting discussions with people who are at least not willing just to surrender and are considering new ideas.
It’s definitely true that not all of these ideas are workable or a guaranteed road to success. Some sound a bit weird, but several have also left an impression. We want to say with the above that it’s too early to give up. Every day more people understand that the old rules will most likely not apply any more; most of them are so busy with day-to-day problems that they don’t have the time to think about what could come next.
We can definitely feel how difficult and demanding the situation is for many. Some have been running companies for a long time and what could be more frustrating than to have the feeling now that their businesses are in danger? If we believe that leather demand and leather production are not going to expand any time soon, it is pretty obvious that there is not room in the market for everyone. A reduction in capacity has never really happened. The consequence is that some manufacturers will have to close. Whether they do this voluntarily are not is a different question.
We can only invite everyone who is related to the leather industry and has a feel for it to take the time and to discuss options. Think differently, talk to people outside the industry. Big changes and big inventions have always been made when people were willing to pass the traditional borders and accept no limits.
At the end of April we are seeing that for the vast majority in the leather pipeline there is pretty negative news. Raw material prices continue to fall because there’s not enough demand from the tanning industry. Suppliers in the beef industry may continue with all kind of stories, but even the notorious optimists have to accept the situation, considering also the season. We see rising raw material availability adding to the stocks that are already around and we are now entering the low manufacturing season, including the summer holidays in the northern hemisphere in July and August. Only a miracle would allow the industry to absorb all the raw material that is going to leave the abattoirs.
The biggest mystery is still the automotive industry. For the first quarter most brands had to acknowledge declining sales versus a year ago. The fascinating part of it is that at least the European premium manufacturers continue to claim that they are going to reach their goals and to meet their targets for 2019 in terms of production, which are mostly set to the levels achieved in 2018. When we consider that car manufacturing and car sales were already down in the second half of 2018, when we read that sales in the first quarter 2019 have been well below the numbers of the previous year then one has really to scratch one’s head and wonder how they are going to achieve this.
Talking to automotive leather manufacturers, they have been telling us since the beginning of the year that they have been advised of rising leather orders for the second quarter. Well, we have already passed more than half of the second quarter and so far we haven’t met or talked to anyone who has had confirmation of these higher orders for the rest of the quarter. Considering that from June the ramp-up of production of new models begins, we find that a bit strange. And actually so do the tanners.
In our very simple logic you would need to see a boom in vehicle manufacturing after the summer holidays to meet the forecasts and confirm the expectations of the car manufacturers. It would need a lot of courage for a chief executive to make predictions in April if they are then not met in December. Production plans in the automotive industry do not allow any kind of large discrepancy between plans and results over a timeframe of eight months.
This still leaves quite a bit of hope for a good recovery because, otherwise, it would really mean that the top management of the car manufacturers had misled the public, investors and stock markets. That would really require a lot of courage and would be sanctioned pretty severely. Even when we consider that the penetration of leather in vehicles is declining, it would still leave quite a bit of upside potential for the rest of the year.
The split market, at least in Europe, is in a pretty strange situation. Due to the situation in the leather industry fewer lime splits are coming to market. For the time being this can still be compensated because the summer is not the busiest time for gelatine and collagen production. However, people are beginning to worry because it’s pretty obvious that sustaining the present level of production will not feed the industry sufficiently. All the stories about problems in the leather industry, the falling demand for hides and the news that certain type of hides are no longer being processed have created some new questions. We would not be surprised to see lime split prices in Europe rise in the second half of the year. A little bit of good news for the tanners.
The skins market continues to remain as fragmented as it has been already for quite a long time. Specialties such as quality double-face, high-quality nappa and specific linings fetch very attractive raw material prices and demand continues to be good. For the average-quality sector the situation is a bit so-so. There were a lot of hopes for the prices for new season lambskins, but on one side the production is still pretty small and on the other the enthusiasm of several suppliers has begun to fade already. People were hoping for skin prices to reach levels above €5 for standard European new season lambs, but so far the tanning industry is not really rushing to follow these ideas. People are being careful because many of them remember that early prices have frequently been the highest.
In Asia we are facing holidays and also most of Europe is going to be closed for a day this week (May 1). Several larger tanners have actually taken several days of extra vacation. Nobody is really making this public, but wherever output can be cut at reasonable cost it is being done. There’s a limit to everything and it seems several companies have decided that the limit has been reached and that further inventory rises should be prevented.
From many sources one can also understand that not only tanners but also abattoirs and hide processors are reducing production. We have not been able to verify any numbers, but several sources are talking about significant stocks of wet blue hides that have built up in various contract tanneries around Europe. Without any extra demand, these can become a burden if most of the wet blue has been made from the extra-heavy bull hides with automotive as the intended destination. For these hides a strong upturn in automotive production and automotive leather demand in the second half of the year is necessary. Low grades will certainly remain a headache, even with better demand.
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