Huachuang Securities: Optimistic about the leading position of the dairy industry's complete industrial chain advantage, focusing on domestic alternatives and differentiation breakthroughs.

Huachuang Securities released a research report stating that deep processing of dairy products is not simply a replication of production capacity, but a systematic test of three key capabilities including the source of milk, technological research and development, production experience accumulation, and service to B-end channels. It is expected that companies with advantages in the entire industry chain or early market entry will be the first to seize the benefits of domestic production. In terms of specific companies, MENGNIU DAIRY (02319) and Inner Mongolia Yili Industrial Group (600887.SH) have prominent advantages in the entire industry chain, and are expected to catch up rapidly. Shanghai Milkground Food Tech (600882.SH) and Ligao Foods Co., Ltd (300973.SZ) have already taken the lead in the cheese, evaporated cream, and other segmented races, and are expected to achieve differentiation breakthroughs under the wave of domestic substitution. The key points of Huachuang Securities are as follows: Deep processing of dairy products industry: Targeting maximization of output value, various technical challenges for different product categories. Output value perspective: Unit output value can be doubled from raw milk. Deep processing of dairy products involves separating, concentrating, and refining the effective components of raw milk, achieving the core path of upgrading from liquid milk to high value-added end products, and has the dual value of "precise demand" and "maximizing output value." By systematically utilizing main and by-products through deep processing, the overall output value can be increased to 1.5-2.2 times the value of raw milk. Technological perspective: Concentrate on experience for concentrated products, focus on technology for extracted products, and strategically prioritize original cheese production. Deep processing products can be divided into concentrated products (evaporated cream/ butter/ cheese) and extracted products (whey protein/ lactose, etc.), where the former emphasizes experience in production and the latter focuses on technology. In terms of production difficulty, it is expected that evaporated cream/ butter/ reconstituted cheese < concentrated whey protein/ separated whey protein < original cheese/ hydrolyzed whey protein, taking into consideration that the by-product of producing original cheese, whey liquid, is a raw material for high-value components such as whey protein. Therefore, the production of original cheese is also an important step in overcoming the bottleneck of self-production of whey protein. With a potential domestic substitution space of over 40 billion RMB in the deep processing of dairy products, the path to expanding product categories and B-end channels is clear. According to calculations, by 2025, the total market size at the raw material end of deep processing products is expected to reach 61.5 billion RMB, of which evaporated cream/ butter/ cheese/ whey and derivative products are approximately 21.3/ 16/ 9/ 15 billion RMB respectively, with an overall domestication rate of only about 30%, leaving a potential market of over 400 billion RMB for import substitution. Specifically: Product category path: Evaporated cream and butter should be prioritized while original cheese production is essential. In terms of product categories, 1) evaporated cream: large scale and high demand, low production difficulty allows latecomers to catch up through innovation with B-end customers; 2) butter: high demands on milk sources can be enhanced through collaborative sales; 3) cheese: strong category extension implies enormous potential space, Chinese companies have mature production experience for reconstituted cheese, but the high technical requirement for original cheese still relies on imports. Considering the vast potential space and the ability to help overcome manufacturing bottlenecks for whey protein, original cheese production is the key to deep processing in China. 4) Other product categories: Developing products from whey protein, etc., can further enhance the value and integrity of the industry chain. Therefore, the Huachuang Securities believes that for Chinese dairy companies entering into deep processing of dairy products, they should start with evaporated cream and butter, both relatively less technically challenging categories, and intensify the production of original cheese, while also exploring the potential of producing proteins from whey liquid to fully exploit the value of by-products. Channel path: Calculations show that the B-end market for dairy products is at least 80 billion RMB, with clear expansion paths in tea and coffee, Western cuisine, and baking. Rough estimates indicate that by 2025, the B-end dairy market space focused on tea and coffee/ Western cuisine/ baking exceeds 800 billion RMB, with the current market size for instant tea and coffee/ Western cuisine/ baking at 545/ 95/ 177 billion RMB respectively. It is expected that this market will grow at a 13% CAGR to exceed one trillion RMB by 2028. The innovation vitality of downstream products implies potential entry opportunities for upstream suppliers, while the high concentration of downstream markets suggests the possibility of following large customers' rapid increase in order volume. Therefore, the Huachuang Securities believes that Chinese dairy companies should prioritize the expansion of deep processing products to the B-end channels, focusing on industries with high market activity and innovation vitality like instant tea and coffee, expanding the customer base in the Western cuisine channel, and entering the relatively decentralized baking channel through chain stores. The value of the entire dairy industry chain is significant: Strengthening the autonomy and control of the dairy industry, opening up growth space for dairy companies. Industry end: Achieve autonomy and control, smooth out the raw milk cycle. In the short term, deep processing is expected to digest surplus raw milk through new projects (with a capacity of consuming over 5 million tons at full production), thereby promoting supply-demand balance. In the medium to long term, it is important to strengthen the autonomy and control of core deep processing categories, as an effective way to smooth out the fluctuation of raw milk cycles. Company end: Value blue ocean needs to be explored urgently, and consolidated the entire industry chain barriers. The deep processing business aligns with the trend of shifting from "drinking milk" to "eating milk", clear domestic substitution space exceeds 400 billion RMB, and the profit potential of the B-end business is underestimated by the market (with reference to the net profit margin of over 10% in the food service sector of Nestle Greater China). It is a value blue ocean that urgently needs to be explored. At the same time, the three major bottlenecks that have hindered the development of domestic dairy companies are gradually being overcome: first, the continuous decline in milk prices and maintenance of a low position, even falling into a premium against foreign milk prices, providing a golden window for industrial development; second, the improvement in the quality of raw milk is expected to drive up product yield and reduce costs; third, dairy companies are constantly overcoming technical bottlenecks through international cooperation and independent innovation. The deep processing business can strengthen production synergy, contribute to performance enhancement, and constantly consolidate the competitive barriers of dairy companies. Risk warning: Technological progress falls short of expectations; Domestic substitution falls short of expectations; Significant fluctuations in raw milk prices, etc.