China Securities Co., Ltd.: Signals of a reversal in the raw milk cycle are emerging, as both upstream and downstream industries welcome a window for operational recovery.

China Securities Co., Ltd. released a research report stating that recent spot milk prices have surpassed contract prices, with daily powder fresh milk production decreasing to a two-year low, and milk prices in major production areas slightly rebounding, showing clear signs of a reversal in the raw milk cycle. With continued reduction in upstream production, raw milk output is expected to gradually tighten. The increased demand from downstream processed dairy production indicates a favorable outlook for a moderate rise in raw milk prices, leading to performance elasticity for leading dairy groups, with a recommendation for YOURAN DAIRY (09858). During the period of rising milk prices, midstream dairy companies will enhance their competitiveness in liquid milk, while upstream-related impairments decrease and investment returns increase, positively affecting performance. The main points from China Securities Co., Ltd. are as follows: Clear signs of a reversal in the raw milk cycle Since May, spot milk prices have risen, driven by factors such as foot-and-mouth disease and heat stress, exceeding contract milk prices, with daily fresh milk production reduced to 4,000 tons. After a year of bottoming out, milk prices in major production areas have slightly increased to 3.06 yuan/kg, marking a year-on-year positive growth. As the peak season approaches, the supply and demand for raw milk are trending toward balance, with an optimistic outlook for further price increases during the Mid-Autumn Festival and National Day. Ongoing improvements in supply and demand, leading to a moderate rise in milk prices On the supply side, the proportion of breeding cows and the age structure are aging. Contract milk prices are still below the social full cost, which will drive sustained reductions in breeding cow inventory. Moreover, the high proportion of aging cattle may slow down the increase in per capita production, and raw milk output is expected to gradually tighten in the future. On the demand side, dairy processing will contribute to industry growth, with over 70 planned or under-construction projects since 2025. High growth in B-end demand combined with domestic substitution of high-value raw materials is driving the development of the deep processing industry. With an increase in capacity utilization, about 4 million tons of fresh milk are expected to be consumed in the future. Under the resonance of supply and demand, there is a positive outlook for the sustainability of this round of milk price increases. Given the continuous improvement in the scale of the industry, the deep binding of dairy groups and large dairy enterprises will smooth out the volatility of milk price cycles, supporting a moderate rise in raw milk prices. In the second half of the year, beef supply will tighten, and meat prices are expected to rise more rapidly. In the first half of the year, domestic beef prices saw only slight increases due to accelerated use of import quotas and inventory accumulation by importers. Starting in 2024, the elimination of breeding cows will significantly reduce supply, while the willingness to replenish herds remains weak, leading to a continuous decrease in domestic beef supply. Starting from 2026-2028, the implementation of import beef quota systems will mean that by 2026, the Australian quota will be fully utilized, and over 90% of Brazilian quotas and more than 50% of Argentine quotas will be used. Considering the supply capabilities of other countries, there will be a shortage of import beef quotas beginning in the second half of the year. Looking ahead, domestic supply will become further constrained, with remaining import quotas decreasing as inventory is reduced, leading to expected price increases during peak seasons. Midstream dairy companies: optimistic about the recovery of leading enterprises during the rising milk price period During the price upturn, leading dairy companies will benefit from improved operations, with significant reductions in upstream-related impairments and increased investment returns from dairy joint ventures, resulting in better corporate performance. As spot milk prices rise, the cost-effectiveness of products from small and medium dairy firms decreases. Risk warnings Capacity reduction may fall short of expectations: Currently, the industry consensus on capacity reduction has been reached, and this trend will continue into the second half of the year, with the milk price cycle nearing its bottom. If leading dairy companies reduce capacity slowly, and social farms continue to operate at a loss while waiting for prices to rise, the pace of capacity reduction will slow, further affecting farm performance. Demand may fall short of expectations: Even if there is a major reduction in the dairy industry, if demand remains weak, the reduced downstream demand for raw milk will further delay the turning point for milk prices. Raw material price fluctuations: Raw materials account for over 70% of sales costs, with significant imports of soybean meal, alfalfa, and oat hay, and this years corn prices have rebounded. If raw material prices experience greater fluctuations, it will impact the feeding costs for farms. Risks related to deep processing investment falling short of expectations: As the cheese, cream, and butter industries develop rapidly, numerous entrants, including large dairy companies, are flooding the market, intensifying competition. If malicious price competition arises, it will negatively affect the overall profitability of the industry.