Leading the next decade, the new quality productive forces in the dairy industry are accelerating.

On April 26, 2024, China Feihe (06186.HK), a leading infant formula company in China, released its "Environmental, Social, and Governance Report (2023)" (hereinafter referred to as the ESG Report), disclosing its progress over the past year. The report shows that in 2023, China Feihe made significant progress in R&D innovation, quality excellence, green and low-carbon initiatives, employee care, and philanthropy. Among these, the author believes that R&D innovation is the most outstanding part of this report, where we are delighted to see the accelerated formation of new productive forces that will lead the dairy industry in the next decade.

01 Enduring R&D Investment

Food is a necessity in our daily lives, providing us with nutrition and deliciousness. These products subtly influence our health. Outstanding food companies often place great emphasis on R&D, upgrading products through innovation, which not only drives corporate growth but also brings tastier and healthier products to the people.

Infant formula is one of the most technologically advanced categories in the food sector. In recent years, as its market share has risen, Feihe has continuously increased its R&D investment. Figure 1 shows Feihe's annual R&D investment since 2017. In 2017, the company's R&D investment was RMB 14.7 million, which increased by 6.4 times in 2018 to RMB 109 million. From 2018 to 2023, the company's R&D investment grew at a compound annual growth rate of 41%.

Figure 1: Feihe's R&D Expenditure (2017-2023)

We also compared the R&D expenditure ratios of mainstream dairy companies. Table 1 shows that China Feihe ranks first, followed by Sanyuan Dairy.

Table 1: R&D Expenditure Ratios of Mainstream Dairy Companies

Note: Yili, Bright Dairy, and New Hope Dairy have not released their 2023 annual reports; the data used is from 2022.

Where does Feihe's confidence in R&D investment come from? What has this investment brought to Feihe?

Reviewing Feihe's ESG reports in recent years, we found that Feihe's R&D focuses on two critical and challenging areas in the infant formula industry: first, breast milk composition research; second, human brain science research. The former has helped Feihe overtake competitors and become the leader in China's infant formula market, while the latter represents Feihe's new approach in the evolving competitive landscape.

02 "Breast Milk Technology" Achieves Market Leadership

Infant formula is the best substitute for breast milk, which should serve as the "gold standard" for product development. Only by understanding breast milk can we design formula that closely resembles it. In 2009, Feihe undertook the national "863" project to establish a Chinese breast milk database.

Feihe first broke through detection technology, reducing the sample size required for breast milk testing to about one-tenth of the industry standard at the time, significantly improving detection efficiency and breast milk utilization. This technological breakthrough facilitated the in-depth advancement of Feihe's breast milk research.

By the end of 2023, Feihe had tested over 9,800 bioactive components in breast milk, including proteins, lipids, and oligosaccharides, achieving industry-leading diversity in its breast milk database.

Traditional breast milk research treated breast milk as a mixture of nutrients, focusing on the content of various components. Feihe's breast milk research adopts the internationally advanced multi-omics approach in biology, viewing breast milk as a complex biological system and studying its metabolic processes and their impact on infant growth and development.

Since 2020, Feihe has published the first systematic reviews on the dynamic changes of Chinese breast milk proteins and amino acids, the first systematic review on the dynamic changes of Chinese breast milk bioactive proteins, and the first systematic review describing the characteristics of Chinese breast milk fatty acid ratios. Using these findings, researchers have for the first time linked Chinese breast milk component types to infant growth and development characteristics.

The "breakthrough" in breast milk research ultimately enabled Feihe to achieve "better suitability" in its products.

Take its flagship product, Starry Flyer Zhuo Rui, as an example. In October 2020, Feihe published research findings in the official journal of the International Society for the Study of Fatty Acids and Lipids, presenting the first systematic review on the characteristics of Chinese breast milk fatty acid content. The study found that the ratio of DHA/ARA, nutrients crucial for infant brain development, is 1:1.7 in Chinese breast milk. Based on this research, Starry Flyer Zhuo Rui's formula sets the DHA/ARA ratio at 1:1.7, closer to the golden standard of Chinese breast milk, making the product more suitable for Chinese babies.

R&D capability translates into product capability, which ultimately converts into market appeal. Feihe has become the longest-standing leader in China's infant formula market.

According to new data from Frost & Sullivan, Feihe has ranked first in infant formula sales in China for five consecutive years (2019-2023) and first globally for three consecutive years. Its Starry Flyer series has become the world's top-selling infant formula product.

03 Tackling "Hard Bones" for Innovative Solutions

Formula is the "core technology" of infant formula. China's dairy industry has gone through a "golden decade." In the past, Feihe differentiated itself by understanding "breast milk" better, achieving "better suitability" in its formula and winning the favor of consumers.

Represented by Feihe, China's dairy industry has proven a hard truth during the "golden decade": those who take the lead in technological innovation will gain the initiative in development. How to lead the next decade? The answer lies in technological innovation, accelerating the cultivation and formation of new productive forces in the dairy industry, which has become an industry consensus.

Feihe is once again taking the lead: focusing on brain development research and using cutting-edge technology to enhance the hard power of its formula.

Research shows that early-life brain and nervous system development outpaces other systems. The first 1,000 days of life are the "window of opportunity" for brain development, with 85% of brain development completed by age three. Once missed, this development is irreversible.

Numerous clinical studies have confirmed the importance of various nutrients, such as proteins and iron, in brain development. Deficiencies in these nutrients can lead to long-term brain dysfunction.

Therefore, providing adequate and necessary nutrition during infancy, based on the stage-specific characteristics of brain development, is an effective way to comprehensively improve infant health and a challenge that infant formula companies must overcome.

Feihe's 2023 ESG report shows that it has elevated brain development research to its strategic agenda. It has collaborated with Peking University Health Science Center, Harvard Boston Children's Hospital, and Peking University Institute of Neuroscience to advance exploration in brain and cognitive development.

Before announcing its "brain strategy," Feihe conducted extensive foundational research on brain development-related bioactive combinations.

Take Feihe's "Brain Development Nutrient Combination Screening" project as an example. This project screened raw material combinations beneficial for brain structure, neuropsychology, cognition, and intellectual development, directly serving as the scientific basis for formula design. Experiments verified the beneficial effects of bioactive proteins, lipids, functional oligosaccharides, and other active ingredients like choline in promoting brain structure development and neurobehavioral outcomes.

To date, Feihe has applied for 11 national invention patents related to brain development. Relevant technological research results have been translated into products.

From technological innovation to product implementation, it is akin to a leap of faith for a company. However, raising public awareness that "the first 1,000 days of life are the window of opportunity for brain development" is the final "kilometer" Feihe needs to bridge.

Highly developed social media has made information more accessible but also brought challenges: the authenticity of information is hard to verify, and experts are of varying quality.

Feihe collaborates with world-class institutions for scientific exploration and correctly disseminates knowledge on infant development and parenting. The 2023 ESG report shows that Feihe continuously carries out this work through its online platform Xing Ma Hui and offline salons. By sharing scientific videos on infant brain and cognitive development and organizing offline scientific discussions, Feihe builds a science-based supportive community where parents can learn from each other, share experiences, adjust parenting methods effectively, and alleviate feelings of isolation.

Breaking through brain development research, achieving product transformation, and completing public education is a monumental task. But for Feihe, it is a necessary endeavor, as it concerns the fate of individuals, the hopes of families, and the future of the nation.

Once again, Feihe rises to the challenge. The new productive forces leading the dairy industry in the next decade are accelerating their formation. $CHINA FEIHE(6186.HK)