Is NetEase a Good Chinese Growth Stock to Buy?

In addition to showing strength in its core online gaming business, NetEase (NTES) has rapidly improved its other business segments. The Chinese company continues to introduce innovative products and to expand in the international markets. As such, we expect the stock to appreciate based on its strong revenue and earnings growth.

NetEase, Inc. (NTES) is primarily a technology company that develops and operates some of China's most popular online PC and mobile games. The company operates through three segments — Online Games Services, Youdao, and Innovative Businesses and Others. In addition to its in-house developed game content, NTES has also partnered with other leading game developers, such as Blizzard Entertainment and Mojang AB. It conducts its businesses in domestic and international markets, including Japan, the United States, Europe, and Southeast Asia.

NetEase’s online game services segment received a big boost during the pandemic, with people spending more time at home and online. However, the company still has plenty of upside, we think, because it has a robust pipeline of games across multiple genres ready for launch.

Moreover, NTES’ net revenues from Youdao increased 159% year-over-year in the last-reported quarter, and net revenues from innovative business and other segments have increased 41.6% year-over-year. The stock has gained more than 45% over the past year.

With a strong performance across all its business segments, coupled with the company’s focus on expanding sustainable growth prospects, the stock is expected to gallop in the coming months and generate healthy ROI for investors. Its impressive performance so far, along with potential upside based on several factors, has helped the stock earn a “Buy” rating in our proprietary rating system.

Here is how our proprietary POWR Ratings system evaluates NTES:

Trade Grade: C

NTES is currently trading slightly above its 50-day and 200-day moving averages of $89.18 and $90.48, respectively. The stock has gained 1.5% over the past month, which does not indicate short-term bullishness.

For the third quarter ended September 30, 020, NTES’ revenue climbed 27.5% year-over-year to $2.7 billion, driven primarily by strong and steady contributions from its online game services, which constituted more than 74% of the total revenue. Its online game services revenue increased 20.2% year-over-year. Gross profit increased 25.6% year-over-year to $1.5 billion, and net income increased 76.4% year-over-year to $441.6 million. Its EPS of $0.82 surpassed the consensus estimate by 110.3%.

On December 17, the company’s NetEase Cloud Music unveiled a new concept, “Music Talent”.  It is designed to support the music talents on the platform who create derivative music content. Youdao’s ‘Youdao Dictionary Pen 3’, which is a new intelligent translator, was unveiled at a product launch event on December 1. And on October 21, the company started selling China's most prestigious liquor brand, Kweichow Moutai, on its e-commerce platform operated by its subsidiary NetEase Yanxuan.

Buy & Hold Grade: B

In terms of proximity to its 52-week high, which is a key factor that our Buy & Hold Grade considers, NTES is well positioned. The stock is currently trading 12.2% below its 52-week high of $103.53, which it hit on August 26th.

The company’s net revenue grew at a CAGR of 10.5% over the past three years, driven by its strong and steady contributions from all its business segments. Also, while EBITDA increased at a CAGR of 5.2% over the past three years, EPS has increased at a CAGR of 2.5% over the same period.

Peer Grade: B

NTES is currently ranked #14 of 115 stocks in the China group. Other popular stocks in the China group are Vipshop Holdings Limited (VIPS), Baidu, Inc. (BIDU), and Alibaba Group Holding Ltd (BABA).

VIPS and BIDU beat NTES, gaining 78% and 54.6%, respectively, over the past year, while BABA returned 26.5% over the same period.

Industry Rank: B

The China group is ranked #36 out of the 123 industries. The companies in this industry are located exclusively in China, and most of their business is conducted in their host country.

Despite the Chinese government’s tightening regulatory controls, companies in the China group are expected to do well when Joe Biden becomes U.S. president on January 20, 2021. This is because the Biden administration is expected to return a degree of predictability and a level of normalcy to the U.S.’ foreign policy. Moreover, China’s impressive economic growth should drive the performance of the companies in this group.

Overall POWR Rating: B (Buy)

NTES is rated “Buy” due to its long-term bullishness, solid growth prospects, and underlying industry strength, as determined by the four components of our overall POWR Rating.

Bottom Line

NTES has the potential to gain in the coming months despite climbing more than 45% over the past year. This potential is based on its continued business growth, favorable earnings and revenue outlook, and strong financials. With its constant product innovations and expansion into international markets, the stock has the potential to generate big returns soon.

The consensus revenue estimate of $13.29 billion for the next year represents an 18.2% increase year-over-year. Its EPS is expected to grow at 14.9% next year. Moreover, NTES has an impressive earnings surprise history, with the company beating consensus EPS estimates in each of the trailing four quarters. This outlook should keep NTES’ price momentum alive in the near future.

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NTES shares were trading at $93.79 per share on Friday morning, up $2.90 (+3.19%). Year-to-date, NTES has gained 54.26%, versus a 16.20% rise in the benchmark S&P 500 index during the same period.

About the Author: Manisha Chatterjee

Since she was young, Manisha has had a strong interest in the stock market. She majored in Economics in college and has a passion for writing, which has led to her career as a research analyst.


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