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NetEase (NTES US) Company Report Summary

Core Content

This report provides an analysis of NetEase's financial performance for the fourth quarter of 2017 (4Q17) and outlook for the fiscal year 2018 (FY18). The key areas covered include revenue growth, segment performance, earnings, and valuation.

Q4 2017 Highlights

• Total Revenue: RMB14.6bn, 5% above consensus and 21% YoY growth.
• Earnings: Below consensus by 15%, mainly due to increased sales and marketing efforts.
• eCommerce (eC): Strong performance, contributing RMB4.7bn in 4Q17, up 175% YoY and 32% of total revenue.
• Mobile Gaming: Continued weakness, despite recovery in some titles like Onmyoji and WJO.
• Gaming Revenue Recovery: Expected in 1Q18, driven by new titles such as Knives Out, Terminator 2, Forever 7, and Chu Liuxiang.
• Survival Games: Seen as a promising genre with potential to account for 5–7% (base case) or 15–20% (bull case) of NetEase's mobile gaming revenue in FY18.

Main Points

Revenue Growth

• Total Revenue: RMB14.6bn in 4Q17, with FY18E revenue revised up by 13% and FY19E revenue forecasted to grow by 29% YoY.
• Growth Rate: FY18E revenue growth is expected at 31.1%, and FY19E at 29.1%.

Earnings and Margins

• Non-GAAP Net Profit: RMB12,713mn in FY17, with FY18E expected at RMB15,307mn and FY19E at RMB18,589mn.
• Non-GAAP Net Margin: 12.9% in FY17, with a forecast of 21.6% and 20.3% for FY18E and FY19E respectively.
• Operating Margin: 9.8% in FY17, with FY18E at 23.1% and FY19E at 21.6%.
• Gross Margin: 39.3% in 4Q17, declining to 41.0% in FY18E.

eCommerce (eC) Performance

• eC Revenue: RMB4.7bn in 4Q17, up 175% YoY, and is expected to grow by over 100% in FY18.
• GPM (Gross Profit Margin): 7.4% in 4Q17, down from 11.5% in 3Q17 and 12.5% in 4Q16, due to promotions and discounts.
• Valuation Shift: Due to the increasing importance of eC, the valuation method was changed to SOTP (Sum of the Parts).

Key Information

Valuation and Target Price

• Target Price (TP): Raised to US$399, representing a 29% potential upside.
• Valuation Metrics:
  • EV/EBIT for Online Gaming: 14x FY19E
  • EV/EBIT for Advertising Services: 15x FY19E
  • P/S for E-commerce, E-mail, and Others: 0.5x FY19E
• Current Trading: At 14x FY18E EV/EBITDA, which is a discount to Tencent (29x, 700 HK).

Segment Analysis

• eCommerce: Dominates the eC segment with a 32% share of total revenue.
• Advertising Services: Grew 11% YoY to RMB737mn in 4Q17.
• Mobile Games: Weak performance, with revenue at RMB5,399mn in 4Q17.
• PC Games: Revenue at RMB2,807mn in 4Q17, up 11% YoY.
• Online Games Services: Revenue at RMB8,004mn in 4Q17, with a slight decline in QoQ.

Financials

• Non-GAAP Diluted EPADS (USD): Increased to USD17.0 in FY18E.
• ROE (Return on Equity): 24.9% in FY18E, declining from 34.4% in FY16.
• Payout Ratio: Remains stable at 25.0% for FY18E.

Shareholding Structure

• Ding, Lei: 44.3%
• New York Life Investment Management: 6.75%
• Orbis Allan Gray Ltd: 4.16%

Key Research

• The report references previous analyses, highlighting the company's performance and expectations across different quarters.

Summary of Financial Projections

Scenario-Based Valuation

Conclusion

NetEase is expected to maintain its BUY rating due to the potential for strong growth in its eC and gaming segments. The company's early mover advantage in survival games is highlighted, along with the positive outlook for the 2018 game pipeline. Despite current challenges in mobile gaming, the overall outlook remains optimistic.