Stock Analysis

We Think NetEase (HKG:9999) Can Manage Its Debt With Ease

SEHK:9999
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that NetEase, Inc. (HKG:9999) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for NetEase

What Is NetEase's Net Debt?

As you can see below, NetEase had CN¥11.0b of debt at September 2024, down from CN¥11.6b a year prior. But on the other hand it also has CN¥124.0b in cash, leading to a CN¥113.0b net cash position.

debt-equity-history-analysis
SEHK:9999 Debt to Equity History January 14th 2025

A Look At NetEase's Liabilities

The latest balance sheet data shows that NetEase had liabilities of CN¥45.7b due within a year, and liabilities of CN¥3.46b falling due after that. Offsetting this, it had CN¥124.0b in cash and CN¥6.17b in receivables that were due within 12 months. So it can boast CN¥81.0b more liquid assets than total liabilities.

This surplus suggests that NetEase is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, NetEase boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that NetEase grew its EBIT by 13% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if NetEase can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While NetEase has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, NetEase actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case NetEase has CN¥113.0b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥36b, being 120% of its EBIT. So we don't think NetEase's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for NetEase you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Valuation is complex, but we're here to simplify it.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.