Is NetEase (NASDAQ:NTES) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies NetEase, Inc. (NASDAQ:NTES) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for NetEase

What Is NetEase's Debt?

As you can see below, at the end of June 2022, NetEase had CN¥31.4b of debt, up from CN¥27.2b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥111.5b in cash, so it actually has CN¥80.2b net cash.

How Strong Is NetEase's Balance Sheet?

We can see from the most recent balance sheet that NetEase had liabilities of CN¥57.4b falling due within a year, and liabilities of CN¥5.83b due beyond that. Offsetting these obligations, it had cash of CN¥111.5b as well as receivables valued at CN¥5.21b due within 12 months. So it can boast CN¥53.5b more liquid assets than total liabilities.

This excess liquidity suggests that NetEase is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that NetEase has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that NetEase has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, NetEase actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case NetEase has CN¥80.2b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 128% of that EBIT to free cash flow, bringing in CN¥23b. When it comes to NetEase's debt, we sufficiently relaxed that our mind turns to the jacuzzi. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for NetEase that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.