Stock Analysis

NetEase (NASDAQ:NTES) Could Easily Take On More Debt

NasdaqGS:NTES
Source: Shutterstock

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 should shareholders be worried about its use of debt?

Advertisement

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for NetEase

What Is NetEase's Net Debt?

As you can see below, at the end of December 2021, NetEase had CN¥20.6b of debt, up from CN¥19.5b a year ago. Click the image for more detail. But it also has CN¥97.5b in cash to offset that, meaning it has CN¥76.9b net cash.

debt-equity-history-analysis
NasdaqGS:NTES Debt to Equity History April 13th 2022

How Healthy Is NetEase's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NetEase had liabilities of CN¥50.5b due within 12 months and liabilities of CN¥3.72b due beyond that. Offsetting this, it had CN¥97.5b in cash and CN¥5.51b in receivables that were due within 12 months. So it actually has CN¥48.8b more liquid assets than total liabilities.

This short term liquidity is a sign that NetEase could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, NetEase boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that NetEase grew its EBIT at 13% over the last year, further increasing its ability to manage debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. Over the last three years, NetEase actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case NetEase has CN¥76.9b 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¥22b. So is NetEase's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of NetEase's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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

Discover if NetEase might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

Access Free Analysis

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.