These 4 Measures Indicate That NetEase (NASDAQ:NTES) Is Using Debt Safely

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. We can see that NetEase, Inc. (NASDAQ:NTES) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for NetEase

What Is NetEase's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 NetEase had CN¥25.9b of debt, an increase on CN¥21.8b, over one year. But on the other hand it also has CN¥102.5b in cash, leading to a CN¥76.6b net cash position.

How Strong Is NetEase's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NetEase had liabilities of CN¥51.8b due within 12 months and liabilities of CN¥5.71b due beyond that. On the other hand, it had cash of CN¥102.5b and CN¥5.28b worth of receivables due within a year. So it can boast CN¥50.3b more liquid assets than total liabilities.

This surplus suggests that NetEase has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that NetEase has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, NetEase grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine NetEase's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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 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¥76.6b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥21b, being 127% of its EBIT. So is NetEase's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in NetEase, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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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.