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.' 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. As with many other companies NetEase, Inc. (NASDAQ:NTES) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Debt?

The image below, which you can click on for greater detail, shows that at September 2022 NetEase had debt of CN¥29.0b, up from CN¥19.6b in one year. However, it does have CN¥116.2b in cash offsetting this, leading to net cash of CN¥87.2b.

How Healthy Is NetEase's Balance Sheet?

The latest balance sheet data shows that NetEase had liabilities of CN¥57.0b due within a year, and liabilities of CN¥6.03b falling due after that. Offsetting this, it had CN¥116.2b in cash and CN¥5.21b in receivables that were due within 12 months. So it actually has CN¥58.4b more liquid assets than total liabilities.

This excess liquidity suggests that NetEase is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble 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 34%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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¥87.2b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 131% of that EBIT to free cash flow, bringing in CN¥24b. The bottom line is that we do not find NetEase's debt levels at all concerning. 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.

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.