Summary
- Consensus estimates, industry sales figures, and game-specific news are among the major items that one should consider before previewing NTES' Q4 2022 financial performance.
- I view the probability of an earnings miss for NetEase as reasonably high, but I have a favorable view of NTES' appealing valuations and its new games pipeline.
- My rating for NetEase stays as a Hold, following a consideration of NTES' upcoming earnings, the outlook for new games approvals, and its valuation metrics.
Elevator Pitch
I rate NetEase, Inc.'s ( NTES ) [9999:HK] shares as a Hold.
I touched on the recent developments for NTES's core gaming business with my prior update for the stock published on August 16, 2022. My current article is focused on previewing NetEase's financial results for the last quarter of the previous year.
On the negative side of things, below-expectations Q4 2022 earnings could lead to a share price correction for NetEase. On the positive side of things, NTES' 2023 outlook is decent as regulatory headwinds are receding, and its current P/E multiple is below its historical average. Taking into account both positives and negatives relating to NTES, I choose to maintain my Hold rating for the stock.
Fourth Quarter Earnings Release Date For NetEase
NTES will reveal the company's Q4 2022 financial performance in the current week on Thursday, February 23 prior to trading hours as per its earlier February 2 announcement .
The Sell-Side Thinks That NTES Underperformed In Q4 2022
Analysts hold the view that Q4 2022 was a very challenging quarter for NetEase. Specifically, the sell-side expects NetEase to report slower top line growth and a severe bottom line contraction in the final quarter of last year based on consensus financial figures sourced from S&P Capital IQ .
NTES' top line expansion, in RMB terms on a YoY basis, slowed from +23.3% in Q4 2021 to 14.8% for Q1 2022, before moderating further to +12.8% and +10.1% in Q2 2022 and Q3 2022, respectively. The market sees NetEase achieving a mere +4.3% YoY increase in its revenue in local currency terms for Q4 2022. This will be the slowest top line growth for NTES in the past 10 quarters. if the sell-side's financial forecasts are accurate.
More significantly, NetEase's normalized EPS is expected to decrease by -21.2% YoY from RMB9.92 in the fourth quarter of fiscal 2021 to RMB7.82 for the most recent quarter as per the analysts' consensus numbers. Notably, NTES had previously recorded positive YoY bottom line growth for five quarters running between Q3 2021 and Q3 2022.
A Q4 Earnings Miss For NetEase Is Likely In My Opinion
My bet is that the market will be disappointed by NTES' actual financial results for the fourth quarter of 2022.
Firstly, NTES benefited from the success of a game known as "Naraka: Bladepoint" and recorded substantial investment gains in the fourth quarter of 2021. These are one-off positives which are unlikely to be repeated for Q4 2022.
At the company's Q4 2021 earnings briefing , NetEase disclosed that "Naraka: Bladepoint" was a "top seller on Steam’s Best of 2021 games list" and "broke the sales record for buy-to-play games made by Chinese developers." Separately, NTES recognized RMB1.6 billion in investment income relating to mark-to-market gains associated with its listed investments for the last quarter of the prior year.
Secondly, the introduction of the "Harry Potter: Magic Awakened" game in foreign markets will be delayed from Q4 2022 to 2023, as highlighted on the game's social media platform in mid-November 2022.
NTES noted in its Q4 2021 results press release that its Chinese version of the "Harry Potter: Magic Awakened" game secured "a leading position on China's iOS download chart and grossing chart multiple times" after being launched in the country in late-2021. Previously, there were expectations that NetEase could be able to earn meaningful revenue relating to the roll-out of "Harry Potter: Magic Awakened" in overseas markets outside China in Q4 2022.
Thirdly, there seems to be a mismatch between the market's expectations of NetEase's revenue growth and the industry's actual performance.
Total gaming sales in China declined by -10% for full-year 2022 (or an implied -19% YoY drop in Q4 2022). In comparison, the analysts are still predicting that NTES' top line will expand by +10.6% and +4.3% for FY 2022 and Q4 2022, respectively. Although NetEase is one of the leading Chinese gaming companies and also has revenue contribution from other non-gaming businesses, the gap between the consensus top line forecast for NTES and the industry sales numbers still appears to be too wide.
In summary, I think that NetEase's Q4 2022 performance could potentially come in below expectations.
NTES' New Games Pipeline And Valuations
Looking beyond a potential Q4 EPS miss for NetEase, investors should focus on the company's new games pipeline for the current year and the stock's valuations.
As per a recent February 10, 2023 Seeking Alpha News article , NTES was among Chinese firms which secured licenses for new games. According to a South China Morning Post commentary published on February 11, 2023, NetEase obtained five and three new gaming approvals in full-year 2022 and 2023 year-to-date, respectively. The PC version of "Fantasy Westward Journey" was among the new games that obtained regulatory approval, and this is significant because the mobile version was one of the most popular mobile games in China for Q3 2022.
Regulatory headwinds for the Chinese gaming industry have eased to a large degree as evidenced by recent news flow highlighted above. This suggests that NetEase might be able to launch a greater number of games in 2023 than what the market expects.
The positive outlook for NetEase's new games pipeline in the current year hasn't been fully reflected in the stock's valuations. NTES currently trades at a consensus forward next twelve months' normalized P/E multiple of 17.1 times, which is much lower than its five-year mean P/E metric of 21.5 times as per S&P Capital IQ valuation data.
Concluding Thoughts
I continue to award a Hold rating to NetEase. If NTES' Q4 2022 results don't meet the market's expectations as per my prediction, the company's shares might suffer from a pullback. But the downside for NTES' stock shouldn't be very substantial, as the company's valuations are inexpensive and the regulatory environment for the Chinese gaming market appears to be getting better. In my view, a Hold rating for NTES is warranted.
For further details see:
NetEase Preview: What To Consider With Q4 Earnings