Analyst Note| Dan Baker |
NetEase’s fourth-quarter result showed strong revenue growth but was overall in line with our expectation. We lift our fair value estimate to USD 88/HKD 137 from USD 82/HKD 127 mainly due to a stronger yuan. The online game segment increased revenue 18% for the full year and 15% for the fourth quarter, supported by existing titles with long operating records, which are the source of our narrow moat rating. Strength in this business is essential, given that it generates around 74% of NetEase’s revenue and we estimate even more of its earnings and cash flow. Much of this cash flow is invested in Internet services, which showed pleasing growth this quarter, although this came at the cost of increased sales and marketing, particularly for Youdao, which lowered NetEase’s consolidated operating profit growth to 1% for the quarter and 5.4% for the year. Despite the slower operating profit growth, operating cash flow grew 49% for the quarter and 47% for the full year. After around a 23% share price increase since the third-quarter result announcement, we now see NetEase shares as slightly overvalued.