Is NetEase (NASDAQ:NTES) A Risky Investment?
Simply Wall St · 09/15 10:38

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. 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.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for NetEase

How Much Debt Does NetEase Carry?

As you can see below, NetEase had CN¥15.8b of debt at June 2023, down from CN¥31.4b a year prior. However, its balance sheet shows it holds CN¥109.8b in cash, so it actually has CN¥94.0b net cash.

NasdaqGS:NTES Debt to Equity History September 15th 2023

A Look At NetEase's Liabilities

The latest balance sheet data shows that NetEase had liabilities of CN¥42.3b due within a year, and liabilities of CN¥7.30b falling due after that. On the other hand, it had cash of CN¥109.8b and CN¥5.34b worth of receivables due within a year. So it can boast CN¥65.5b 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 19% over the last year, further increasing its ability to manage debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. NetEase may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. 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¥94.0b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 127% of that EBIT to free cash flow, bringing in CN¥27b. So we don't think NetEase's use of debt is risky. 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.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.