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Wall Street’s Best Digest Daily Alert

This emerging market stock took off yesterday, after a great earnings beat.

This emerging market stock took off yesterday, after a great earnings beat.

NetEase Inc. (NTES)
From Cabot Emerging Markets Investor

NetEase Inc. (NTES) describes itself as an internet technology company whose online services are “centered around content, community, communication and commerce,” which takes in just about the entire internet. And that’s appropriate for a company that operates one of the major Chinese Web portals that offers all the news, weather, sports, email, messaging and interest groups that such sites offer.

The site is the largest email provider in China and offers NetEase Cloud Music, one of the most popular music apps in China. There are also e-commerce, online payment, commodity trading and other services. But in practical terms, NetEase is an online game company whose results are driven by PC and mobile games.

The company caught the attention of western investors in 2009 when it gained the license from Blizzard Entertainment to exclusive operation of World of Warcraft in China. But while the relationship with Blizzard has expanded to include many other games and updates, the bulk of NetEase’s revenue now comes from Chinese-themed games—like Fantasy Westward Journey—that it has developed all by itself.

NetEase gets game revenue from selling playing time and from selling in-game items that enhance characters’ power and appearance. Online game services contributed $1.6 billion of the company’s $2 billion in net revenue in the first quarter. That game services number was up 72% from Q1 2016 and total revenue was up by 52%. The remainder of revenue came from email, e-commerce and other online services ($357.4 million, up 63% y-o-y) and advertising services ($64.7 million, up 13%). The company has a long history of growing revenue, from the 15% advances in 2012 and 2013 to 26% in 2014, 90% in 2015 and 58% in 2016. After-tax profit margins have topped 30% in eight of the past nine quarters.

In its first-quarter report, NetEase also revealed nearly $6 billion in cash and cash equivalents and raised its dividend to $1.08 per share (up from $1.01 per share in Q4 2016). Also, the company’s share repurchase program was reported to have bought less than $24 million of its up to $1 billion authorization, so there’s plenty of buying power left.

The strength of the company’s numbers prompts the question of why NetEase hasn’t been a routine component of our portfolio. And the answer is that, while the long-term trend for NTES has been clearly upward (from 17 in February 2009, near the end of the Great Recession), the stock has also been quite volatile. Significant pullbacks have occurred in August 2015, the first four months of 2016, November and December 2016 and March and April 2017.

We last bought NTES in June 2016 at 175 and sold at 275 in April 2017 for a substantial profit.

What we like about NTES right now is that the stock had been trading sideways under resistance at 318 since July 13 before today’s push higher. NetEase will report its second-quarter results on August 9 before the market opens, and with a flat base of a few weeks to build on, good news could provide a nice boost.

Analysts are calling for revenue of $1.91 billion and earnings of $3.79 per share. We’re always reluctant to put a major chunk of money into a stock just ahead of earnings, but the stock’s calm action looks like a good opportunity to take a small position. We recommend taking a half position in NTES and will be watching the stock’s action after the August 9 earnings report. BUY A HALF. (WSBI Editor’s note: NTES’ earnings came in at $4.40 vs the $4.05 estimate)

Paul Goodwin, Cabot Emerging Markets Investor,, 978-745-5532, July 27, 2017