NetEase (NASDAQ:NTES), a leading Chinese online gaming company announced its Q4 2013 earnings yesterday (Feb 13) after market close. The quarter saw the company launch new games across mobile and PC apart from expansion packs for its leading titles like Heroes of Tang Dynasty, Kung Fu Master, etc. The quarterly result was yet again a testimony to our confidence in the company as it registered growth across topline as well as bottom line.
Netease Q4 2013 performance
Let’s now take a look at the actual numbers as reported in yesterday’s earnings call. The table below shows the company’s growth in comparison to Q4 2012.
|Q4 2012||Q4 2013||YoY Growth|
|Revenue (in millions of $)||373.5||427||14.3%|
|Gross Profit (in millions of $)||258.15||285.31||10.5%|
|Operating Profit (in millions of $)||164.99||178.23||8.0%|
|Net Profit (in millions of $)||161.88||204.34||26.2%|
|Earnings per Share (EPS)||1.23||1.57||27.6%|
The company saw topline growth of 14.3% on a Y/Y basis. However the revenue growth was impacted by a 3% positive forex impact. The growth on a constant currency basis came in at 11% Y/Y. The revenue growth outpaced the growth in profits as the company saw margin compression on account of increased investment activity. The margin contraction becomes clear once we take a look at the profit margins for the two comparable quarters.
|Q4 2012||Q4 2013||YoY Change|
|Gross Profit Margin||69.1%||66.8%||-2.3%|
|Operating Profit Margin||44.2%||41.7%||-2.4%|
|Net Profit Margin||43.3%||47.9%||4.5%|
The gross margin saw a Y/Y contraction of 2.3 percentage points. The contraction in gross margins was on account of tax rule changes made by the Chinese government during 2013. On account of the new taxation rules, online games are now subject to value-added tax in China against the business tax charged earlier.
Moving on to operating margins, the increase in operating expenses was driven by increased stock based compensation and higher research & development expenses (+29% Y/Y). The net effect of increase in operating expenses was a 10 basis point reduction in the operating margins. The combination of gross margin contraction and increase in operating expenses led to a 2.4 % contraction in the operating margins.
While the growth remained strong and well ahead of analyst estimates, the minor contraction is no cause of worry as the company remains extremely healthy at the operating and net profit levels with margins exceeding 40%.
Let’s now look at the company’s cash flows during the quarter and cash position at the end of Q4 2013.
NetEase Cash Analysis
|in millions USD||Q4 2012||Q4 2013||YoY Growth|
|Cash, cash equivalents and investments||2,608.78||3,218.69||23.4%|
|Cash from operations||214.51||268.07||25.0%|
|Free Cash Flow (FCF)||207.92||250.05||20.3%|
The company saw a 25% Y/Y increase in cash flow from operations. The free cash flow margin for the quarter was huge at 58.6%, a 3 percentage improvement over Q4 2012. The healthy cash flows during the quarter helped the company end Q4 with cash and cash equivalents of $3.2 billion, an increase of 23.4% over Q4 2012.
Let’s now take a look at the current valuation multiples of NetEase post the Q4 2013 numbers. The table below represents the company’s valuation multiples based on the closing price of Feb 20.
Netease Valuation Multiples
|LTM earnings per Ads||$5.64|
The company continues to remain at attractive valuations considering its earnings and revenue growth potential as we head into 2014 and beyond.
Actuals v/s Estimates
The company beat analyst estimates on both revenue as well as earnings. The reported quarterly revenue of $427 million was 4.7% higher than the consensus estimate of Streetinsider.com. The earnings surprise was even higher at 10.5%, with reported earnings of $1.57 per ADS against the analyst consensus estimate of $1.42.
The Q4 2013 performance was largely along our expectations as self-developed games and mobile versions gained traction during the quarter. The revenue contribution from the mobile platform will be critical to drive revenues over the coming quarters.
The company has been on our positive watchlist and we continue to hold a positive long term outlook on the company. Considering the strong quarter and the future potential from self-developed games and the attractive current valuations, we reiterate our target price of $89.32, as per our valuation of NetEase. Keep reading for further updates on any of the internet and technology stocks you love.
To see Netease’s latest stock price movement, click here (NASDAQ:NTES)