Is NetEase (NASDAQ:NTES) Using Too Much Debt?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies NetEase, Inc. (NASDAQ:NTES) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for NetEase
What Is NetEase's Debt?
As you can see below, at the end of June 2020, NetEase had CN¥21.4b of debt, up from CN¥13.6b a year ago. Click the image for more detail. However, it does have CN¥96.2b in cash offsetting this, leading to net cash of CN¥74.8b.
How Healthy Is NetEase's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that NetEase had liabilities of CN¥45.2b due within 12 months and liabilities of CN¥1.46b due beyond that. Offsetting this, it had CN¥96.2b in cash and CN¥5.02b in receivables that were due within 12 months. So it can boast CN¥54.5b more liquid assets than total liabilities.
This surplus suggests that NetEase has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that NetEase has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that NetEase has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. 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. Over the last three years, NetEase actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that NetEase has net cash of CN¥74.8b, as well as more liquid assets than liabilities. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in CN¥18b. So we don't think NetEase's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - NetEase has 1 warning sign we think you should be aware of.
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.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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