NetEase’s (NTES) Old Hits Are Still Doing The Heavy Lifting

NetEase (NTES) reported robust second-quarter results on August 20, driven primarily by its well-established games and services. Net revenue soared to RMB 30.1 billion, a 7.9% increase year-over-year, with the games and related value-added services unit contributing significantly, growing 9.7% to RMB 25 billion. The company's top-line growth was notable, but its profit line was even more impressive, reflecting strong performance in its mature games.

Online games revenue climbed 10% year-over-year to RMB 24.5 billion, largely thanks to time-tested franchises rather than a single blockbuster hit. Noteworthy games included "Sword of Justice," which reached over 10 million active players on the launch day of its anniversary update, pushing concurrent users to a two-year high; "Eggy Party," boasting 700 million registered users and maintaining a monthly active user base above 100 million; and "Youdao," which saw a 48.9% gross margin as its Confucius 4 language model rolled out.

Gross margin in the games segment surged to 76.1% from 70.2% a year prior, largely due to lower revenue-sharing costs, leading to a 17.5% increase in gross profit. Outside China, NetEase's "Where Winds Meet" launched on Xbox in June, maintaining a Steam rating above 87%, while "Marvel Rivals" claimed top seller status in the U.S. and other regions following its summer festival content.

However, the quarter's financial performance was tempered by a drop in non-GAAP net income to RMB 7.7 billion, attributed to investment losses, despite solid revenue, gross profit, and margin growth. Additionally, the company faced execution challenges with "Sea of Remnants," acknowledging difficulties in lowering the learning curve for new players, which negatively impacted the initial player experience.

Other revenue streams, including e-commerce and AI services (Youdao and Cloud Music), contributed a combined RMB 3.5 billion, highlighting the company's reliance on its gaming business. Hedge fund ownership rose from 23 to 33 funds, and short interest remains low at 0.95% of float, signaling confidence among investors. Despite the robust financials, NetEase's stock trades at a forward P/E of 14.16, a moderate valuation for a company posting double-digit growth.

The quarter underscores the company's success in maintaining high margins while investing in its legacy franchises, but it also raises questions about their scalability to new titles like "Sea of Remnants" and "Ananta," given management's admission of onboarding issues. The bullish sentiment is tempered by the belief that other AI stocks may offer greater upside with lower risk.