NetEase Stock Must Overcome Credibility Issues for Q4 Earnings

Chinese companies have suffered a tumultuous period over the trailing year, and (NASDAQ:NTES) is no different. In 2018, NTES stock returned a massive loss of nearly 32%, due in large part to the U.S.-China economic conflict. But with its fourth-quarter fiscal 2018 earnings report just around the corner, will NetEase turn things around?

Technically, the current momentum — or lack thereof — don’t bode well. After trudging forward since hitting a low in September, NetEase stock lost traction earlier this month. Year-to-date, NTES shares are about 2% under parity, which isn’t a great look for management. After all, they’re trying to convince investors that the worst is behind them.

Changes for NetEase

However, recent news involving Amazon (NASDAQ:AMZN) just might shake up NTES stock from its doldrums. For over a decade, Amazon attempted to crack the Chinese retail code but to little success. In 2016, the tech superstar managed to capture less than 1% of the Chinese commerce sector. Nearer-term data suggests things haven’t changed that much.

As a result, industry reports indicate that Amazon will merge its China-based import arm with Kaola, a Chinese shopping platform. NTES owns Kaola, which potentially adds a new wrinkle to NetEase stock.

That’s because NetEase either leverages diversity or suffers from an identity crisis, depending on your perspective. While most folks primarily recognize NTES stock as an investment in Chinese video games, the underlying firm has a rich and storied history.

Initially, NTES owned a successful news portal and email business. Later, it moved to video games and e-commerce via Kaola. At the same time, it’s also operating music and anime-content streaming services, working with and conversely competing against Tencent (OTCMKTS:TCEHY).

Merging with an Amazon-run business offers several synergies. But will investors find NetEase stock too complicated for its own good?

NTES Stock Faces a Credibility Risk

While some analysts may find encouragement with the latest rumors, neither NetEase nor Amazon have confirmed them yet. More importantly, the investing public will likely seek tangible results from NTES stock. Unfortunately, this arena is where the gaming/e-commerce/streaming company has faltered.

For Q4, the consensus estimate for earnings per share calls for $10.20. This is decidedly on the higher end of individual forecasts, which ranges between $6.80 and $12.31. But the general optimism also has a flip-side: the markets expect management to deliver.

In the year-ago quarter, NTES generated an EPS of $9.71, badly missing consensus EPS of $12.47. Upon disclosure, NetEase stock absorbed a sharp decline. It briefly recovered before skidding throughout most of last year.

Since year-over-year EPS expectations fell, NetEase must put some meat on the table. Not doing so could reduce investor confidence in an already-challenging environment.

On the revenue front, Wall Street’s consensus estimate targets $2.9 billion. This forecast rests right in the middle of the spectrum, which ranges from $2.8 billion to $3 billion. In Q4 2017, the company rang up $2.2 billion.

From outside appearances, NetEase should at least easily best the prior-year quarter’s sales haul. But for stakeholders in NTES stock, they have a much higher standard. Between fiscal years 2014 and 2017, revenue growth averaged a whopping 64%. But more than likely in FY 2018, that growth will slow to a relative snail’s pace.

Even if Q4 sales hit the high end of $3 billion, annual growth for 2018 will slip sharply to under 25%. The issue then becomes that the more convoluted NetEase stock has become more expensive. That additional nominal growth has disproportionately decelerated earnings. Therefore, prospective buyers want to see justification for the premium.

Better Options Exist

I don’t want to give the impression that NTES stock is in danger of crumbling. Certainly, its positive fundamentals, such as a rock-solid balance sheet, will keep it in the game.

But tech investors aren’t interested in merely staying in the game: they want to see growth and lots of it. Unfortunately, the data suggests that the robust growth phase for NetEase stock has faded. Now, they’re in a struggle with industry titans like Tencent and Alibaba (NYSE:BABA).

Of course, the Amazon rumor is a sentiment lift for the company. But in order to bolster its e-commerce arm, management must invest significant resources. Currently, NetEase generates most of its revenue from gaming. So to make an effective transition to e-commerce will likely incur serious expenses.

Management could very well pull this off. However, investors have other options which don’t carry such big question marks. Therefore, I’d wait before making any risky moves towards NTES ahead of Q4.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

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