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NetEase Inc:3Q17-A miss,but hope is alive

时间:2019-09-21 16:45来源:股票升降趋势
Hope of improving outlook outweighs 3Q17 earnings miss. Softness in stock in the next two months could be a buyingopportunity.     3Q17 earnings missed, as we had previewed, but the stock may findbetter neartermsupport than we had worrie

Hope of improving outlook outweighs 3Q17 earnings miss.

Softness in stock in the next two months could be a buying opportunity.

    3Q17 earnings missed, as we had previewed, but the stock may find better neartermsupport than we had worried over. We expect the stock narrative to shifttowards whether 3Q17 marks a trough in sequential momentum or not. Our basecase is to assume a gradual U-shaped recovery through 2018; sharp improvementvia new game in late 2017 could get us, and the stock, more excited earlier. Weremain positive on the stock over the mid-term. Between downside risk to neartermearnings and excitement for new games, we acknowledge the potential fornear-term volatility in the stock; retain Buy.

    We still see a mix of investors cautious and optimistic about NetEase's outlook.

    What was incremental for us from the 3Q17 print.

    Thus, we think a potential 3Q17 earnings miss could prompt another shake outin the stock and help reset expectations. That said, we may be nearing the endof bearish sentiment beyond 3Q17 earnings, especially if NetEase's new gamepipeline unveiling in December is promising. We make earnings adjustments thatlower our target price to US$325 from US$348 but with 20% implied upside, wemaintain our Buy rating.

    1) We had braced for a meaningful decline in deferred revenue, which was broadlyflat QoQ. The implied magnitude of decline for 4Q17 thus may not be as harsh aswe had initially thought. In fact, we see the possibility that 4Q mobile revenue issequentially up, not down, based on the current run-rate. 2) We thought NTES'4Q17 pipeline would have been light, but now note that Tribes & Empires, apromising title that had been delayed since the May announcement, and OnmyojiMOBA are on the roster of scheduled releases. Tribes & Empires is a mobileMMORPG, a genre NTES has historically excelled in, and could bear good results.

    Softness in mobile game driving potential 3Q17 earnings miss.

    3) Start of Minecraft monetization could also brighten 2018 outlook. The bestscenario for NTES is to have a new strong successful title coming out of late 2017,proving meaningful earnings visibility into 2018's outlook. Compared to investorfeedback, our expectation for Wilderness Action or Terminator 2: Judgement Dayis rather light.

    We end the September quarter with our mobile game tracker indicating -20%QoQ (+46% YoY) versus our previous expectation of -12% QoQ, largely as Onmyojicontinued to fade and some softness in other key mobile titles. The cut to revenuecascades down to lower earnings where we revise down our 3Q17 FDEPADS toUS$3.0 from US$3.4 and a further 2017/2018 EPS cut of 4%/7% respectively. Thesoftness in mobile gaming trends is broadly known by the market, based on ourongoing discussion with investors. That said, we bore witness to a sharp stockcorrection after a similar trackable earnings miss in 2Q17 and we are concernedit could happen again during 3Q17 earnings.

    Valuation and key risks.

    Strong e-commerce performance offers some buffer to valuation and stock.

    We update our probability-weighted valuation between bull/base/bear casescenario. In our base case, we assume NTES is able to secure a new #1~#2 title inChina from 2Q18 onward, implying a fair value of US$354. Our bull case assumesNTES can achieve 1.5 successful new games in the #1~#3 category, implying afair value of US$400. Our bear case assumes there are no new growth hereforth,implying US202. We make minor adjustments to our assumption, lifting targetprice by 3%. Key downside risks are deterioration of existing games or the failedlaunch of new ones.

    Management's tone remains strong for e-commerce and we see possibility thatStreet explicitly or implicitly start to give the stock value for it, especially ifreporting transparency improves. For now, our back of the envelope calculationis that the business could be worth US$3bn, or ~9% of current market cap,and provide some modest support to overall valuations. For example, our bearcase scenario analysis involves NetEase weakening to US$216, but with somebuffer from e-commerce, we may see downside support around US$235~US$240. For the time being, the key driver of stock fluctuations resides with thegame business, in our view.

    Valuation and key risk.

    We value NetEase on a probability-weighted earnings taking into considerationthe bull, base, and bear case scenario for 2018. Key downside risk is significantdeterioration of key existing PC and mobile games and/or accelerated decline ingross margins.

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