Netease vs. Tencent: Which Chinese Stock is a Better Buy?

NetEase, Inc. (NTES) and Tencent Music Entertainment Group (TME) are two prominent entertainment services providers based in China. NTES provides online services focusing on gaming, communication, and commerce internationally. It develops and operates PC and mobile games and offers games licensed by other developers. In comparison, TME operates online music entertainment platforms that provide music streaming, online karaoke, and music-centric live streaming services supported by content offerings, technology, and data. It has a strategic partnership with China Literature.

Growing concerns over the Russia-Ukrainian war make the equity markets volatile for nations having significant exposure to the crisis. China’s less exposure to this conflict is likely to keep its stock markets in better shape in the near term. According to emerging-market veteran Mark Mobius, “it’s a good idea to increase China exposure, given the country is less at risk from the conflict in Europe.” Moreover, the nation’s self-reliant innovation strategy and efforts to ensure improved security and better user experience should enable many Chinese stocks to gain in the future. 

NTES is a winner with 7.7% gains versus TME’s 32.9% loss over the past six months. But which of these stocks is a better pick now? Let’s find out.

Latest Developments

On November 5, 2021, NTES’s NetEase Cloud Classroom, operated by Youdao, Inc. (DAO), announced that it introduced around 100 free-to-use digital training courses offered by Amazon Web Services, an Amazon.com, Inc. company (AMZN). Localized in Simplified Chinese, the AWS courses on NetEase Cloud Classroom cover content on AWS cloud concepts, core services, security, architecture, pricing, support systems, among others. NTES should witness high demand in the coming months.

On May 17, 2021, TME and Sony Corporation’s (SONY) Sony Music Entertainment (SME) announced the multi-year extension of the digital distribution agreement between the two parties. TME will continue to make music from SME available across all its online music platforms in mainland China as well as its live-streaming platforms and WeSing, its online karaoke platform, and make them available on specific designated connected devices in mainland China. As the music industry in China is booming and set to become increasingly important on the international music map, this alliance with SONY will help TME gain expanding reach.

Recent Financial Results

NTES’ net sales for its fiscal 2021 fourth quarter ended December 31, 2021, increased 23.3% year-over-year to $3.83 billion. The company’s gross profit came in at $2.03 billion, indicating a 30.1% year-over-year improvement. Its operating profit came in at $723.12 million, indicating a 53% rise from the prior-year period. NTES’ non-GAAP net income came in at RMB19.76 billion ($3.10 billion) for the quarter, up 34.3% from the prior-year period. Its earnings per ADS increased 499.3% year-over-year to $1.34. As of December 31, 2021, the company had $2.28 billion in cash and cash equivalents.

For its fiscal 2021 third quarter ended September 30, 2021, TME’s revenues increased 3% year-over-year to $1.21 billion. However, the company’s adjusted gross profit came in at $358 million, representing a 6.1% decline from the year-ago period. Its operating profit came in at $143 million, down 27.1% from the prior-year period. TME’s net profit came in at $122 million, indicating a 30.6% year-over-year decline. Its earnings per ADS decreased 34.3% year-over-year at $0.07. The company had $788 million in cash and cash equivalents as of September 30, 2021.

Past and Expected Financial Performance

NTES’ EBITDA and tangible book value have grown at CAGRs of 25.7% and 26%, respectively, over the past three years. The company’s total assets have increased at a CAGR of 22.7% over the past three years.

NTES’ EPS is expected to grow 1.8% year-over-year in the fiscal 2022 first quarter, ending March 31, 2022. Its revenue is expected to grow 16% year-over-year in fiscal 2022.

In comparison, TME’s EBITDA and tangible book value have increased at CAGRs of 8.8% and 20%, respectively, over the past three years. The company’s total assets have grown at a CAGR of 18.7% over the past three years.

Analysts expect TME’s EPS to decline 27.2% from the prior-year period in fiscal 2022 first quarter, ending March 31, 2022. Its revenue is expected to decline 2.8% year-over-year in fiscal 2022.

Valuation

In terms of forward EV/Sales, NTES is currently trading at 3.65x, 153.5% higher than TME’s 1.44x. In terms of forward EV/EBITDA, TME’s 11.34x compares with NTES’ 17.20x.

Profitability

NTES’ trailing-12-month revenue is almost 2.6 times TME’s. NTES is more profitable, with a 53% gross profit margin versus TME’s 31%.

Furthermore, NTES’ ROE, ROA and ROTC of 12.7%, 6.3%, and 7.9% compare with TME’s 7.7%, 3.6%, and 4.3%, respectively.

POWR Ratings

While NTES has an overall A grade, which translates to Strong Buy in our proprietary POWR Ratings system, TME has an overall D grade, equating to a Sell. The POWR Ratings are calculated by considering 118 distinct factors, each weighted to an optimal degree.

Both NTES and TME have a B grade for Value, reflecting their lower-than-industry valuations. NTES has a 1.08x non-GAAP forward PEG, 13.3% lower than the 1.25x industry average. TME’s 1.44x forward EV/Sales is 37.3% higher than the industry average of 2.30x.

NTES has a B grade for Quality, consistent with its higher-than-industry profitability ratios. NTES’ 22% trailing-12-month EBITDA margin is 8.8% higher than the 20.2% industry average. TME’s D grade for Quality is in sync with its lower-than-industry profitability ratios. TME has a 14.4% trailing-12-month EBITDA margin, 28.9% lower than the industry average of 20.2%.

Of the 50 stocks in the China industry, NTES is ranked #1. On the other hand, TME is ranked #15 of 19 stocks in the Entertainment - Media Producers industry.

Beyond what we have stated above, our POWR Ratings system has also rated NTES and TME for Stability, Sentiment, Growth, and Momentum. Get all NTES ratings here. Also, click here to see the additional POWR Ratings for TME.

The Winner

Both NTES and TME should benefit from China’s less exposure to the Russia-Ukrainian conflict and the nation’s efforts to provide an enhanced user experience and boost its domestic production better than its peers. However, higher profitability makes NTES a better buy here.

Our research shows that the odds of success increase if one bets on stocks with an Overall POWR Rating of Buy or Strong Buy. Click here to access the top-rated stocks in the China industry, and here for those in the Entertainment - Media Producers industry.

NTES shares were unchanged in after-hours trading Thursday. Year-to-date, NTES has declined -8.82%, versus a -9.82% rise in the benchmark S&P 500 index during the same period.

Sweta is an investment analyst and journalist with a special interest in finding market inefficiencies. She’s passionate about educating investors, so that they may find success in the stock market.

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