Morningstar likes this 'very undervalued' Chinese gaming stock

Published Fri, Sep 3 20211:29 AM EDT

Regulatory fears may have left Chinese tech stocks battered for much of 2021— but Morningstar says one stock is "very undervalued." Chinese video gaming giant NetEase has seen a lot of volatility in recent months, after several regulatory blows including new rules curbing the number of hours children can spend playing online games to just three hours a week. As of Wednesday's close, the company's Hong Kong-listed stock was up 2.17% for the year, but still more than 25% lower than its February high. "Times have been rough for narrow-moat NetEase, but it's not likely to get much worse," Ivan Su, a senior equity analyst at Morningstar, wrote in a Aug. 31 note. Morningstar raised its price target for NetEase's Hong Kong-listed stock to 217 Hong Kong dollars (about $27.90) — an upgrade from the previous 142 Hong Kong dollars ($18.26). The stock last closed at 148.90 Hong Kong dollars, representing an upside of about 45%. We believe the market has overreacted to recent regulatory risks and overlooked the firm's long-term opportunities overseas. We now consider NetEase very undervalued. senior equity analyst, Morningstar Ivan Su The increased price target came largely due to expectations of higher long-term growth and profitability in the gaming segment for NetEase, Su said. "We believe the market has overreacted to recent regulatory risks and overlooked the firm's long-term opportunities overseas," the analyst said. "We now consider NetEase very undervalued." The recent regulatory changes in China limiting online gaming time for those under 18 are expected to have "negligible impact" on NetEase's long-term earnings, the analyst said, as NetEase disclosed that this age group "contributed to less than 1% of its overall grosses." Opportunities outside China NetEase's operating margin is expected to increase as its core gaming business expands into more profitable overseas markets, Su said, adding that the company currently has less than 1% market share in the gaming market outside of China. Having proved its ability to make high-quality and longstanding mobile games for the Japanese market, NetEase is "well positioned to capitalize on this massive opportunity outside its home," and is expected to achieve moderate success expanding to the U.S. and Europe. "We forecast overseas operations will contribute 30% of game revenue in 2024, a significant increase from the 12% posted in 2020," Su said. He said the current game pipeline for NetEase is "perhaps the strongest it's been for the last few years," citing the