2Q26 earnings beat; legacy game titles maintain solid performance

2Q26earnings beat; legacy game titlesmaintain solid performance Target PriceUS$159.50(Previous TPUS$155.00)Up/Downside33.1%Current PriceUS$119.81 NetEasereported 2Q26 financialresults: total revenuegrewby8% YoY toRMB30.1bn, 2.5%ahead of Visible Alpha (VA) consensus estimate thankstothe solid game business performance; operatingincomeincreased by 33% YoYto RMB12.1bn, 17.1% ahead of VA consensusmainly due to the strong GPMexpansion andimprovedoperationalefficiency.Legacygame titles likeWhereWinds Meetcontinue to maintain solid performance with active users reachingnewrecord high,although the launch of Sea of Remnants was belowexpectation and more time is needed for its revenue to ramp up. We lift ourFY26-28E operating profit forecasts by 8-9% given the strong GPM andoperationalefficiencyimprovement. We raise our SOTP-derived target price toUS$159.5 (previous: US$155.0). Maintain BUY on NetEase’s strong gameportfolio and solid earnings growth outlook. China Internet Saiyi HE, CFA(852) 3916 1739hesaiyi@cmbi.com.hk Wentao LU, CFAluwentao@cmbi.com.hk Solidgames revenuegrowth.Games & related VAS revenuewas up by10% YoY toRMB25.0bn in2Q26, 4% ahead of consensus estimate thanksto the strong performance oflegacy titles. Contractliabilitiesrecorded solidgrowth of 14% YoY as of Jun 2026. By products: 1)Where Winds Meetachieved record-high MAUs and healthy YoY revenue growth in 2Q26,thanks to the new content update; 2)Sword of Justice’sconcurrent usersreached a 2-year high after the launch of its majoranniversaryupdate inJune,demonstrating longevity of the game;3)Eggy Party furtherstrengthenedits leadership in party game genre, with registered userssurpassing700mn in June.For Sea of Remnants,managementacknowledgedthe steep learning curve impacted user experience at initiallaunch, butalso sawimproving user feedbacks after content update andrefined operations.Looking ahead, major new game titles includeANANTA(无限大),Tamas: Shadowveil(诡影藏锋),Beneath the Mist(雾海之下) andBlood Message(归唐). Ye TAO, CFA(852) 3850 5226franktao@cmbi.com.hk Shuyin GUO(852) 3916 3716guoshuyin@cmbi.com.hk Stock Data Shareholding Structure Non-gaming businesses maintained steady performance.NetEaseCloudMusic revenuewas largely flattish YoY atRMB1.98bn in2Q26 amidintensifying competitiveenvironment.Youdao revenueincreasedby3.5%YoY to RMB1.47bn in2Q26, mainly attributable to the solid growth oflearnings services. Innovative businessesand othersrevenue dropped by4% YoY toRMB1.64bn in2Q26, mainly due todecreased net revenues fromthee-commercebusiness. Continuousmargin expansion.Overall GPM improved by 5.8pptsYoYto 70.5% in 2Q26, mainly underpinned by thefavourablerevenue mixshiftand channel cost optimization. Total opex to revenue ratio also dropped by1.9pptsYoY to 30.3% in 2Q26, thanks to the enhanced operatingefficiencyandprudent expensescontrol. Overall OPM expanded by 7.7pptsYoY to40.2% in 2Q26. We expect operating income to grow by 33% YoY in FY26E,underpinned by the strong GPM expansion andefficiencyimprovement.Thecompany’s current valuation (13x FY26 non-GAAP PE) offersattractiverisk-reward, in our view. Source: FactSet We usesum-of-the-parts (SOTP) valuation methodology to value NetEase’s four mainbusiness segments. Our SOTP-derived target price is US$159.5, comprising: 1) US$142.0for the online game business (89.0% of total valuation),based on15x 2026EEV/EBIT,on parwith the industry average; 2) US$1.0for Youdao (0.6% of total valuation), based on1.2x 2026E EV/revenue, on parwith the industry average; 3) US$2.2(1.4% of total valuation) for theNetEaseCloud Music business, based on2.0x2026E EV/revenue,on parwith the industry average; 4) US$1.1(0.7% of total valuation) for the innovative businesses and others, based on0.7x2026EEV/revenue, on par with the industry average; 5) US$13.3for net cash. RisksDecline in revenue oflegacy titles; delay in new game launch; tightening regulations. Disclosures& Disclaimers Analyst CertificationThe research analyst who is primary responsible for the content of this research report, in whole or in part, certifiesthat with respect to the securities or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about the subject securities or issuer; and (2)no part of his or her compensation was, is,or will be, directly or indirectly, related to the specific views expressed by that analyst in this report.Besides, the analyst confirms that neither the analyst nor his/her associates (as defined in the code of conduct issued by The Hong Kong Securitiesand Futures Commission) (1) have dealt in or traded in the stock(s) covered in this research report within 30 calendar days prior to thedate of issue of this report; (2) willdeal in or trade in the stock(s) covered in this research report 3 business daysafter the date of issue of this report; (3) serve as an officer of any of the HongKong listed companies covered in this report; and (4)