NetEase’s 2Q26 operating profit and margin beat expectations, with evergreen-game resilience supporting its defensive value

Overview

This report reviews NetEase’s 2Q26 results and assesses the impact of evergreen games, the new-game pipeline, gaming business margins, and non-operating gains and losses on earnings forecasts and valuation. Nomura believes core operating performance was solid. Although net profit was weighed down by investment losses and a higher tax rate, the resilience of the gaming business, margin improvement, and sustained capital returns continue to make NetEase defensively attractive.

Core views

NetEase’s core operating metrics for 2Q26 were better than expected. Total revenue increased 8% year over year to CNY30.1bn, 3% above Nomura’s forecast; operating profit rose 33% year over year to CNY12.1bn, exceeding Nomura’s forecast and Bloomberg consensus by 12% and 13%, respectively. Most notably, the operating margin increased 7.7 percentage points year over year to 40.2%, 3.1 percentage points above Nomura’s forecast. The report attributes this improvement to broad-based gross-margin expansion across business segments, particularly the strong expansion in the gaming segment’s gross margin, while revenue growth also generated positive operating leverage. Bottom-line performance contrasted with the strength at the operating level. Non-GAAP net profit declined 19% year over year to CNY7.7bn, falling 18% and 24% below Nomura’s forecast and market consensus, respectively. The report believes the main drag came not from core operations but from non-operating items: the effective tax rate rose to 25.5%, significantly above 14.7% in the same period last year and Nomura’s original forecast of 18.0%; the company also recorded nearly CNY3bn in investment losses, which Nomura believes may have been related to mark-to-market adjustments on its holdings in PDD and Alibaba. Deferred revenue declined 11.5% quarter over quarter, reflecting weaker seasonal performance. Core evergreen games continued to demonstrate the durability of their IP and user bases. The PC title FWJ has remained an important driver of revenue and gross margin in recent quarters, but with the classic version reaching its first anniversary, Nomura expects its growth to begin normalizing from 3Q26. Eggy Party’s monthly active users remain above 100mn, while daily active users reached a new high this summer; the report believes the product has gradually evolved into a user-generated-content and light-content platform supported by a highly engaged player base. Performance among new titles has been mixed. Sea of Remnants (SoR) performed below market expectations after launch. Management acknowledged the shortfall and is working to improve the onboarding experience and optimize content for the retained core players; an anticipated near-term version update may re-engage churned players. The subsequent pipeline includes Beneath the Mist, Shadowveil, and ANANTA. Nomura views ANANTA as the most promising project among them. Management stated that development remains on schedule but has not yet provided a specific launch date. The gaming business’s gross margin increased 5.9 percentage points year over year, mainly due to a higher contribution from high-margin PC games, reduced reliance on lower-margin licensed games, and lower channel commissions paid to the iOS and Android app stores. Management indicated that channel optimization would continue, but the resulting incremental margin gains are expected to slow. Accordingly, Nomura expects the gaming gross margin to stabilize at its current level of approximately 76% in the second half of the year. This level remains significantly above that of the same period last year, but suggests that margins may be entering a plateau rather than continuing the rapid sequential expansion seen over the past several quarters. Following the results, Nomura raised its FY26F and FY27F non-GAAP operating profit forecasts by 12% and 10%, respectively, to reflect higher margin assumptions. The FY26F non-GAAP EPS forecast was largely unchanged because the operating profit upgrade was offset by the 2Q investment losses and a higher full-year tax-rate assumption; the full-year tax-rate assumption was raised from 17.0% to 20.0%. FY27F non-GAAP EPS was raised by 5%. On valuation, Nomura reiterates its “Buy” rating and slightly raises its target price from USD155 to USD157. The new target price implies 14.5x FY27F P/E, down from 15.1x previously, reflecting the recent derating in sector valuation multiples; NetEase was trading at 12x FY27F P/E at the time. In the sum-of-the-parts valuation, the online gaming business is valued at USD74bn based on 17x FY27F P/E, while the music business is valued at USD2bn based on its latest market capitalization, resulting in a target price of USD157. The report ultimately concludes that the resilience of the evergreen-game portfolio, together with sustained capital returns, supports NetEase’s appeal as a defensive stock.

Analysis framework

Nomura first compares 2Q26 revenue, operating profit, margins, and non-GAAP net profit with its own forecasts and market consensus, and then separately analyzes operating improvements and non-operating drags such as investment losses and the higher tax rate. The report subsequently explains the future growth and margin trajectory through the performance of evergreen games, the new-game pipeline, and changes in the channel mix, adjusts its FY26F and FY27F earnings forecasts accordingly, and finally derives the target price using a sum-of-the-parts valuation and P/E multiples.

Methodology notes

• Industry/Sector Analysis FrameworkVolume-price decomposition

  Revenue, margin, and business-mix decomposition

  The report decomposes operating profit growth into revenue growth, gross-margin improvement, and operating leverage, and further explains the increase in the gaming gross margin through changes in the contribution from PC games, the share of licensed games, and channel commissions.

• Valuation MethodP/E and PEG Valuation

  FY27F P/E valuation

  The report estimates the value of the online gaming business at 17x FY27F P/E and validates the USD157 target price using an implied overall FY27F P/E of 14.5x; this multiple is below the previous 15.1x to reflect the sector derating.

• Valuation MethodSOTP Valuation

  Combined valuation of the online gaming and music businesses

  The report separately estimates the values of the online gaming and music businesses: USD74bn for the former and USD2bn for the latter based on its latest market capitalization, and then derives NetEase’s USD157 target price.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• NetEase (NTES.US)

  The report believes its evergreen-game portfolio, improvement in gaming margins, and sustained capital returns collectively support its defensive appeal, and reiterates its Buy rating.

  Strengths

  Strong resilience among core evergreen games; Eggy Party has more than 100mn monthly active users; a higher contribution from PC games and channel optimization are driving margin expansion; operating profit significantly exceeded expectations.

  Weaknesses

  Non-GAAP net profit was weighed down by investment losses and a higher tax rate; deferred revenue declined quarter over quarter; SoR’s post-launch performance was below market expectations; room for further rapid margin expansion is becoming limited.

  Comparison

  2Q26 operating profit exceeded Nomura’s forecast and Bloomberg consensus by 12% and 13%, respectively, but non-GAAP net profit fell 18% and 24% below them, respectively; the target price implies 14.5x FY27F P/E, while the stock currently trades at 12x.

  Risks

  Margin contraction in incubation businesses may be greater than expected, and gross billings from evergreen games such as FWJ may fall below expectations.

Key data

• 2Q26 Total RevenueCNY30.1bnUp 8% year over year and 3% above Nomura’s forecast
• 2Q26 Operating ProfitCNY12.1bnUp 33% year over year, 12% above Nomura’s forecast, and 13% above Bloomberg consensus
• 2Q26 Operating Margin40.2%Up 7.7 percentage points year over year and 3.1 percentage points above Nomura’s forecast
• 2Q26 Non-GAAP Net ProfitCNY7.7bnDown 19% year over year, 18% below Nomura’s forecast, and 24% below market consensus
• 2Q26 Effective Tax Rate25.5%14.7% in the same period last year versus Nomura’s original forecast of 18.0%
• Investment LossesNearly CNY3bnNomura believes they may have been related to mark-to-market adjustments on holdings in PDD and Alibaba
• Deferred Revenue-11.5% q-qThe report states that the decline reflects weaker seasonal performance
• Eggy Party Monthly Active UsersOver 100mnDaily active users reached a new high this summer
• Year-over-Year Change in Gaming Gross Margin+5.9pptDriven by a higher contribution from PC games, reduced reliance on licensed games, and lower channel commissions
• Second-Half Gaming Gross-Margin ForecastApproximately 76%Expected to stabilize near the current level as margin improvement enters a plateau
• FY26F Non-GAAP Operating Profit Forecast Revision+12%Reflecting higher margin assumptions
• FY27F Non-GAAP Operating Profit Forecast Revision+10%Reflecting higher margin assumptions
• FY26F Full-Year Tax-Rate Assumption20.0%Previously forecast at 17.0%
• FY27F Non-GAAP EPS Forecast Revision+5%FY26F non-GAAP EPS remains largely unchanged
• Target PriceUSD157Previously USD155
• Target Price-Implied FY27F P/E14.5xPreviously 15.1x; the adjustment reflects the sector derating
• Current FY27F P/E12xCurrent trading valuation stated in the report
• Online Gaming Business ValuationUSD74bnBased on 17x FY27F P/E
• Music Business ValuationUSD2bnBased on the latest market capitalization
• Closing PriceUSD128.17As of 21-Aug-2026

Impact & implications

The report believes the 2Q26 operating beat was driven mainly by relatively sustainable improvements in the gaming mix and operating leverage, while the net-profit miss was caused more by investment losses and a high tax rate. Evergreen games and capital returns support the defensive positioning, but the normalization of FWJ’s growth, the plateauing of gaming margins, and the execution of new titles will determine the extent to which subsequent growth and earnings improvement can continue.

Risks

• Margin contraction in incubation businesses may be greater than expected.
• Gross billings from evergreen games such as FWJ may fall below expectations.

What to watch

• Monitor the extent to which FWJ’s growth normalizes from 3Q26 after the classic version reaches its first anniversary.
• Monitor whether the upcoming Sea of Remnants update can improve the onboarding experience and re-engage churned players.
• Monitor the development progress of Beneath the Mist, Shadowveil, and ANANTA, particularly ANANTA’s as-yet unspecified launch date.
• Monitor whether the gaming gross margin can stabilize at approximately 76% in the second half and whether incremental improvements from channel optimization slow as expected.