NetEase's second-quarter gaming revenue and gross margin beat expectations; non-operating factors weighed on net profit but did not alter the resilience of the core business

Overview

This report evaluates NetEase's 2Q26 results, major game operating trends, new-title pipeline and valuation. UBS believes that strong core gaming revenue and gross margin performance outweighed pressure from investment losses, a higher tax rate and a limited near-term new-title pipeline. Despite lowering its earnings forecasts and price target, UBS maintains its 12-month Buy rating.

Core views

NetEase's 2Q26 operating performance exceeded market expectations. Revenue increased 8% YoY, 2% above consensus; gaming revenue rose 10% YoY, accelerating further from 7% in the first quarter. Operating profit beat expectations by 14%, mainly due to stronger revenue performance and a higher gaming gross margin. In contrast, adjusted net profit declined 19% YoY to RMB7.7 billion, 21% below consensus, mainly because of investment losses, including those related to holdings in PDD and Alibaba, as well as a higher effective tax rate. Management noted that the tax-rate impact was temporary and related to non-cash items. UBS therefore interprets the quarter as featuring strong core operations but significant drag on reported net profit from non-operating items. Regarding the game portfolio, UBS continues to see resilience in NetEase's evergreen titles. Sea of Remnants had a weak launch, and management believes its innovative gameplay did not sufficiently lower the learning barrier for users during their initial experience. However, early signs of improved user acceptance have emerged following continued content optimization, and management remains positive about its long-term prospects. FWJ PC game gross billings remained solid, and the upcoming mobile version of its free-to-play server is expected to provide an incremental contribution. Justice Mobile and Eggy Party have recently shown recoveries in user momentum and gross billings, while Eggy Party's summer daily active users reached a multi-year high. The title is also evolving into a broader content platform by encouraging third-party creation and building a creator ecosystem, with cumulative revenue sharing paid to third-party creators exceeding RMB200 million. UBS believes these results demonstrate NetEase's mature long-term operating capabilities in extending product life cycles and maintaining user engagement. Gross margin was the primary driver of the quarter's better-than-expected earnings. Lower channel commission rates, a higher share of PC revenue and continued optimization of game operations jointly lifted the gaming gross margin. UBS considers these factors structural and expects the gross margin to remain at its current level, potentially prompting the market to raise its margin expectations. The company also continues to maintain expense discipline. However, because gross margin is already at a high base, further expansion may become more gradual rather than continuing to rise rapidly. Regarding the new-title pipeline, Ananta and Blood Message remain under development as planned, while Beneath the Mist and Tama: Shadowveil have recently entered testing. Management reiterated its strategic focus on high-quality content and gameplay innovation and is using artificial intelligence to accelerate R&D and improve in-game experiences. While evaluating multiple product directions, the company remains prudent in project approvals and resource allocation. The near-term issue is the limited number of new titles, while the FWJ PC game and Where Winds Meet have established high gross-billings comparison bases since the second half of 2025. UBS therefore expects relatively moderate gaming growth in the second half of 2026, with the next major new-game cycle more likely to be concentrated in 2027. For overseas products, Where Winds Meet has maintained stable performance supported by a steady core user base. Marvel Rivals has revived sales and user engagement through the continuous release of seasonal content, live-service updates and community events. These products support NetEase's overseas operations, but the report does not describe them as immediate catalysts sufficient to offset the near-term gap in the new-title cycle. UBS believes the post-results share-price weakness may reflect three concerns: net profit missed expectations because of investment losses; a limited new-title pipeline, high comparison bases and a high gross-margin base imply moderate growth expectations for the second half; and catalysts are lacking over the coming months, while the major new-game cycle may be delayed until 2027. The Quantitative Research Review also assessed the next three months as “No Catalyst” and assigned scores of 3 to the industry structure, regulatory environment, operating trends, next consensus-expectation variance and earnings-risk bias over the next six months, indicating broadly no clear directional change. Although near-term sentiment may remain under pressure, UBS continues to view NetEase as a defensive, undemandingly valued investment opportunity that does not depend on the AI theme, because its evergreen game portfolio and long-term operating capabilities can maintain earnings visibility during periods with fewer new releases. Regarding forecast revisions, UBS reduced its 2026 adjusted net profit forecast by 13% due to the second-quarter net profit miss, weak new-title launches and slower revenue growth in the second half. For diluted earnings per share forecasts, 2026 was reduced 12% from RMB68.35 to RMB59.85; 2027 was reduced 7% from RMB77.86 to RMB72.52; and 2028 was reduced 8% from RMB85.28 to RMB78.14. UBS now forecasts 2026 revenue of RMB119.094 billion, EBIT of RMB49.241 billion and net profit of RMB38.577 billion. The valuation uses a discounted cash flow method with a discount rate, or weighted average cost of capital, of 11%. Following the earnings forecast reductions, the NTES.US price target was lowered from US$176.00 to US$165.00, while the price target for NetEase's Hong Kong-listed shares, 9999.HK, was correspondingly reduced from HK$274.60 to HK$257.40. The US$165.00 price target represents 19 times forecast 2026 P/E, or 17 times excluding investment losses. The report states that the current valuation is approximately 14 times forecast 2026 P/E, or 13 times excluding investment losses. Based on the August 20, 2026 price of US$121.28, forecast price appreciation is 36.0%, forecast dividend yield is 3.3%, and forecast total stock return is 39.4%, which is 28.2 percentage points above the assumed market return of 11.2%.

Analysis framework

UBS first compares actual second-quarter revenue, gaming growth, operating profit and adjusted net profit with YoY figures and market consensus, distinguishing improvements in the core business from non-operating effects such as investment losses and taxes. It then reviews evergreen games, the new-title pipeline, overseas products, gross-margin drivers and expense discipline item by item and adjusts future revenue, profit and earnings-per-share forecasts accordingly. Finally, it calculates the price target using a discounted cash flow method and cross-presents valuation and near-term catalyst conditions using forecast 2026 P/E and a quantitative questionnaire on short-term factors.

Methodology notes

• Valuation methodDCF discounted cash flow

  Discounted cash flow valuation

  This method discounts projected future free cash flows to their present value. UBS uses an 11% weighted average cost of capital as the discount rate and lowered its NTES.US price target to US$165.00 after reducing its earnings and cash flow forecasts.

• Valuation methodPE/PEG valuation

  Forecast P/E comparison

  The report uses the multiple of the share price or price target relative to forecast 2026 earnings to provide additional valuation context: the current valuation is approximately 14 times, or 13 times excluding investment losses; the price target represents 19 times, or 17 times excluding investment losses.

• Industry/sector analysis frameworkVolume-price decomposition

  Decomposition of revenue growth and margin drivers

  The report decomposes the operating profit beat into revenue growth and gaming gross-margin improvement, further attributing the margin improvement to lower channel commissions, a higher share of PC revenue and operational optimization.

• Quantitative/factor/portfolio theory

  Quantitative Research Review short-term factor scoring

  UBS uses a 1-to-5 questionnaire to assess changes in industry, regulatory, operating and earnings expectations over the next six months and separately records whether catalysts exist over the next three months. All categories in this report received a score of 3, and the catalyst assessment was “No Catalyst.”

Asset mapping & comparison

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

• NetEase NTES.US

  The report maintains its 12-month Buy rating and lowers its DCF-based price target from US$176.00 to US$165.00.

  Strengths

  A solid evergreen game portfolio and mature long-term operating capabilities, with lower channel commissions, a higher share of PC revenue and operational optimization supporting gross margin.

  Weaknesses

  Adjusted net profit was weighed down by investment losses and a higher tax rate, the near-term new-title pipeline is limited, and growth in the second half of 2026 faces high comparison bases.

  Comparison

  The current valuation is approximately 14 times forecast 2026 P/E, or 13 times excluding investment losses; the price target represents 19 times, or 17 times excluding investment losses.

  Risks

  New-title performance is uncertain, the core game portfolio is maturing and MMORPGs account for a relatively high share of revenue, while regulatory risks, competitive costs and pressure on cross-border e-commerce margins also exist.

• NetEase 9999.HK

  Following its earnings forecast revisions, UBS lowered the Hong Kong-listed share price target from HK$274.60 to HK$257.40.

  Strengths

  Shares the group's evergreen game portfolio, user operation capabilities and fundamental support from improved gaming gross margin.

  Weaknesses

  Also affected by a limited near-term new-title pipeline, high comparison bases and volatility in non-operating gains and losses.

  Comparison

  The report does not provide a valuation or equity-structure comparison with NTES.US.

  Risks

  The same as NetEase's overall business, including regulatory and product risks, a maturing game portfolio, business concentration and rising costs due to competition.

Key data

• 2Q26 revenue growth+8% YoY2% above market consensus
• 2Q26 gaming revenue growth+10% YoYAbove the first quarter's 7%
• Operating profit versus expectations14% above expectationsDriven by better-than-expected revenue and a higher gaming gross margin
• 2Q26 adjusted net profitRMB7.7 billionDown 19% YoY and 21% below consensus
• Eggy Party creator revenue sharingCumulatively exceeded RMB200 millionReflects progress in third-party creation and creator ecosystem development
• Revision to 2026 adjusted net profit forecastReduced by 13%Reflects the second-quarter net profit miss and slower revenue growth in the second half
• 2026 diluted earnings per share forecastRMB59.85Previously RMB68.35, reduced by 12%
• 2027 diluted earnings per share forecastRMB72.52Previously RMB77.86, reduced by 7%
• 2028 diluted earnings per share forecastRMB78.14Previously RMB85.28, reduced by 8%
• 2026 revenue forecastRMB119.094 billionUBS forecast
• DCF weighted average cost of capital11%Discount-rate assumption for the price target
• NTES.US price targetUS$165.00Reduced from US$176.00
• 9999.HK price targetHK$257.40Reduced from HK$274.60
• Forecast total stock return39.4%Includes 36.0% forecast price appreciation and a 3.3% forecast dividend yield
• Forecast excess return28.2%Relative to the assumed market return of 11.2%

Impact & implications

The report believes the core signal from NetEase's second quarter is structural improvement in gaming revenue and gross margin, rather than the decline in net profit caused by investment losses and a temporary tax-rate impact. Evergreen games and long-term operating capabilities should help maintain earnings visibility during the gap in new releases, but growth in the second half of 2026, near-term market sentiment and valuation recovery may remain constrained by high comparison bases, a limited new-title pipeline and a lack of catalysts. The next major growth validation is more likely to be concentrated in the 2027 new-title cycle.

Risks

• The gaming industry faces regulatory risks and substantial product risk due to the high uncertainty of new-title success.
• Intensifying competition may increase R&D, user-acquisition and operating costs.
• The core game portfolio is gradually maturing, business diversification is limited, and MMORPGs still contribute a relatively high proportion of gaming revenue.
• The cross-border e-commerce business may pressure margins.
• A limited new-title pipeline and high comparison bases may cause gaming revenue growth in the second half of 2026 to fall below expectations.
• Investment losses and changes in the effective tax rate may continue to cause net profit volatility.
• Gross margin is already at a high base, and further improvement may be gradual.
• Major catalysts are lacking over the coming months, and the next major new-game cycle may be delayed until 2027.

What to watch

• Monitor whether content optimization for Sea of Remnants can continue improving user acceptance and long-term performance.
• Track the incremental contribution from the mobile version of FWJ's free-to-play server and the recovery in users and gross billings for Justice Mobile and Eggy Party.
• Observe whether Eggy Party's high summer daily active users can be sustained and monitor the subsequent development of its third-party creator ecosystem and revenue sharing.
• Monitor whether lower channel commissions, a higher share of PC revenue and operational optimization can keep the gaming gross margin at its current level.
• Track the development progress of Ananta and Blood Message and the testing results for Beneath the Mist and Tama: Shadowveil.
• Observe how seasonal content, live-service updates and community events for Where Winds Meet and Marvel Rivals drive overseas sales and engagement.
• Monitor actual progress in gaming growth during the second half of 2026 and the major 2027 new-title cycle.
• Track whether investment gains and losses and the effective tax rate normalize, as well as how the next earnings update compares with consensus expectations.