3 ‘Backdoor’ Emerging-Market Stocks for 2011

Most experienced globetrotters have come across a copy of Rick Steves’ Europe Through the Back Door in one of their travels. Appealing to budget-conscious students and backpackers, the book tells you how to avoid many of the expensive pitfalls of foreign travel and offers cheaper “backdoor” ways to enjoy Europe’s treasures.

I want to do precisely the opposite: I want to recommend that investors use Europe itself as a backdoor way to access the riches of emerging markets. The explosive growth of emerging titans like China, India, Brazil, and Turkey is real. Living standards are quickly rising, and tens of millions of eager consumers join the ranks of the global middle class every year. The problem is that it’s not always easy to access their pocketbooks.

Quite frankly, most investment options are terrible. Consider the case of the popular iShares MSCI Emerging Markets ETF (NYSE: EEM). This fund has an average daily trading volume of 60 million shares, making it one of the most widely traded ETFs on the market.

Unfortunately, it’s also one of the most poorly named ETFs on the market — it’s not really an emerging-market ETF at all. It’s an indirect play on the U.S., Europe and global factors, since most of its components are export-oriented companies, materials companies, and banks. Furthermore, nearly one-fourth of the fund is allocated to South Korea and Taiwan — two countries that are not emerging — they’ve already emerged.

Investors wanting direct exposure can instead buy shares of the EG Shares Emerging Market Consumer ETF (NYSE: ECON), which invests in emerging-market companies that cater to those domestic consumers I mentioned above.

But some of the best bargains now are actually indirect backdoor plays. The lingering sovereign debt crisis has curbed investor enthusiasm for European stocks in general. But with crisis comes opportunity, I’m recommending three dirt-cheap European blue chips that are well-placed to benefit from the continued rise of the emerging-market consumer.

I’ll start with British premium spirits company Diageo PLC (NYSE: DEO). You may have never heard of this company, but I guarantee you’ve heard of its brands. Diageo has the No. 1 premium Scotch whiskey in the world by sales in Johnnie Walker, and the No.1 premium vodka in Smirnoff. In Tanqueray gin, Bailey’s Irish Cream, Jose Cuervo tequila and Guiness Irish stout beer, Diageo enjoys category leadership. Other brands of note include Captain Morgan rum, J&B Scotch whiskey, Crown Royal Canadian whisky, and the high-end Ketel One vodka.

Diageo has excellent exposure to emerging markets, where premium spirits are still a growth industry. In the U.S., Europe, Japan, and Canada, the drinks business is highly profitable, but it’s a mature industry. Consumer tastes are always changing to some extent, and consumers are likely to continue moving upscale.

But the real growth story is in emerging markets, where rising incomes have made premium spirits affordable to millions of new middle-and-upper-class consumers.

Diageo gets a full one-third of its revenue from emerging markets. The past three years of economic turmoil have taken their toll on the American and European desire to celebrate, and sales have been mostly flat in developed markets. In emerging markets, however, the party continues. Sales in the Middle East and North Africa region have grown at a nice 16.3% clip in 2010, followed closely by Latin America at 15.4%. Russia and Africa also posted decent increases at 11.2% and 10.4%, respectively.

Diageo trades at a modest 13 times forward earning and sports a 4% dividend yield. That’s not bad considering growth prospects in the developing world.

Next on the list is Anglo-Dutch consumer products company Unilever PLC (NYSE: UL), which is essentially a European version of the American consumer conglomerate (and Warren Buffett favorite) Procter & Gamble (NYSE:PG). American readers will be most familiar with its condiment brands — including Hellmanns, Wish-Bone and Ragu — and its market-leading Lipton tea. The company also offers popular personal care brands like Axe, Dove, Suave and Vaseline.

Unilever also happens to get half its revenue from emerging markets. In 2011, this number will likely move well above the 50% mark, as growth in these countries should far outpace that of austerity-burdened Europe.

Like Diageo, Unilever is attractively priced at a forward P/E of 14 and a dividend yield of 3.8%. Both companies are also proud members of the Mergent Dividend Achievers Index, meaning that they have a long history of rewarding their shareholders with annual dividend increases. Given the persistence of low bond yields, this would make these two all the more appealing.

I saved my favorite for last — Spanish telecom giant Telefónica (NYSE: TEF). Though the European sovereign debt crisis has been centered on Ireland of late, we see the best values in Spain. By the Financial Times’ estimates, Spain is the only major market in Europe with a P/E lower than 10. Part of this is legitimate worry that Spain is simply too big to bail out like Greece or Ireland and that the country is at high risk of defaulting on its debts.

While I don’t see Spain defaulting, if it did happen, all Spanish stocks would at least temporarily plunge in value, even rock- solid multinationals like Telefónica. The question then becomes at current prices, are we being compensated for this risk? And to this I give an emphatic “yes!”

Telefonica trades at a P/E ratio of 7. Yes, 7. This is one of the finest telecommunications companies in the world and it gets 40% of its revenue from the fast growing markets of Latin America — only 33% comes from Spain itself. It also yields a very impressive 6.2%.

If the European sovereign debt crisis takes another turn for the worse, any or all of these recommendations could take a short-term hit. But given the quality of the companies and the fear already reflected in current prices, the downside would appear to be limited while the upside could be years of market-beating returns.


Article printed from InvestorPlace Media, https://investorplace.com/2010/12/3-backdoor-emerging-market-stocks-for-2011/.

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