Bargains in Emerging Markets (from Smartmoney.com)

As the U.S. struggles to reverse the economic slide, some emerging markets are ahead of the game. The International Monetary Fund projects that while the world’s advanced economies will contract this year, emerging economies will expand by as much as 2.5 percent, and some countries will grow a lot faster. Even better news: Some pros are finding they don’t have to pay a lot to own profitable foreign stocks. The valuations on foreign stocks have become “very, very attractive,” says Uri Landesman, chief equity strategist for asset manager ING Investment Management Americas.

It was only two years ago that investors plowed more than $16 billion into emerging-market mutual funds, trying to find the next big Chinese Internet start-up or Russian coal mine. Unfortunately, like many investing trends, a lot of people piled into emerging-market stocks just as they peaked. Growth did slow around the world, and the stocks tanked. Even with this spring’s market rally, emerging-market stocks, as a group, have lost more than 40 percent since October 2007.
However, many of these nations are not mired in the housing market disasters that plague wealthier countries, and their banking systems are healthier as a consequence. Meanwhile, millions of people in these nations are moving into their middle class. The fortunes of these countries aren’t completely beholden to the health of the U.S. economy, either. China’s economy, for example, is expected to grow at least 5 percent in 2009.
For decades, stocks in China, Chile and other emerging nations traded at a significant discount to their American counterparts. By mid-2007, some were trading at a premium. The market wipeout brought emerging-market valuations closer to their normal discount. Of course, that return to normal cost some investors a lot of money, but the lower prices could give new investors a chance to buy into growing nations at a more reasonable price.
Here are five picks—all of which are listed on U.S. stock exchanges.

China Mobile
More than 160 million mobile phones were purchased in China in 2008, and analysts expect that number to grow another 5 percent this year. That bodes well for Hong Kong-based China Mobile, which has almost 75 percent market share of mobile-phone service in China. It has 470 million subscribers—a throng 50 percent larger than the entire U.S. population. Amazingly, analysts estimate there are still several hundred million Chinese who don’t yet have a mobile phone but eventually could. In the short term, if cash-strapped consumers are forced to choose between a landline and a mobile phone, they usually opt to go wireless, says Phil Kendall, director of the global wireless practice at market research firm Strategy Analytics.

The Chinese government restructured the country’s phone industry last year, allowing its biggest landline company, China Telecom, to join a wireless market formerly occupied by just China Mobile (CHL: 50.74*, +0.06, +0.11%) and China Unicom. But even with the competition, China Mobile’s dominant market position allows the company to negotiate favorable rates with vendors. In 2007 the company launched its own instant-messaging system for its phones, allowing it to keep more revenue than if it used a system made by Microsoft or another firm.

China Mobile’s stock trades at about 11 times 2010’s expected profits, well below its 10-year average price/earnings ratio of more than 24. China Mobile has said the sluggish economy and increased competition will temper its growth this year, but it will still grow. Many analysts remain confident the company will continue to increase revenue and profits steadily over the next several years, global recession or not. In the meantime, the stock has a 3.9 percent dividend yield, so investors are paid to wait for the economy to improve.

HDFC Bank
Many of the senior executives of Mumbai-based HDFC Bank (HDB: 101.20*, -0.83, -0.81%) are native Indians who worked for Citibank and other Western banks outside India. But when they opened their bank in 1995, when there were very few private banks in India, they came home to serve Indian customers. As banks worldwide loaded their balance sheets with exotic, risky mortgages, HDFC stuck with serving India’s burgeoning middle class. About 70 percent of HDFC’s revenue still comes from plain old retail banking, like issuing credit cards and loaning money to small businesses. That has kept it from having to take write-downs that burdened many other banks, says Ferrill Roll, portfolio manager for Harding Loevner, which owns HDFC shares.

HDFC’s toughest competition is from state-owned banks. While HDFC branches offer more efficient service, according to analysts, state-run banks reach much more of India’s 1.1 billion population. In India, government banks carry the perception of increased safety, and consumers worldwide find it annoying to switch banks.

Despite these challenges, HDFC is well positioned to attract new customers. Over the next two decades, the country’s middle class will grow from about 5 percent of the population to more than 40 percent, creating the world’s fifth-largest consumer market, according to McKinsey & Co. Assuming HDFC keeps up its superior customer service, it stands to capture a large share of this new market.

HDFC shares have rallied sharply in recent weeks, so investors might want to wait for a pullback before buying. With a P/E ratio of 21 times next year’s estimated earnings of $590 million, HDFC is not the cheapest bank stock. But analysts expect the bank to increase profits 25 percent in its fiscal 2010 (which started in April) and another 26 percent in fiscal 2011. “It’s one of the best-managed banks in the world,” says Cabot Money Management’s Lutts, who also owns the stock.


Vale
The booming economies of China, India and other emerging nations gave mining firm Vale (VALE: 19.24*, -0.13, -0.67%) years of spectacular profit and revenue growth, solidifying its position as one of Brazil’s largest companies and the world’s largest producer of iron ore. Vale’s main competitive advantage over rivals BHP Billiton of Australia and English firm Rio Tinto is its top-quality, plentiful iron ore deposits, says Tony Robson, cohead of mining research at BMO Capital Markets. China is the biggest market for Vale’s iron ore, accounting for more than 17 percent of the company’s revenue. China’s steel production (iron ore is a primary component of steel) is expected to decline only slightly this year, thanks to the nation’s quick implementation of an infrastructure-focused economic stimulus package, says Jorge Beristain, head of Americas metals and mining research for Deutsche Bank Securities. Vale has expanded its client base in China, adding small and medium-size steel mills to compensate for the reduced demand from the larger mills. Vale CEO Roger Agnelli has said he expects iron ore exports to China to hold steady for the rest of 2009.


Still, the global downturn has forced the Rio de Janeiro–based firm to scale back projects and cancel some others, and the company recently cut its capital spending plans for 200 to $9 billion from $14 billion. Investors have pounded down Vale’s shares over the past year as the price of iron ore has tumbled. Longer term, however, many analysts are confident that Vale will benefit from an economic recovery worldwide. In the meantime, the stock trades at 13 times this year’s expected profits of $8.5 billion.


SQM
It certainly helps any company to have a corner on the market. Half the customers who buy specialty fertilizer from Chile’s Sociedad Química y Minera de Chile (SQM: 36.26*, -0.59, -1.60%) can’t easily substitute anything else for the product, says Brian Chase, head of Southern Cone and Andean Equity Research and Strategy for J.P. Morgan. Crops such as tobacco, wine grapes and blueberries need special fertilizers that only SQM can provide in the region.

Much of SQM’s competitive advantage comes from its access to the Atacama Salt desert in Chile, land rich with nitrates, iodine, potash and lithium, all useful in fertilizer production. Besides having a monopoly on fertilizer in Chile, SQM also claims a 30 percent share of the world’s market for lithium (used in hybrid-car batteries) and 33 percent market share of iodine (used in X-ray dye and LCD televisions). Asia accounted for 15 percent of SQM’s $1.8 billion in revenue last year, and Chase expects that share to rise as China increases its fertilizer imports to help feed its people.

SQM is not immune to the global downturn, of course. Many fertilizer stocks, including SQM’s, fell dramatically in the second half of 2008 as fertilizer prices dropped. Yet demand for the company’s all-organic fertilizer should continue to grow. Farmers need to use organic fertilizer to have their fruits and vegetables certified as organic by the U.S. Department of Agriculture and similar government bodies in other countries. Demand for high-end fertilizer might actually increase in an economic slowdown, as people eat at home more and seek out high-quality ingredients, says Jim O’Leary, manager of the Touchstone International fund.

Analysts predict a modest bump in SQM’s earnings this year over last. In 2008, SQM posted earnings of $501 million, a 179 percent increase over 2007 earnings. Don’t expect such a monster gain this year, but analysts still predict a 14 percent gain in profits. The stock trades at about 22 times estimated earnings of $627 million, about its 10-year average P/E.

CNOOC
As the global economy slowed and the price of oil tanked over the past year, oil companies around the world pulled back on drilling for crude. But that’s not the case with China National Offshore Oil Corp., the giant firm that brings up oil from, you guessed it, the ocean waters off the coast of China. The firm, commonly known as CNOOC (pronounced see-nook) is increasing its capital spending by 19 percent in 2009, to $6.8 billion. The company can sell anything it brings up from the ocean floor. In fact, Hong Kong–based CNOOC (CEO: 141.35*, +0.28, +0.19%) sells oil to its major Chinese rivals because the other two can’t produce enough on their own.

CNOOC is majority-owned by the Chinese government. It teams up with major oil companies that have the expertise to build and operate offshore drilling platforms. When they find oil, CNOOC shares in the profits. When they don’t, the foreign companies bear all the costs.

Don’t expect its profits to be even close to the $6.4 billion in made in 2008, however, because the price of oil has fallen to around $60 from its $147 peak last July. CNOOC has no refining business, so its profits are tied almost exclusively to the price of crude. Still, it cost the company, on average, only about $20 to bring up a barrel of oil from the sea in 2008, Xiao Zongwei, CNOOC’s general manager of investor relations, told SmartMoney. So even if the price of oil resumes its descent, CNOOC should yield fatter profit margins relative to other oil companies, says Steve Cao, comanager of the AIM Developing Markets fund, which also owns the stock.

At nearly 16 times this year’s lower profits, CNOOC is not a steal. But some analysts feel that its growth prospects over the long term should command a premium. China’s fuel needs will only rise as the country’s growing middle class hits the road in its new cars, analysts say.