Four Dividend Plays in Emerging Markets

02/12/2010 9:34 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Just the idea of emerging market dividend stocks might seem strange to you. But they can indeed be found in the growing markets of China, the Philippines, Indonesia, and elsewhere.

When emerging stock markets hand you lemons, make lemonade.

Specifically, dividend-paying lemonade.

So far, 2010 hasn't exactly been kind to emerging market stocks. An index-tracking exchange traded fund, iShares MSCI Emerging Markets Index (NYSE: EEM), declined 6.4% from December 31 through February 8.

Individual emerging market ETFs did even worse. The iShares MSCI Brazil Index ETF (NYSE: EWZ) dropped 15.8% over the same period. The iShares FTSE/Xinhua China 25 Index ETF (NYSE: FXI) fell 12%. The iShares MSCI BRIC Index ETF (NYSE: BKX) of stocks from Brazil, Russia, India, and China went down 13.4%.

So how do you make lemonade from these lemons? Especially when it's not clear whether these markets, which have tumbled on worries about a slowdown in China's economic growth and on fears that the budget crisis in Greece could spread to the rest of the European Union, are done falling?

Think dividends.

I grant you that dividends and emerging market stocks aren't two concepts that immediately jump to mind together. Most emerging market stocks don't pay dividends for the same reason that most startup companies anywhere don't pay dividends: They've got plenty of extremely profitable places to invest every bit of internally generated cash. Other emerging market companies don't pay dividends because nobody else does in their local stock market or because it's not in the culture, or, well, for countless reasons that have to do with what can be the ins and outs of convoluted ownership structures.

Still, some emerging market companies do pay dividends, largely in the electric utility and telecommunications sectors. Even in emerging markets, the shares of companies like these use dividends to attract investors because they're in capital-intensive businesses and are constantly on the lookout to raise capital. Dividends are one way to ensure they have a steady demand for new shares.

Sometimes dividends are paid in sectors and industries you probably wouldn't expect. For example, I don't know why China Nepstar Chain Drugstore (NYSE: NPD), the largest retail drugstore chain in China, has paid a hefty 5.63% dividend over the past year, but it has.

In the rest of this column, I'll give you some caveats for dividend investors that are especially important to investing for yield in emerging markets, then identify four dividend plays—three for further research and one that I'm going to add to my dividend income portfolio on Friday. (For some help in figuring out an asset allocation that includes these emerging market plays, see this recent post.)

Yes, Dividends, But When?

Cash flows from dividends in emerging market stocks can be unevenly distributed during the year. So it's smart to pay close attention to when they’ve paid dividends historically. You can wind up waiting a long time between a company's payouts or discover that you'd just missed one of only two payouts during the year or the biggest of the year's uneven payouts.

Look at the pattern at Brazilian electric utility Centrais Elétricas Brasileiras (Electrobrás) (NYSE: EBR), for example. In the past two years, the company has paid out two sets of dividends. On May 5, 2009, Electrobrás paid out a cash dividend of 2.66 cents a share and a special cash dividend of 61.84 cents a share. This year, on February 1, the company paid out a cash dividend of $1.1947 a share and a special cash dividend of $1.329. I couldn't tell you exactly how long you'd have to wait for the next payout or what it might be.

Remember that these are emerging markets and that the fortunes of even a stodgy utility or telecommunications company in the United States or Japan can turn on a dime on a change in regulation or a shift in government that favors one player over another.

That's exactly what overtook Turkcell Iletisim Hizmetleri (NYSE: TKC). The Turkish government introduced mobile phone number portability (so that users who switch carriers get to keep the same phone number) in November, and that's set off a war. Turkcell has maintained its subscriber growth rate, but increased churn (as customers switch providers) and deeper discounts to attract new customers has cut average revenue per user by about 20% in the fourth quarter. I don't think that endangers the stock's current 4.8% yield, but it could well keep a lid on any price appreciation in the shares.

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And finally, learn as much as you can about who owns the company and the bulk of its shares. You'd like to see majority owners and investors whose interests are aligned with your own. It's never easy for a minority owner in a company—and unless you've got a whole lot more money to invest than I do, that's what you'll be in any of these stocks.

Beware of companies where owners may have family strategic objectives that see cash flow from one family business as a source of capital or where influential domestic institutions have the ability to siphon off profits before they get to public shareholders. In many cases, the best guarantee for minority shareholders is the reputation of a big international investor that owns a hunk of the stock.

One Stock to Buy, Three to Watch

Two emerging market telecommunications companies make my list of stocks to check out.

First, I like Telekomunikasi Indonesia, also known as Telkom Indonesia (NYSE: TLK). Over the past two years, the dividends have been delivered in twice-yearly distributions with the next due, I estimate, this coming spring. The dividend yield now is 3.5%. This is by far the dominant telecommunications company in Indonesia, with the majority of the country's fixed-line market, and through its 65%-owned subsidiary, about 45% of the wireless market. Big outside investor Singapore Telecommunications (OTC: SGTCF) gives minority investors decent assurance of fair treatment.

Here you're buying a piece of one of the best growth and fiscal responsibility stories in Asia. The Indonesian economy is forecast to grow 5.2% in 2010 after growing by 4.3% last year. Indonesia's projected budget deficit for 2010 is just 1.6% of gross domestic product. On February 8, Fitch Rating upgraded Indonesia's sovereign debt to BB+ from BB. I'm adding this stock to my dividend income portfolio today, and later, I'll post a buy in Jubak’s Picks with more of my logic.

Second, keep an eye on Philippine Long Distance Telephone (NYSE: PHI). The stock of the largest telecommunications company in the Philippines pays a dividend of roughly 6%. As the dominant fixed-line carrier, Philippine Long Distance faces a problem faced by all fixed-line companies around the world: Business is shrinking as wireless phones take a bigger share of the market. Fortunately, Philippine Long Distance owns more than half that market, too.

The company operates in a relatively small domestic market, so investors aren't looking at the kind of subscriber growth they'd get from Indonesia, for example. But data services and broadband Internet connections are just starting to take off in this market, and the higher profit margins on those businesses will fuel Philippine Long Distance's growth. In the past two years, the dividend has been distributed in two payments; on trend, the next distribution would be in March. Two outside investors, First Pacific (OTC: FPAFY), a Hong Kong investment company, and Nippon Telegraph and Telephone (NYSE: NTT) own slightly less than half of the company. With this column, I'm adding this stock to Jim's Watch List.

Two Chinese growth companies that pay a hefty dividend also are being added to the watch list. Neither is without risk—and not just because they trade in one of the world's most volatile markets. Both of these companies face strong competitors and are facing pressure on their profit margins. How attractive they are to you will depend on your take on how successful they'll be in defending their turf.

One is China Nepstar Chain Drugstore (NYSE: NPD), which has seen growth fueled by government initiatives to separate drug prescribing in hospitals and clinics from drug dispensing. Now it faces competition from the government's effort to centralize distribution of the 300 most commonly prescribed drugs through the community health service. Margins in the drugstore business in China are even slighter than in the US, and so drugstore chains in China, like drugstore chains here, try to bolster margins by selling private-label products and adding services such as ATMs to draw traffic. The stock has a projected yield, based on the most recent dividend payment, of about 5.2%. The next distribution looks likely in April.

The other prospect is China Medical Technologies (NASDAQ: CMED), a medical testing company that faces competition not from China's government, but from the huge multinationals that dominate the medical testing business in much of the rest of the world. As China Medical has faced local competition on price that has cut into margins on its commodity tests, it has moved up the testing ladder into technologies such as semiautomatic enhanced immunoassay devices that let hospitals offer a wide variety of tests with limited staffs.

As it enters this market, China Medical will increasingly run into competitors such as General Electric (NYSE: GE). That's likely to slow the company's growth, but leave operating margins near 30% for the medium term. The stock now yields roughly 4.2%. In recent years, the dividend has been paid in a single installment in either July or September.

At the time of publication, Jim Jubak owned shares of the following companies mentioned in this column: China Medical Technologies and Telkom Indonesia.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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