1 Easy Way to Play Emerging Markets

Foreign industry titans like Petrobras and Sasol present exciting opportunities for American investors.

Jul 8, 2014 at 6:15PM

About Sasol
Source: Sasol.com.

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some emerging-market companies to your portfolio but don't have the time or expertise to hand-pick a few, the iShares MSCI Emerging Markets ETF (NYSEMKT:EEM) could save you a lot of trouble. Instead of trying to figure out which stocks will perform best, you can use this exchange-traded fund to invest in lots of emerging-market companies simultaneously.

Why this ETF, and why emerging markets?
It's always smart to diversify your portfolio holdings with some international exposure, and this ETF gives you that, focusing on developing economies that have the potential to grow faster than more established economies like the U.S. (It keeps roughly a third of its assets in developed economies, too, which can serve as ballast.) The ETF has recently concentrated on China, South Korea, Taiwan, and Brazil, while holding less in the sizable markets of Russia and India. That's reasonable, given Russia's recent strife with Ukraine and other regions and India's rampant food inflation, overwhelmed infrastructure, and low productivity.

ETFs often sport lower expense ratios than their mutual fund cousins. This ETF is no exception, with an annual fee of 0.67%. It handily outperformed the MSCI EAFE index over the past decade, but has lagged it in recent years. The ETF offers a wide range of companies based in emerging markets, relatively low fees, and even some income, with its recent dividend yield of 2%.

A closer look at some components
On your own, you might not have selected Petroleo Brasileiro Petrobras SA (NYSE:PBR) or Sasol Limited (NYSE:SSL) as emerging-markets companies for your portfolio, but this ETF includes them among its 800-plus holdings.

Petroleo Brasileiro, or Petrobras, is an oil giant majority-owned by the Brazilian government. Its forward P/E ratio of less than seven draws interest, but that number is low in part because the stock has been beaten down by charges of mismanagement and bribery, as well as concerns over production delays and the company's steep debt load.

There is ample reason to steer clear of the company, such as its debt and relatively low profit margins. But there's a bull case, too. Petrobras is investing heavily in projects that can fuel growth (though it has been adding to its debt in order to do so). Its offshore developments are promising, and the company is aggressively aiming to double production capacity by the end of the decade. Petrobras reported record production in its pre-salt fields in the Campos basin, but pre-salt oil extraction is expensive, pressuring profit margins, which have been falling significantly.

Pre Salt
Source: Petrobras.com.

You might consider Petrobras for your portfolio, but keep in mind that the company is vulnerable to governmental meddling in its business, e.g., when gas prices are kept below costs for the benefit of the people. More recently, Petrobras has made a huge offshore oil discovery, but the government is collecting billions from the company in exchange for drilling rights. The government presents a big risk factor, adding a lot of uncertainty to the stock. Couple that with big debt (much of which is subject to rising rates), and it looks reasonable to invest elsewhere.

Sasol Limited
Based in South Africa, Sasol is another big, integrated oil company, with a market cap north of $37 billion and a 2% dividend yield. It offers operational diversification for a portfolio, as it encompasses natural gas, oil, synthetic fuels, coal mining, chemicals, gases, fertilizer, and more. It even sports pipelines and service stations. Sasol also offers geographic diversification, as it's present in dozens of nations. Indeed, it boasts the largest foreign direct investment in Louisiana with its gas-to-liquids facility there.

When you think of Africa these days, violence and political instability might come to mind. That's why some big international oil companies are shedding assets in Africa. This can work to the long-term advantage of Sasol if it can buy competitors at attractive prices. In March, management discussed financial results, noting a battle against rising costs in South Africa but also a 40% increase in the company's interim dividend.

Sasol's top and bottom lines, along with its profit margins and free cash flow, have all been growing in recent years. Its net margin recently topped 14%. With a forward P/E ratio recently below 11, Sasol is a stock worth considering for your portfolio, especially if you're seeking international exposure.

The big picture
It makes sense to consider adding some emerging-markets companies to your portfolio. You can do so easily via an ETF. Alternatively, you might simply investigate its holdings and then cherry-pick from among them after doing some research on your own.

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Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, has no position in any stocks mentioned. The Motley Fool recommends Sasol. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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