An Emerging-Market Bank to Bank On

As readers might have noticed from some of my articles over the past year, I have been an unabashed bull with regards to emerging-market stocks.

Heck, I know that this asset class is risky at the best of times. But there is also a way to mitigate at least part of this perceived risk, and that is to invest in individual companies that hold a strong competitive position in their home markets, have excellent growth prospects, and are attractively valued: essentially, blue-chip companies by any other name. In particular, I like the prospects of emerging-market banks that cater to the burgeoning growth in credit demand -- especially for mortgages and credit cards -- from the newly minted middle-class consumers in many of these nations. One of my favorite plays in this sector remains India's HDFC Bank (NYSE: HDB).

Let's take a look, shall we?

HDFC Bank
HDFC Bank, through its relationship with parent HDFC Housing, is one of the top mortgage lenders in India and one of that nation's fastest-growing banks. For one thing, it's one of the best ways to play the booming housing market in India -- a market where demand is expected to average at least 25 million homes a year over the next 10 years, according to the National Real Estate Development Council. And HDFC Bank should also benefit from the growth opportunities in credit card issuance ... as is amply illustrated by the fact that, according to Visa International, fiscal 2005 was a banner year in India, with spending on Visa credit cards growing 66% to $3.8 billion. To put that number in perspective, American consumers spent more than $1.5 trillion on all credit cards during the same period.

Another key point in looking at HDFC Bank is that the company is an extremely efficient operator. For example, HDFC boasted an average cost of deposit of 3.3% for the fiscal year ended March 31, 2006, down from 3.9% in 2004, and one of the lowest rates in the industry. Net interest margin stood at 4%, well ahead of the 2.4% posted by rival ICICI Bank, and up from 3.8% in 2004. Non-performing loans stood at 1.2%, lower than even many Western banks, and the company had a Tier 1 Capital ratio (basically, required reserves) of 8.3%, ahead of the Reserve Bank of India's requirement of 4.5%.

Hmm ... vast growth opportunities and excellent operational efficiency ... little wonder that the company has managed to post a compound annual earnings growth rate in excess of 30% since coming public back in July 2001.

Now, I'll grant that shares of HDFC Bank might seem a bit rich, trading at roughly 23 times forward estimates of $3.22 -- well ahead of the multiples afforded less risky plays such as Citigroup (NYSE: C) and Bank of America (NYSE: BAC). But this still represents a 23% discount to the company's projected long-term growth rate. Given the immense growth opportunities in India's protected home-mortgage and credit card markets, I believe that shares of HDFC Bank deserve to trade in line with projected growth, or at roughly $96-$97 per share, and would urge risk-tolerant investors to consider depositing some cash in shares of this top-notch Indian bank.

Foolish bottom line
Emerging-market stocks continue to benefit from favorable demographic trends, strong GDP growth, and the rapidly expanding ranks of the middle-class consumer in emerging-market nations. The iShares Emerging Market Index Fund (AMEX: EEM) racked up a gain of 31% in 2006, well ahead of the quite respectable 16% advance posted by the Dow and beating the pants off the 9% increase recorded by the once-mighty Nasdaq.

My prediction for emerging markets in 2007? More of the same, as the fundamental investment thesis mentioned above remains intact. Consider adding some quality international stocks like HDFC Bank to your portfolio.

For related Foolishness:

• Don't Pass Me By, India!
• You Can't Afford Not To

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Fool contributor Will Frankenhoff is enjoying his time writing for the Fool more than reading The Financial Times or taking a nap. He welcomes your feedback and does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.