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Israeli Stocks to Watch

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The tiny country in the Middle East has bucked the sovereign default trend.

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Israel may have its image problems, but its economic prowess is something to admire as countries around the globe continue to fall into financial turmoil.

It was one of the last countries to enter the global recession and one of the earliest to exit. In a recent note, Barclays Capital said the country "passed through the global recession with only light damage and the economy is ready to resume growing."

Israel's financial sector remained stable during the global credit crisis and its exports rebounded swiftly. The country's gross domestic product grew 4.4% in the fourth quarter of 2009, well above Barclays Capital's forecast of 3.2%, and the brokerage firm said it "appears to be enjoying rapid growth without much inflation."

Finding relatively safe investments overseas may seem like a challenge these days, but Israel could be a promising place for American investors. In 2009, Israel's Tel Aviv-25 benchmark index gained 75%, handily beating the S&P 500, and today sits narrowly below its lifetime high.

On a recent trip to Israel, I saw a country alive with opportunity. Tel Aviv, the cosmopolitan and technological center, is a city that really does not sleep. The street life is invigorating: bars, falafel and shwarma stands open all night, open-air markets where bargaining is like a sport, and crowds all along the promenade on the Mediterranean. Skyscrapers are going up and the city is sprawling outward as more people move there. Storefront vacancies, something found even in trendy parts of New York, were almost nonexistent.

The easiest and safest way to invest in Israel is to look to its biggest companies. Many smaller companies are thinly traded on the NASDAQ or New York Stock Exchange.

Israel's embrace of technology over the years has been good news for Cellcom (CEL), its largest telecommunications company. Established in 1994, Cellcom had 3.3 million subscribers as of September 30, 2009. Its competitors are Partner (PTNR) and Bezeq, and together these three companies make up a "rationally competitive market," according to Anupam Palit, the lead analyst on Cellcom at Jefferies & Co. Without a turf war, like we've seen in the United States, there hasn't been a race to the bottom in terms of pricing, Palit said in an interview.

Cellcom's biggest selling point is its dividend: a fruitful yield of about 9%. Cellcom pays out nearly all of its net income in dividends and the stock has gone up more than 50% over the last 12 months. Palit says the hefty dividend isn't going anywhere: The company has very strong free cash flow and low capital expenditures, the latter a product of arid, flat land and the clustering of most people in and around Tel Aviv and Jerusalem. In fact, Palit believes there could even be a special dividend in the second half of the year.

Palit says future growth for Cellcom should come not from subscriber growth -- the saturation rate of wireless devices is already 130% -- but from new revenue streams and a change in the nature of consumption, once smartphones become more popular. (The iPhone (AAPL), for example, only arrived in December).

Israel also is home to the world's largest generic drugmaker. Making inexpensive copies of blockbuster drugs, Teva Pharmaceutical (TEVA) has given headaches to Big Pharma for a long time. Many Israelis proudly call it "Israel's stock." The company accounts for 22% of all generic prescriptions written in the US, according to a recent Forbes story. In 2008, Teva's CEO, Shlomo Yanai, whose popularity makes him like the Steve Jobs of Israel, declared that Teva, then a $9-billion-a-year company, would reach $20 billion in revenues and 20% profit margins by 2012.

The company is on target to reach Yanai's audacious target. In 2008, it acquired competitor Barr Pharmaceuticals of Montvale, New Jersey. Several weeks ago, the company maintained its 2010 outlook and predicted earnings per share of $4.40 to $4.60 and revenues of $16 billion for the year.

"Heading into what we believe will be an exceptionally strong 2010, we remain encouraged by Teva's overall sales trends," JPMorgan analyst Chris Schott said in clients' note.

As Big Pharma companies show flat earnings, Teva's growth shines. "Over the next three years some $89 billion worth of drugs will lose patent exclusivity, according to research firm IMS Health," Forbes wrote last August. "Teva is waiting with open arms."

A bet on Teva is also a bet on Israel. Indeed, this is the case with the iShares MSCI Israel Capped Investable Market Index Fund (EIS).

This ETF is designed to take into account the aggregate Israeli market, but Teva makes up nearly one-quarter of the portfolio. Other top holdings, Israel Chemicals and Check Point Software (CHKP), account for 10% and 8% of the fund, respectively. EIS gives investors exposure to companies not traded here, such as Israel's biggest banks, Bank Leumi and Bank Hapoalim.
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No positions in stocks mentioned.

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