Analysis - Rampant Turkish stocks have further to run

ISTANBUL (Reuters) - Further gains lie in store for Turkish stocks which are trading at life highs and have massively outperformed the BRICs and eastern Europe this year, yet still offer valuations below average for emerging markets.

Underpinning the Istanbul Stock Exchange's (ISE) 14-percent rise this year is a robust economic recovery in Turkey, due to its large domestic market, well-capitalised banks, benign inflation outlook and continued record low interest rates.

The central bank has said rates will stay low until 2011, and Turkish lenders, which account for around half of the weighting of the ISE, are expected to post another quarter of solid profit growth as lending accelerates.

Banking sector profits rose 14 percent in the first five months of 2010 according to the banking regulator (BDDK).

"Increasing interest in Turkish equities is a long-term re-rating story, as Turkey moves towards investment grade. I don't see any reason for a change to this," said Namik Aksel, who runs funds of $1.2 billion (767.6 million pounds) in Turkish stocks and debt at HSBC in Istanbul.

Turkey was rewarded with a series of upgrades to its sovereign debt last year for its handling of the financial crisis and its improved debt management, but it has still not reached investment grade, a move analysts see as long overdue.

While Turkey has easily outperformed the flat MSCI emerging equities benchmark, Russian stocks are up only 2 percent since the start of 2010, and Chinese stocks have slumped almost 20 percent.

Despite the gain Turkish stocks still trade at 11 times 2010 earnings, compared to around 13 times in Poland, 12 times in the Czech Republic and some 15 times earnings for the MSCI.

The ISE index which breached the 60,000 points mark last week is currently trading at 60,734.47 points, after setting successive record highs.

"Technically I believe an upside of 5-10 percent is possible, we could see 64,000-65,000 points," Aksel said.

Head of Research at Oyak Securities Yurdal Yalman thinks while it could get somewhat harder for the index to rally it still has room to grow up to 15 percent in the next 12 months.

The Turkish economy, which contracted 4.7 percent in 2009, notched up growth of 11.7 percent in the first quarter. The government has an official target of 3.5 percent growth this year but most analysts see expansion at around 6 percent.

Turkey's once-chronic inflation fell to an almost 40-year low in May 2009. Although it spiked with the onset of the recovery it has since eased prompting the central bank to cut its inflation forecast to 7.5 percent from 8.4 percent.

"Turkish valuation multiples might not look cheap versus history, but one needs to look at this in the context of interest rates at historic lows, which has brought down the cost of capital, in addition to the medium-term attractions of the economy and market. This provides justification for where we are now," said Tom Wilson, manager of the Schroder ISF Emerging Europe fund.

"From a macro perspective it (Turkey) is not only attractive for dedicated money but it is also attractive for crossover money as well. That has been driving the market and will likely continue to do so."

RISKS AHEAD?

With almost two-thirds of the ISE in foreign hands the index is highly sensitive to wider risk appetite, which could take a knock if global recovery fails to continue apace elsewhere.

On the domestic front a referendum due on September 12 on the government's reforms to Turkey's constitution could increase political noise in the country of 73 million, although many analysts downplay the chance of any serious hit to confidence in Turkey. For a factbox on reforms click on

"Foreign investors are not too worried, in all honesty. There has been talk of the risk of an early election in case of a "no," but I don't see a chance of an early poll," said Yalman.

Potential downsides could be a stock overhang from secondary public offers which could come later this year, such as in government-controlled Halkbank.

The fate of General Electric's planned sale of its 20.85-percent stake in Garanti Bank is still unknown and part of it could become publicly traded, pressuring the stock price.

But risk factors notwithstanding, analysts say, there are enough positives to keep the Turkey investment case intact.

"The long-term structural growth story for Turkey is very interesting: it enjoys good demographics via a young and growing population, a well-run and well-capitalised banking system and an excellent geographic position as an export hub," said Schroder's Wilson.

(Editing by Sitaraman Shankar)