(Adds CEO/CFO comment, detail on Brazil, hedging, trucks)
By Nick Tattersall
FRANKFURT, July 25 (Reuters) - Volkswagen said on Friday its core profits more than halved in the second quarter due to a strong euro, new product costs and slumping demand, but a rise in the value of its equity investments bolstered its pre-tax profit.
Europe's biggest carmaker said operating profit fell to 616 million euros ($708 million) from 1.4 billion a year ago, mainly due to lower volumes in the U.S., Europe and Brazil and currency effects.
"The exchange rates are unfavourable, and unfortunately we don't expect that to change. And the group has a peak of up-front launch costs this year," Chief Executive Bernd Pischetsrieder told a conference call, but pledged an improvement in 2004 when new models were on the market.
VW's pre-tax profit dropped 46 percent to 679 million euros -- a smaller decline than many analysts had expected -- on strong contributions from its joint ventures and equity revaluations after stock markets improved in the second quarter.
The company's own stock has recovered from seven-year lows plumbed in March, when it first warned operating profit would fall this year. It was up 1.38 percent at 36.80 euros by 1536 GMT, outperforming European peers .
"It is not as awful as many people were expecting, and the actual figures are not so far from the forecasts. In some parts they are a touch better," said Helaba analyst Christian Schmidt.
French peer PSA Peugeot Citroen , Europe's second-biggest carmaker, also posted a sharp slide in first-half profits on Thursday and cut full-year forecasts due to a strong euro and shrinking demand in western Europe.
"When you remember that even a company like PSA is having some difficulty defending its targets, VW doesn't look so bad. I'd say that VW may be better positioned than PSA in 2004," said Metzler Bank analyst Juergen Pieper, who rates VW "sell".
PAYBACK TIME
Like its rivals, VW has been battling with shrinking auto markets and tougher pricing competition in Europe and the U.S., but is further saddled by the cost of a massive product overhaul and relatively weak currency hedging.
Ramping up new models cost around 300 million euros in the second quarter, an expense the company vows it will pay off in the second half, expecting earnings to improve as its recently launched Touran minivan and Touareg off-roader, and the forthcoming fifth-generation Golf hatchback, buoy sales.
Cashflow in the core automotive division fell 39 percent to 2.9 billion euros in the first half, with factory upgrades for the updated Golf, its best-selling model, accounting for much of its investment in the period.
Incoming finance chief Hans-Dieter Poetsch said the group would strive for positive free cash flow in 2004, but did not expect it this year.
Although exchange rates sliced 400 million euros off pre-tax profit in the second quarter, some of that was mitigated by hedging, the company said.
VW still hedges less than rivals, but lifted its protection earlier this year to cover 40 percent of its exposure to the dollar, yen and British pound.
BRAZILIAN BLUES, SWEDISH TEMPTATION
Volkswagen said full-year operating profit would be significantly lower than last year's 4.76 billion euros, hit in part by restructuring measures at its loss-making Brazilian operation, which is aiming to break even next year.
It is to slash nearly 4,000 jobs, 16 percent of the workforce, at its Brazilian arm, which is set up to assemble 740,000 vehicles a year but is currently only producing 473,000 due to weak demand in Latin America.
Pischetsrieder also said VW was ready to play a role in expected consolidation in the European truck sector, saying it would make sense for Sweden's Scania and Germany's MAN to cooperate.
"If VW can be helpful on that we wouldn't refrain from it -- on the contrary. But we are talking about cooperation. Everything else I cannot comment on," he said.
Industry sources say VW is interested in buying MAN's trucks unit and has held initial talks with the group, though no firm negotiations are underway. It also owns a strategic stake in Scania, which some financial sources say it would be well advised to sell. (Additional reporting by Madeline Chambers)