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UPDATE 4-VW waters down outlook after strong Q2

(Adds CEO quotes paragraphs 8-9, 14, board member, 21-23)

By Michael Steen

FRANKFURT, July 30 (Reuters) - Volkswagen AG , Europe's biggest carmaker, posted stronger-than-expected second-quarter earnings on Tuesday but bowed to what many saw as the inevitable and cut its profit outlook for the full year.

Hit by shrinking markets in Europe, the United States and South America and only able to offer an ageing range of models, VW had come under increasing pressure to concede weakness.

It chose to do so at the same time as unveiling first-half results which beat expectations. The company said second-quarter pre-tax profits rose 13.5 percent compared with a year ago to 1.266 billion euros ($1.24 billion).

Shares in the firm climbed strongly on the announcement and by 1656 GMT, the stock was up 3.61 percent at 46.26 euros, leading gainers on the DAX and outperforming the pan-European DJ Stoxx auto index , which was up just 0.38 percent.

Volkswagen said it expected a pre-tax profit of "around four billion euros" for the full year, down from previous forecasts that it would match last year's record 4.4 billion euros.

"This is the first sign that VW management understands what equities investors want," said Lehman Brothers analyst Chris Will, who rates VW 'hold'. "The long-term story at VW was good but the profit forecast for 2002 was at odds with what analysts expected and that created a short-term risk."

Volkswagen said it had changed its outlook because signs of a pickup in the economies of western Europe and the United States had not materialised in the second half.

With first-half pre-tax profit already at 2.263 billion euros, Chief Executive Bernd Pischetsrieder said the new forecast might appear conservative, but he expected the fourth quarter to be the market's worst over the next 18 months.

"Since the second half of the year will not be easier, I think we are on the safe side," he told a telephone conference.

Sales for the first half were down 3.2 percent at 44.060 billion euros, VW said.

CHEAP SHARES?

The revised outlook means both Volkswagen and German-U.S. carmaker DaimlerChrysler , which builds luxury Mercedes-Benz cars as well as middle-market Chryslers, are expecting to make about the same pre-tax profit this year.

Daimler will require more than one-and-a-half times Volkwagen's revenues to do so, yet VW's shares are the worse performing, down 12 percent so far this year. Only Italy's Fiat has dropped further in the European sector.

The company said it expected unit sales of just under five million vehicles in 2002, in line with comments from senior executives that it might not reach last year's five million.

Pischetsrieder said the company had successfully cut costs, particularly in engineering, purchasing and logistics. He said the firm would target a return on investment of 9-11 percent, but gave no indication of where it stood now in those terms.

"In spite of the tough conditions in their home market and the unfavourable point in their product cycle, they seem to have managed matters on the cost side," said Trudbert Merkel, who manages four billion euros of German shares for Deka.

"Really this is a very convincing result," he said, adding he would buy more VW stock.

Many analysts had been anticipating the group would reduce its guidance for the full year amid weak global auto markets.

TOUGH SECOND HALF

"If this is (a profit warning), we are not particularly worried because it is not severe," said analyst Xavier Gunner at UBS Warburg. "We knew that the second half of the year was always going to be difficult."

Pischetsrieder had repeatedly said the firm would match last year's record profit, but the company faces a challenging period as some of its best-selling cars, such as the Golf, begin to show their age.

Rivals such as France's PSA Peugeot Citroen have newer cars on the market in a segment hit by slowing sales.

Robert Buechelhofer, the board member responsible for sales and marketing, accused VW's competitors of grabbing market share with steep discounts on their list prices.

"Our incentive level is one third that of those who give the most, who are our French competitors," he told the conference call. "We are not buying market share at any price."

The firm is to launch 12 new models by the end of 2003, including a new multi-purpose vehicle (MPV) -- a segment which the firm has to date let others dominate.

"Everyone knew with its ageing models 2002 was going to be a bad year," said Lehman's Will. "Once it has launched its new models, the Golf and Passat, VW will become much stronger, like Peugeot in the late 1990s."

Pischetsrieder is seeking to re-align the company's brands -- which include SEAT, Skoda, Audi, Lamborghini and Bentley -- to stop them from competing against each other.

Deka's Merkel said Pischetsrieder, who took over the helm earlier this year, could make up for lost ground in VW's communications with investors.

The new CEO must also contend with tough competition in shrinking markets. VW said its western European market share slipped to 18.2 percent from 18.9 in the first half. Its share of U.S. imports dropped to 9.5 percent from 10.0, and Brazilian market share eroded to 27.1 percent from 29.0 percent. (Additional reporting by Madeline Chambers and Marius Bosch)