UPDATE 2-Expansion costs hit H&M earnings
* Pretax profit 6.6 bln SEK vs consensus 6.8 bln
* Gross margin 61.6 pct vs forecast 61.6 pct
* To open 325 new stores this year vs 304 in 2011/12
* Sees Q1 markdowns unchanged vs year-ago
* Shares down 2.8 percent (Adds analyst comments, background)
By Anna Ringstrom and Veronica Ek
STOCKHOLM, Jan 30 (Reuters) - Hennes & Mauritz, the world's No.2 fashion retailer, posted an unexpected drop in quarterly earnings, hit by competition in tough European markets and the cost of its expansion drive to take on bigger rival Inditex.
The Swedish group does the bulk of its business in Europe, where the region's debt crisis and rising unemployment have dampened consumer spending.
At the same time, it has been making long-term investments in online shopping and new chains of stores, such as the recently-launched "& Other Stories," in a bid to catch up with the broader offering of Spanish rival Inditex, which runs the Zara chain and a string of other brands.
"These long-term investments have created cost increases and to a great extent have not yet generated any revenue," chief executive Karl-Johan Persson said on Wednesday.
"However, we consider these investments to be both necessary and wise as they aim to secure future expansion and profits and thereby further strengthen H&M's position," he added.
Pretax earnings in the September-November period fell to 6.6 billion Swedish crowns ($1.0 billion) from a year-earlier 6.8 billion, hit also by a strong crown. Analysts had on average forecast an unchanged profit.
H&M said a tough economic backdrop led to widespread price promotions and markdowns in the fashion industry, although its own level of markdowns in relation to sales was the same as in the fourth quarter of the year before.
Stocks were somewhat higher than planned at the end of the period, although the group said markdowns in the first quarter would also be around the same level as the year earlier.
Bernstein analysts said this would be a challenge, particularly given the likely disruption to sales from snow.
"These are disappointing results, as management continues to step up investment in both the product and longer term initiatives, yet sales performance has not rebounded," they said.
H&M predicted local-currency sales growth in January, the second month of its fiscal year, of 5 percent, the weakest figure since October, due to cold weather.
Its shares were down 2.8 percent to 228.5 crowns by 0945 GMT, within a European retail index down 0.2 percent.
H&M, present in 48 markets, said it would open a net 325 stores this year, with most planned in China and the United States. It would also launch online sales in the United States.
It saw expansion opportunities in big European markets like Russia, Germany, Britain, Italy, Poland and France as well.
"For the medium term, they're trying to develop more brands, they're entering five new countries this year, they're laying down 12 percent more space ... So in terms of their own strategy, I actually think that they are sticking to it, and it makes long-term sense," said UBS analyst Adam Cochrane.
H&M said its gross profit margin, which disappointed in the third quarter, shrank to 61.6 percent from 61.9 percent, matching forecasts. It proposed an unchanged dividend, as expected, of 9.50 crowns per share.
($1 = 6.3815 Swedish crowns) (Reporting by Anna Ringstrom. Editing by Patrick Lannin and Mark Potter)