* H1 cash flow 1.67 bln euros vs 203 mln year ago
* H1 net loss 114 mln euros vs 471 mln loss year ago
* New CEO reports progress on pricing, costs
* Shares up 6 percent (Adds CEO and analyst comments, details, background)
By Laurence Frost and Gilles Guillaume
PARIS, July 30 (Reuters) - PSA Peugeot Citroen reported a surprise surge in first-half cash flow and the first auto-division profit in three years, sending the French carmaker's shares soaring as its turnaround plan began to show results.
Operating cash flow jumped to 1.67 billion euros ($2.23 billion) in January-June from 203 million a year earlier, as new Chief Executive Carlos Tavares slashed vehicle inventories and began stamping out supply-chain inefficiencies.
Peugeot shares rose as much as 8.5 percent after the company narrowed its net loss to 114 million euros from 471 million and said the core manufacturing business was back in the black.
"PSA certainly surprised us this morning," London-based ISI Group analyst Erich Hauser said. "It looks like PSA is actually performing well ahead of plan."
Peugeot sold stakes to China's Dongfeng and the French state earlier this year as part of a 3 billion euro share issue, after racking up losses of 7.3 billion in two years.
Tavares pledged soon afterwards to trim the model line-up by almost half, cut capacity, raise pricing and pare wage and component costs to lift the automotive operating margin to 2 percent in 2018 and 5 percent by 2023.
On Wednesday, the former Renault second-in-command gave an account of his efforts to press for leaner manufacturing - which frees up cash by reducing stocks of parts and vehicles.
"You look at those lines (of inventory) and ask people how you manage production," Tavares told analysts in Paris.
"After the first step, where people tell you that you're already optimized, bla bla bla, in fact there are many ideas," he said. "What we've seen is a very joyful implementation of new ideas that delivered great results."
By 2016, Peugeot aims to cut 1 billion euros from stocks of parts, materials and finished vehicles through improved supply-chain management. The number of vehicles in inventory fell to 406,200 by June 30, down 7 percent on the previous year.
Despite stiff emerging-market currency headwinds, the auto division returned to a 7 million euros operating profit - its first since 2011 - from a 538 million loss.
Overall operating income swung to a 477 million euro profit, for a 1.7 percent group operating margin, from a year-earlier loss of 100 million.
Sales financing arm Banque PSA Finance reported a 7 percent operating income decline to 172 million euros, while parts maker Faurecia, majority owned by Peugeot, raised its contribution to 311 million euros from 55 million.
Paris-based Peugeot's stock was up 6.2 percent at 11.255 euros as of 1010 GMT, the strongest performer on the STOXX Europe 600 autos & parts index.
Some 550 million euros of the cash-flow gain, which excludes restructuring, stemmed from working capital reductions that will reverse in the second half, Peugeot cautioned.
But the company also reported pricing progress as it seeks to narrow Peugeot's gap with Volkswagen and deliver similar improvements for the Citroen and upscale DS brands.
New models including a DS sport utility vehicle and Citroen C4 Cactus will offer further help, it said.
While the group's overall European market share was broadly stable at 12.1 percent, Peugeot said it had increased its slice of the lucrative consumer market by a percentage point and cut down on loss-making sales to car rental companies.
"The mix stands out, thanks to PSA's focus on profitable channels," said Exane BNP Paribas analyst Stuart Pearson. "With a cleaned up balance sheet and lowered capacity, PSA has not had to chase volume with low pricing as in the past."
Peugeot reiterated its medium-term recovery goals but refrained from giving guidance for full-year 2014, warning that serious risks remain in its path.
Group revenue fell 0.4 percent to 27.62 billion euros in the first half as emerging-market currencies continued their slide against the euro, putting a 251 million dent in earnings.
High overseas plant costs and weak supplier networks have left Peugeot particularly exposed to the currency swings.
First-half sales volumes slumped 27 percent in Latin America and 26 percent in Russia, far outpacing each market's decline.
In Europe, Peugeot said, the recovery in vehicle demand remains fragile and is especially weak in France, the group's second-biggest market after China. European car registrations increased in June for a tenth straight month but were boosted by heavier discounting.
"We remain very cautious about surfing on this European growth," CEO Tavares said. "We need to stay lucid and recognize that we are only at the beginning of our turnaround."
1 US dollar = 0.7465 euro Editing by Mark John, James Regan and Mark Potter