* Renault cost-cutting boosts margin as sales decline
* Model changeovers swell inventory, negative cash flow
* Renault shares down 3.2 pct (Adds analyst, Renault comments, details, background)
By Laurence Frost
PARIS, July 29 (Reuters) - Renault made progress towards a core profitability goal as cost-cutting helped to counter currency headwinds in the first half, the French carmaker said, but sales and cash flow suffered ahead of the replacement of key models.
Operating profit rose 25 percent to 729 million euros ($979 million), Renault announced on Tuesday, lifting the operating margin from 2.9 percent to 3.7 percent of sales, which fell 3 percent to 19.82 billion euros.
But Renault shares sagged 3.2 percent after it said automotive free cash flow weakened to a negative 360 million euros from a year-earlier deficit of 31 million.
Renault reported “slightly lower sales and a less aggressive inventory management than what we had come to expect”, London-based ISI Group analyst Erich Hauser said.
Renault, whose low-cost cars and emerging-market presence helped ride out a six-year European auto slump, is now grappling with weakening currencies and demand in many of the same overseas markets. But its Dacia-branded budget models are far outperforming a fragile European recovery.
The company is cutting thousands of jobs, mainly in France, as it implements a 2013 union deal in pursuit of a 5 percent margin goal for 2016. Renault last year reduced its domestic workforce by almost 5,600 jobs to 48,550 as of Dec. 31.
Net income, which had been blighted by more than 500 million euros in writedowns on Renault’s Iranian business last year, rose to 801 million euros from 97 million.
“We’ve seen a significant increase in group profitability,” Chief Financial Officer Dominique Thormann told reporters. “The improvement to our margin stems from a very firm cost control.”
Savings from purchasing - increasingly pooled with 43.4 percent-owned alliance partner Nissan - trimmed 200 million euros from first-half costs, he said. Logistics, research and development delivered a further 190 million.
“We continue to believe that the miss on free cash flow is less significant than it first appears,” Citi analyst Philip Watkins said.
Renault shares had nonetheless fallen to 67.28 euros at 0823 GMT, valuing the company at 20.5 billion euros.
The cash flow suffered as Renault increased its own inventories to 158,000 vehicles from 100,000 while cutting dealer stocks, ahead of the replacement of key models including the Twingo and no-frills Sandero subcompacts.
The run-out of older models also saw pricing weaken by about a percentage point against a mass-market peer average, sales chief Jerome Stoll said.
The carmaker raised its European market forecast for 2014, predicting a 3-4 percent expansion instead of the 2-3 percent previously assumed. But Stoll warned that Russian demand may contract more than the 10 percent previously forecast.
Stoll said carmakers were in ongoing talks with Moscow over new incentives or other government measures to counter the slump, worsened by international sanctions and a weaker rouble.
Analysts had on average predicted a 717 million euro operating profit on 20.87 billion in sales, for a more modest 3.4 percent margin, according to a company-compiled survey based on more than 20 estimates.
1 US dollar = 0.7446 euro Editing by James Regan and Mark Potter