By Andreas Cremer
BERLIN (Reuters) - Profits at Volkswagen's <VOWG_p.DE> core brand plunged more than a half in the three months through September, turning up the pressure on the German carmaker to strike a big cost-cutting deal with its powerful works council.
Europe's biggest automaker is still struggling with the fallout from its admission more than a year ago that it rigged U.S. diesel emissions tests, a scandal set to cost it billions of dollars in compensation and vehicle refits and which has led it to announce a costly shift to more electric vehicles.
The group as a whole raised its full-year profit and revenue forecasts on Thursday, helped by a strong third-quarter performance at its premium Porsche brand.
But quarterly operating profit at the mass-market VW brand, the group's largest by sales and seen as crucial to any long-term revival in fortunes, dropped more than expected.
"VW has maneuvered itself into a cost and complexity situation that needs to be solved," said Evercore ISI analyst Arndt Ellinghorst. He has a "buy" recommendation on the stock, in part because of turnaround hopes for the VW brand.
Volkswagen has said it expects to reach a deal with the brand's labor leaders on cost cutting and strategy in the coming weeks, but sources close to the matter told Reuters last week that talks were faltering.
Although the group has been pledging for more than a year to bring down research and development (R&D) costs, spending on R&D climbed almost 2 percent in the first nine months of the year to 10.1 billion euros ($11 billion), its quarterly results showed.
Operating profit at the VW brand dropped to 363 million euros ($396 million) in the third quarter from 801 million a year earlier, when the emissions scandal broke in the final two weeks of the reporting period.
Analysts had expected an operating profit of 462 million euros.
They said the decline was partly due to a brief dispute with suppliers in August, and also to the widespread use of incentives to attract buyers.
Volkswagen said earlier this month VW brand sales jumped 6.7 percent year-on-year in September and that group sales growth was the strongest for two-and-a-half years.
"Some of those gains, especially in the U.S., are in part due to a massive use of incentives," said NordLB analyst Frank Schwope, who has a "hold" rating on Volkswagen shares.
The quarterly results showed distribution costs, which include buyer incentives, totaled more than 5 billion euros in the first nine months of the year, broadly in line with the same months in 2015 but up from 4.6 billion in the 2014 period.
The VW brand's profit margin in the third quarter was just 1.5 percent, well below its long-term target of 6 percent and the high single-digit percentages at some rivals such as Toyota.
At 0655 ET, Volkswagen's shares were down 0.3 percent at 125.5 euros.
The group also raised the amount of money it has set aside to cover the costs of its emissions scandal to 18.2 billion euros from 17.8 billion.
Its VW and Audi brands are still to find a fix for 85,000 polluting 3.0-litre vehicles even after the group this week agreed a record settlement with U.S. authorities and the owners of 475,000 smaller diesel cars.
Group operating profit, adjusted for one-off items, came in higher-than-expected in the third quarter at 3.3 billion euros, reflecting strong demand for Porsche's top-selling Macan SUV.
The group said it now expected revenue this year to match last year's record 213 billion euros, having previously predicted it might fall as much as 5 percent. It also said the group operating margin might come in at the upper end of its 5-6 percent target range, before one-off items, this year.
However, Audi - the biggest contributor to group profit - cut its margin guidance due to rising costs for the emissions scandal.
($1 = 0.9169 euros)
(Reporting by Andreas Cremer; Editing by Georgina Prodhan and Mark Potter)