Lufthansa reins in profit expectations amid tough competition

* Lufthansa 2015 EBIT meets expectations

* Restores dividend with proposed payout of 0.50 eur/share

* Sees (Shanghai: 600481.SS - news) slight increase in profit in 2016

* Budget rivals pressure prices in Europe

* Shares (Berlin: DI6.BE - news) drop 4 percent in early trade, biggest Dax faller (Adds shares, detail on profit outlook, analyst)

By Victoria Bryan

FRANKFURT, March 17 (Reuters) - German airline group Lufthansa forecast only slightly higher profits in 2016, despite lower fuel prices, warning of cut-price competition and falling average fares as it ramps up its Eurowings budget business.

Like rivals Air France-KLM (LSE: 0LN7.L - news) and British Airways owner IAG, Lufthansa benefited from low oil prices and strong travel demand in 2015, enabling it on Thursday to restore dividend payments to shareholders.

However, low cost rivals such as Ryanair and easyJet have also benefited and are challenging Lufthansa's new budget operation, Eurowings, adding more seats in Europe and especially Germany and putting pressure on ticket prices.

Lufthansa forecast a significant decline this year in yields, a key industry measure of revenues per mile per passenger, due also to the expansion of Eurowings on long-haul routes. Chief Financial Officer Simone Menne told journalists she could not see yields in Europe improving any time soon.

Lufthansa said it expected a slight increase in profit for 2016 after reporting adjusted earnings before interest and tax of 1.82 billion euros ($2.05 billion) for 2015.

Before Thursday's update, analysts had on average predicted an increase in profit to 2.08 billion euros, and the carrier's shares dropped 4 percent in early trading.

The group is still struggling to reach agreement with staff on new pay and pension deals, with last year seeing both pilot and cabin crew strikes, costing the carrier 231 million euros in lost earnings in 2015.

"We remain concerned the group is struggling to deal with multiple strategic challenges, with cheaper fuel masking the problems in the short term," Liberum analyst Gerald Khoo, who has a "sell" rating on the stock, wrote in a note.

CFO Menne told analysts the group was reluctant to give a more ambitious forecast so early in the year.

Alongside a 1 billion euro drop in its fuel bill for 2016, Lufthansa said it would lower costs, after its unit costs, excluding fuel and currency effects, rose 2.4 percent in 2015.

Attacks on popular tourist destinations, from Paris to Tunisia and Turkey, have also knocked traveller confidence at the start of the year.

Menne said people were still travelling, albeit booking tickets later.

"We see caution on forward bookings, but we aren't seeing fewer passengers. It (Other OTC: ITGL - news) 's a change in booking trends," she said.

($1 = 0.8870 euros) (Reporting by Victoria Bryan; Editing by Maria Sheahan and Mark Potter)