Mercedes-Benz narrows profit gap with German rivals

* Operating profit up 67 pct to 3.73 bln euros

* To spend 22 bln euros on plants, equipment, R&D in 2014/15

* Mercedes (Xetra: 710000 - news) -Benz return on sales strongest for 3 yrs

* Daimler cashflow strong, but no large acquisitions planned (Adds CFO comment on improved pricing, liquidity)

By Edward Taylor and Andreas Cremer

FRANKFURT, Oct 23 (Reuters) - Daimler AG lifted sales and profits at its core Mercedes-Benz luxury car division in the third quarter, showing the group is narrowing the gap with rivals Audi (Other OTC: AUDVF - news) and BMW.

The results are a sign that the Stuttgart-based company's efforts to regain the top spot in luxury cars it last held in 2004 are beginning to have an impact. But some analysts question whether Daimler has enough momentum to catch peers, whose profit margins have surged ahead.

Daimler is modernising its production facilities to regain ground. In total, the company will spend 22 billion euros on plants, equipment and research and development in 2014 to 2015, Chief Financial Officer Bodo Uebber told journalists.

Daimler will focus on strengthening its core business rather than making large acquisitions, despite a recent windfall from the sale of a 4 percent stake in Tesla, Uebber said, declining to elaborate on whether this precluded smaller acquisitions such as taking a stake in motorbike maker MV Agusta.

Although Daimler's industrial cash flow was healthy, Uebber said he would retain it for investments in the company's operating business rather than in special dividends or takeovers. "In this volatile time we want to sit on a high level of liquidity," Uebber said.

Mercedes-Benz Car's return on sales from ongoing business rose to 8.6 percent in the third quarter from 7.6 percent, its highest level for this measure of profitability in more than three years thanks to improved pricing. This performance helped to boost group operating profit (EBIT) by 67 percent.

But Juergen Pieper, automotive analyst at Metzler bank, said Mercedes cars margins were not yet satisfactory.

"I think Daimler has peaked. The margin in the cars division is really good for Mercedes standards, but it is not where it should be for a leading premium manufacturer."

Daimler said it still expected a significant rise in group core profit for 2014 and that sales of Mercedes-Benz and smart branded vehicles would rise above 1.6 million vehicles from 1.57 million last year, as new models help to ride out a slowdown in worldwide passenger car demand and prop up price levels.

Mercedes said it will maintain a similar rate of production in the fourth quarter, even as global passenger car sales slow to 3 percent growth this year, down from an earlier forecast of 4-5 percent, as the Ukraine-Russia crisis and emerging markets dampen demand.

Shares (Berlin: DI6.BE - news) in Daimler slid 0.1 percent to 59.70 euros by 0124 GMT, underperforming a 0.46 percent rise in the German blue-chip DAX.

Analyst Pieper also said he was concerned about the company's exposure to the trucks market, which is heavily dependent on shaky emerging markets.

On a group level, Daimler's core profit (EBIT) was 3.73 billion euros ($4.72 billion), including a 1.01 billion-euro gain from the sale of a 50 percent stake in Rolls-Royce Power Systems.

Core earnings from the ongoing business rose 21 percent to 2.79 billion euros, helped by strong sales of Mercedes-Benz Cars that bucked a trend of slowing demand for passenger cars, and steady sales of trucks.

LAGGING PEERS

Commerzbank (Xetra: CBK100 - news) auto analyst Daniel Schwarz said: "Earnings quality was good and Daimler has not reached the peak of its product cycle yet, so there is no reason why they can't also earn as much as peers."

The company unveiled a new S-Class flagship limousine in July 2013 and its compact models, which include the GLA offroader and the B-Class, have been recently launched or overhauled.

Earnings momentum is expected to continue as a new generation of its C-Class sedan, the company's best selling model which accounts for about 30 percent of sales, went into production in China, the world's largest car market, in July.

Earnings momentum will continue next year, with the global rollout of the GLA offroader, the AMG GT Coupe, and a new long-wheelbase version of the S-Class, Daimler said.

In previous quarters, the return on sales margin at Mercedes has lagged that of its German peers.

In the second quarter, BMW's automotive margin, came in at 11.7 percent, exceeding the 7.9 percent achieved by Mercedes-Benz and 9.9 percent by Volkswagen (Other OTC: VLKAF - news) 's Audi .

Last year, BMW was the leading luxury car manufacturer with 1.65 million vehicles sold worldwide. Audi was next at 1.57 million and Daimler in third place, with 1.47 million Mercedes-Benz branded cars sold.

Daimler is the first of the German premium auto makers to release third-quarter results, which included the group's best-ever month for sales of Mercedes-Benz cars in September, benefiting from new models and growing demand in China. .

Volkswagen is due to report on Oct. 30 and BMW on Nov. 4.

(1 US dollar = 0.7908 euro) (Additional reporting by Ilona Wissenbach; Editing by Georgina Prodhan, Jane Merriman and Vincent Baby)