H&M says will struggle to hit annual sales target

* March-May pretax profit ahead of consensus

* Sees June sales up 7 percent, below consensus 8 percent

* Higher markdown levels seen in third quarter (Adds CEO comment, analyst comment, updates shares)

By Anna Ringstrom and Helena Soderpalm

STOCKHOLM, June 29 (Reuters) - Swedish fashion retailer H&M will struggle to hit its sales target this year after falling short in the first half and as key markets such as China and the United States remain challenging, it said on Thursday.

After decades of strong growth, H&M has repeatedly missed sales forecasts over the past year, with earnings squeezed by heavy investment and stiff competition from budget rivals such as Primark and online firms Zalando (Swiss: OXZALG.SW - news) and Asos (LSE: ASC.L - news) .

The world's second-biggest fashion group reported a better than forecast 10 percent rise in pretax profit for March-May but said unexpectedly low sales and higher inventories meant it had to mark down the prices of its clothes more to get them sold.

CEO Karl-Johan Persson told Reuters it was looking "tough" to reach a target given in January for 10 percent to 15 percent sales growth this year after first-half sales came in lower than H&M had expected.

H&M's shares have been on a downward slope since 2015 and have fallen 18 percent in 2017 alone, whereas market leader Inditex (Amsterdam: IT6.AS - news) , the owner of Zara, has weathered sluggish markets better and seen its shares rise.

H&M's shares were up 2 percent by 1220 GMT as investors weighed the upbeat quarterly profit of 7.71 billion crowns ($904 million) against an uncertain outlook. Analysts had on average forecast profit of 7.1 billion crowns.

"Whilst the outcome for the quarter is better than expected, there is plenty here for the bears too," said Morgan Stanley (Xetra: 885836 - news) analysts, who have an "underweight" rating on H&M stock.

The company put the profit increase down to better cost control and the opening of more stores.

INVESTMENT PAYOFF?

H&M has made large investments to integrate its brick-and-mortar stores better with online shopping and speed up its supply chain. Analysts complain, however, that they are still seeing little sign of the investment paying off.

"H&M has been investing heavily in online capability (IT, logistics and integration) for some time now, but sales growth has yet to respond to this," said Societe Generale (Swiss: 519928.SW - news) analyst Anne (Shenzhen: 002235.SZ - news) Critchlow, who rates H&M stock as "sell".

"For the H&M concept's young value fashion target audience, stronger investment may be required, for example through a free delivery and returns offer, in line with some of the pure online competitors," she said.

Persson told a news conference investment would remain high. The company, which does not report online sales separately, predicted annual online sales growth of least 25 percent going forward.

"H&M is showing good confidence in the outlook for online sales and profitability. It still remains to be seen though whether its investments will have a net incremental benefit or if H&M is merely playing catch up," said RBC analyst Richard Chamberlain who has an "outperform" rating on the stock.

H&M warned of more price markdowns in its third quarter, after inventories also rose in the second quarter.

It expected sales growth measured in local currencies in June, the first month of its third quarter, of 7 percent from a year earlier. Critchlow said that implied unchanged like-for-like sales and no improvement on the rest of the year so far.

To reach more shoppers and reduce its exposure to the increasingly crowded budget clothes market, H&M is branching out into new separate brands with higher prices than its core brand.

H&M reiterated on Thursday that its biggest separate chain, COS, would have sales of 10 billion crowns this year.

Inditex this month reported an 18 percent rise in quarterly profit.

H&M also announced plans to open stores in new markets Uruguay and Ukraine next year. ($1 = 8.5256 Swedish crowns) (Editing by Keith Weir and David Clarke)