Evidence of turnaround sends Morrisons' shares soaring

* First (Other OTC: FSTC - news) rise in interim profit in four years

* Third straight quarter of underlying sales growth

* Improved guidance for cost savings, cash flow, debt

* Shares (Berlin: DI6.BE - news) rise by up to 9 pct, pulling sector higher (Adds fund manager, CEO comments, updates shares)

By James Davey

LONDON, Sept 15 (Reuters) - Morrisons, Britain's No.4 supermarket group, reported better than expected results on Thursday as shoppers returned to its stores, suggesting a recovery under new management is gaining momentum and sending its shares sharply higher.

The Bradford, northern England-based group reported a rise in first-half profit for the first time in four years and a third straight quarter of underlying sales growth. It also raised forecasts for cost savings, cash flow and debt reduction.

Its shares rose by up to 9 percent, while those of bigger rivals, market leader Tesco (Frankfurt: 852647 - news) and Sainsbury (Amsterdam: SJ6.AS - news) 's increased by up to 4 percent and 3 percent respectively on renewed hopes Britain's traditional big supermarkets could fight back successfully against German discounters Aldi and Lidl.

Paul Mumford, fund manager at Cavendish, noted Morrisons was currently the second most "shorted" UK stock. Some 18 percent of its shares are out on loan with investors betting they will fall, with levels for Tesco and Sainsbury's not far behind.

"Should these positions be forced into reverse, prices will buoy (further)," he said.

Former Tesco executive David Potts joined Morrisons as CEO in March 2015 with a remit to revive the group after it was hurt by the rapid rise of the discounters in its northern heartlands.

"We're very much still in the foothills of our recovery programme," he told reporters. "But so far, so good."

Potts has reversed Morrisons' loss of customers by cutting prices, improving product quality and availability and bolstering store standards and customer service.

"When we get it right customers come back," he said, pointing to a 4 percent rise in the second quarter year-on-year.

Potts has also overhauled Morrisons' online strategy through a renegotiated distribution agreement with Ocado and a wholesale supply deal with Amazon.

FIGHTING BACK

In the 26 weeks to July 31, Morrisons' underlying pretax profit rose 11 percent to 157 million pounds ($208 million), beating analysts' average forecast of 150 million pounds.

Sales at stores open over a year were up 2 percent in the second quarter versus a 0.7 percent rise in the first.

Potts said Morrisons' supermarkets, stripping out online sales, saw a rise in like-for-like sales in the second quarter for the first time since 2011-12.

Net (LSE: 0LN0.L - news) debt was reduced by 477 million pounds to 1.27 billion pounds, below a target of 1.4-1.5 billion for the end of the fiscal year. That target has now been cut to 1.2 billion, with debt expected to be less than 1 billion by the end of 2017-18.

Morrisons also said it would beat its cost savings target of 1 billion pounds this fiscal year and hit its goal of 2 billion of free cash flow six months early. It lifted a working capital improvement target by 200 million pounds to 1 billion pounds. The interim dividend was up 5.3 percent to 1.58 pence a share.

Echoing other UK retailers, Potts said consumer behaviour had not been impacted by Britain's vote to leave the European Union (KSE: 000910.KS - news) . However, he added the fall in sterling since the vote could lead to an easing of deflation in the industry as the cost of importing food is driven higher.

($1 = 0.7553 pounds)

(Editing by Greg Mahlich and Mark Potter)