UK grocer Morrisons' profit warning prompts price war fears

* 2013-14 underlying profit down 13 pct to 785 mln stg

* Sees 2014-15 underlying profit collapsing to 325-375 mln

* To invest 1 bln stg in cutting prices over three years

* To sell property, cut costs, exit non-core activities

* Shares fall as much as 13.6 pct, price war fear hits rivals (Adds CEO, chairman comments, graphic, shares)

By James Davey

LONDON, March 13 (Reuters) - Britain's Wm Morrison Supermarkets sparked fears of an industry price war on Thursday after it posted its lowest profit for five years and said it would invest 1 billion pounds ($1.7 billion) in price cuts over three years to win back customers.

Britain's No.4 grocer, which has been losing market share to discounters Aldi and Lidl and lagged rivals in entering fast-growing online and convenience store markets, warned its profits would more than halve this year as it tries to restore its low-price image with shoppers, sending its shares plunging 12 percent to a near eight-year low.

Shares in bigger rivals Tesco (Xetra: TCO.DE - news) and J Sainsbury fell 5 percent and 8.5 percent respectively.

Jefferies analysts said the scale of Morrisons' price investment was equivalent to "getting the bazooka out," while Phil Dorrell, director of consultants Retail Remedy, said it had raised industry fears of a profit-sapping battle over price.

"It doesn't look great," said one top 50 shareholder in Morrisons on condition of anonymity. "The certainty with the strategy is that profits will be lower; what is less certain is that the lower prices will stem sales declines."

Britain's "big four" grocers - Tesco, Wal-Mart's Asda, Sainsbury (Berlin: SUY1.BE - news) 's and Morrisons - are all being outpaced by sales growth at discounters in a fragile economic recovery, while upmarket chain Waitrose is also trading ahead of the pack.

Morrisons has fared the worst, however.

"We cannot have our head in the sand and not confront the brutal reality," Chief Executive Dalton Philips, told reporters, adding that the extent of change the discounters had prompted in the market had not been seen since the late 1950s.

"There is this big debate going on ... in terms of is this cyclical or is this structural? And we're saying this is structural. We're going to be bold and act decisively," Philips (Amsterdam: PHIA.AS - news) said, adding other grocers mistakenly regarded the rise of the discounters as cyclical.

Morrisons would help fund price cuts by reducing its cost base by one billion pounds through operating improvements and lower capital spending and by raising the same amount from selling off properties over three years.

Morrisons will also exit non-core activities - baby goods firm Kiddicare and its stake in U.S. online grocer Fresh Direct.

CHAIRMAN'S BACKING

Morrisons shares closed at 205.2 pence, having hit an eight-year low of 201.4 pence.

The threat of a supermarket price war also hit food producers like Premier Foods (LSE: PFD.L - news) , Dairy Crest (LSE: DCG.L - news) and Associated British Foods (LSE: ABF.L - news) as their profit margins could ultimately be squeezed by the retailers.

The latest data this week showed sales at discounters Aldi and Lidl surged 33.5 percent and 16.6 percent respectively, though together they only account for around 7.5 percent of Britain's total grocery market.

"All of a sudden everybody has realised that it's more serious than first thought," said John Ibbotson, director of consultants Retail Vision, referring to the competitive challenges to the "big four" supermarket groups.

"It's now a long-term structural thing. The middle is shrinking and it will keep on shrinking ... It's hitting Morrisons worst because their position is worst."

Morrisons will invest 300 million pounds in 2014-15 to narrow the price gap with discounters, following similar moves by Tesco, Asda and the Co-op. . It will also launch a loyalty card.

Philips, who succeeded Marc Bolland, now boss at Marks & Spencer, was endorsed by his chairman Ian Gibson. "Yes we back the plan and yes we back the executive," he said.

Morrisons profit before tax and one-off items dropped 13 percent to 785 million pounds in the year to Feb. 2, a second straight year of decline. Turnover fell 2 percent to 17.7 billion pounds, with like-for-like sales down 2.8 percent.

The group warned underlying profit in 2014-15 would slump to a range of 325-375 million pounds, which at the midpoint is less than half the level analysts were on average forecasting.

After exceptional non-recurring costs of 903 million pounds including a writedown on underperforming businesses, sites it no longer intends to build stores on and mature stores, Morrisons made a pretax loss of 176 million pounds in 2013-14.

Despite the profit fall and warning, the group raised its 2013-14 dividend by 10 percent to 13 pence a share and committed to a 5 percent minimum rise in 2014-15. It said it would return surplus cash to shareholders as appropriate.

($1 = 0.6022 British Pounds) (Additional reporting by Paul Sandle, Neil Maidment, Kate Holton and Chris Vellacott; Editing by Mark Potter and Elaine Hardcastle)