German flagship airline Deutsche Lufthansa vowed to make tough cost cuts and restructure its loss-making Austrian unit as it warned on Thursday that economic uncertainty and high fuel prices would cut into its operating profit this year.

It is going to be hard work, because in order to structurally and sustainably strengthen the group's earnings power, we are going to have to rebuild the group itself and we have to be willing to make some unpopular decisions, Chief Executive Christoph Franz said at the company's annual results press conference.

Shares of Lufthansa fell 2.3 percent to 10.28 euros by 09.55 a.m., underperforming the German blue-chip DAX index <.GDAXI>, which was up 0.3 percent.

European airlines are being hit with a toxic mixture of soaring fuel prices -- which accounted for a fifth of Lufthansa's costs last year -- weak demand due to the European debt crisis and burdens from new national taxes on air travel.

In addition, fierce competition from Gulf rivals such as Emirates and Etihad, which recently bought a stake in Germany's No.2 carrier Air Berlin , as well as low-cost carriers like Ryanair is putting pressure on legacy airlines.

To improve profits, Lufthansa plans to cut costs by 1.5 billion euros (1.25 billion pounds) by the end of 2014, is selling loss-making British unit BMI and now plans to inject as much as 140 million euros of fresh equity capital into Austrian Airlines.

Our market conditions have changed drastically, and they will continue to change further. In order to stay ahead in this hard-fought competition, we too must continue to change, Franz said.

Lufthansa has not said what specific measures it plans or how many jobs may be cut, but said it aims to pool purchasing volumes and slash administrative staff costs, among others.

NOT HAPPY

Lufthansa saw operating profit drop by almost 20 percent to 820 million euros in 2011 and said it saw profit shrinking to a mid-three-digit million euro figure this year, in line with a 580 million consensus in Thomson Reuters StarMine.

Its adjusted operating margin narrowed by 1.3 percentage points to 3.4 percent in 2011, which Chief Financial Officer Stephan Gemkow said Lufthansa was not happy with.

Lufthansa said the first few weeks of this year had showed that economic uncertainty was here to stay for now, echoing comments by peers Air France-KLM and International Airlines Group (IAG) , the owner of British Airways and Iberia.

It also cut its expansion plans again, saying it now expected to add only 2 percent more seats at its airlines, including Austrian Airlines, Swiss and Brussels Airlines. It already slashed its original 9 percent plan in October.

Lufthansa last week announced a surprise net loss of 13 million euros for 2011 due to a larger-than-expected charge on BMI, the British unit it is selling to IAG.

This year, net profit will improve thanks to the sale of loss-making BMI. It also said it expected to post a further increase in revenue and an operating profit for 2013, assuming the market recovers.

(Reporting by Maria Sheahan; Editing by Hans-Juergen Peters and Helen Massy-Beresford)