TOKYO - Honda Motor Co and Nissan Motor Co surprised markets by eking out small profits last quarter helped by cost cuts, but a sustained recovery looks some way off with demand relying largely on government stimulus.

Japan's No.2 and No.3 automakers have seen global auto sales crumble in the past year due to mounting jobs losses and tight credit markets that helped drive U.S. rivals General Motors and Chrysler to bankruptcy.

While most see the worst as now past, auto executives remain cautious about a convincing turnaround in demand, resorting to cutting operational and R&D costs to ride out the tough times.

Conditions remain extremely severe in the auto market, Honda Executive Vice President Koichi Kondo told a news conference.

Sales were especially falling short of expectations in the key U.S. market, Kondo said, adding that Honda planned to spend about $300 million more than anticipated in profit-eroding incentives this year to sell its mainstay Accord and Civic cars.

Honda, also the world's top motorcycle maker, posted an 88 percent fall in operating profit to 25.2 billion yen ($267 million) in the April-June financial first quarter, beating a consensus estimate for a 106 billion yen loss in a survey of four analysts polled by Reuters.

It made a net 7.6 billion yen in profit in the first quarter compared with a profit of 173.4 billion yen a year ago.

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For the full year, Honda lifted its operating profit forecast to 70 billion yen from 10 billion yen, and net profit to 55 billion yen from 40 billion yen.

The market expected a loss so this is really a surprise, especially given that Honda seems to be having a tough situation in the United States and a lot of inventory, said Hiroaki Osakabe, fund manager, Chibagin Asset Management.

Honda now expects better car sales in Japan and China, but worse in the United States and Europe. Overall, it lifted its global sales forecast by about 80,000 cars to 3.295 million for the year to March 2010.

The revision came despite Honda's assumption for a stronger yen against the dollar, at an average 91 yen for the financial year instead of 95 yen. It expects a stronger euro of 127 yen versus the previous 125 yen assumption.


Nissan, meanwhile, held its dollar assumption at 95 yen -- one risk factor that it said had kept it from revising its annual forecasts after a surprise profit in the first quarter.

We believed it would have been premature to lift forecasts at this juncture, Nissan Chief Operating Officer Toshiyuki Shiga said, listing among the other risks a drop in global car sales when government steps to stimulate demand come to an end.

Governments from Tokyo to Berlin and Beijing have offered subsidies and tax incentives to encourage consumers to buy new fuel efficient models to boost their auto industries.

Nissan, held 44 percent by France's Renault SA, made an operating profit of 11.6 billion yen ($122.9 million) in April-June, down 86 percent, but beating a consensus loss estimate of 117 billion yen.

It kept its full-year operating loss forecast at 100 billion yen.

With no major hybrid models to prop up sales in Japan, as they have done for Honda, Nissan is pouring its efforts into creating a market for pure electric cars with the first launches in Japan and the United States next year.

It is also due to roll out a new entry-level car next year to attack the growing Chinese and Indian markets.

In the shorter term, Nissan is focusing on returning to positive free cash flow by the end of this financial year through joint cost-cutting with Renault.

We're making progress in this area, Nissan's Shiga said.

Shares in Honda have risen 44 percent in the year to date, in line with Tokyo's transport sub-index .ITEQP.T.

Partly in anticipation of its lead in the zero-emission vehicle field, shares in Nissan have almost doubled in price this year, making them the top performer in the domestic auto sector.

Ahead of the results, Honda ended up 1.1 percent and Nissan ended up 0.8 percent. The transport sector gained 0.3 percent.

Top ranked Toyota's first-quarter results are due on Aug. 4. ($1=94.38 Yen) (Additional reporting by Elaine Lies; Editing by Lincoln Feast) ((; +81 3 6441 1804; Reuters Messaging: Reuters 3000 Xtra clients can now view daily data on how reported Asian company earnings compare with analysts' forecasts, as measured by Reuters Estimates.