LONDON (Reuters) - British retailer Marks & Spencer's (>> Marks and Spencer Group Plc) efforts to boost profitability in its troubled clothing business are starting to pay off even though sales fell again in the latest quarter.

M&S, a 131-year-old stalwart of Britain's shopping streets, raised guidance for margin growth in its non-food division in 2015-16, beat forecasts for overall first-half profit and increased its dividend, sending its shares up as much as 4.2 percent.

The performance provides a boost to Chief Executive Marc Bolland, who, rather than chasing unprofitable non-food sales has focussed on growing gross margins - the difference between the price M&S pays for goods and the price it sells them - mainly through sourcing improvements.

Bolland, CEO since 2010, regards general merchandise, spanning clothing, footwear and homewares, as a modest sales growth opportunity but a significant one for margin growth.

"We have delivered more sourcing gains and earlier than planned," he said on Wednesday, also forecasting further gross margin growth in 2016-17 and 2017-18 years.

Bolland has spent billions of pounds on the redesign of products, stores, supply chain logistics and the website to address decades of under investment at the clothing business. Hopes that this will pay off has contributed to M&S shares rising by a third over the last year.

But his critics argue increasing gross margins alone is not a source of long-term growth and say M&S is still failing to tempt younger shoppers, who can choose from a myriad of fashion brands including Zara (>> Inditex SA) and Next (>> NEXT plc) and online-only players such as ASOS (>> ASOS plc).

"The top line performance is nothing sparkling, but the upside surprise is in the gross margin, where gains are significantly better than hoped," one major institutional investor in the retailer said.

M&S's update was its first since Steve Rowe's switch in July from running the food business to heading general merchandise.

ACCELERATION

"The team is really focussed to improve sales. However, not at the expense of margin," said Bolland, predicting a "spiky" market in terms of promotions in the run-up to Christmas and dismissing speculation he was considering the acquisition of third party brands.

Bolland said Rowe would accelerate improvements to M&S's clothing design and availability.

General merchandise sales at stores open over a year fell 1.9 percent in the 13 weeks to Sept. 26, its fiscal second quarter - at the bottom end of analysts' forecasts and following a first-quarter fall of 0.4 percent.

Bolland said this reflected unseasonal conditions and a decision to focus on full price sales.

Over the first half, online sales increased 34.2 percent, while like-for-like sales in stores were down 6 percent.

But the general merchandise division increased its gross margin by a greater than expected 2.85 percentage points and raised full-year guidance to up 2 to 2.5 percentage points from up 1 to 1.5 percentage points previously.

"This buys the company some time to rediscover the magic potion which may tempt younger shoppers into its stores," Richard Hunter, head of equities at Hargreaves Lansdown, said.

First-half underlying pretax profit rose 6.1 percent to 284 million pounds ($438 million), ahead of analysts' average forecast of 270 million, on total sales up 1.4 percent to 5.0 billion.

UK profits rose 14.6 percent, but overall profit growth was held back by a weak international performance, where profit slumped 52 percent, hurt by currency and macroeconomic issues particularly in Russia, Ukraine and Turkey.

In food, M&S is outperforming Britain's grocery industry, benefiting from product innovation and a focus on providing for special occasions.

Second quarter like-for-like sales in food rose 0.2 percent, a 24th straight quarterly increase.

Before Wednesday's update analysts' consensus for full 2015-16 year profit was 703 million pounds, up from 661 million in 2014-15. Haitong Research analyst Tony Shiret expects the consensus to rise by 10-15 million pounds.

Bolland declined to say how long he planned to stay as CEO but reiterated he would definitely be around to present full-year results in May.

"I'm enjoying this role tremendously," he said.

(Reporting by James Davey; editing by Kate Holton and Jane Merriman)

By James Davey

Stocks treated in this article : ASOS plc, NEXT plc, Marks and Spencer Group Plc, Inditex SA