Top U.S. auto dealer chain AutoNation Inc posted a 29 percent drop in quarterly earnings, but forecast an improving market after slashing inventory costs and seeing a sharp gain in July sales.

The downward spiral has been broken, AutoNation Chief Executive Mike Jackson said. We saw a stabilization in sales in the second quarter and there will be a recovery in auto sales. There's no question about it.

AutoNation's showroom traffic jumped by 36 percent over the past week since the introduction of the U.S. government's cash for clunkers sales incentive, Jackson told Reuters.

In addition, the company increased new vehicle orders by 45 percent in the second quarter to prepare for an anticipated recovery in industrywide auto sales.

Second-quarter net earnings fell 29 percent to $36.7 million, or 21 cents per share, from $51.8 million, or 29 cents per share, a year earlier. Revenue dropped 29 percent to $2.6 billion.

Excluding one-time items, earnings from continuing operations were 29 cents per share. That was above the 25 cents that analysts on average had forecast on that basis, according to Reuters Estimates.

AutoNation shares were down just over 2 percent at $20.15 on Friday. The stock has gained about 37 percent since mid-May as investors began to react to signs of stabilizing auto sales.

JP Morgan analyst Himanshu Patel said in a note to clients that the strong rally for auto retailers had made it hard to expect further immediate gains for AutoNation shares.

It was a solid quarter in which AutoNation demonstrated its ability to remain firmly profitable despite tough industry conditions, Patel said.

CASH FOR CLUNKERS

U.S. officials said on Thursday that the popularity of the cash for clunkers program might have exhausted the $1 billion in funding for the incentives just a week into the launch.

The federal program, which was modeled on similar government-run incentives in Europe, offers consumers up to $4,500 to trade in older and less fuel-efficient vehicles to be scrapped.

Jackson said the program had become the most successful economic stimulus policy to date from the U.S. government and said there was a strong case for the administration and Congress to find expanded funding for it now.

Speaking to analysts on a conference call, Jackson said he expected U.S. officials to move heaven and earth to find additional funding for the cash for clunkers program because of its initial success.

Jackson said that the second-quarter marked a pivotal moment for the auto industry because of the government- sponsored bankruptcies for General Motors Co and Chrysler Group.

Stabilizing industry-wide U.S. sales and higher prices for used trucks and SUVs have also been positive factors that suggest a turning point, he said.

Although AutoNation has been reducing its exposure to U.S. automakers for the past five years, Jackson said he believed the Detroit automakers had turned a corner.

I would say at the right price, I would definitely be interested in a Chevy or a Ford store. I think it's a new world, he told analysts.

In addition to buying dealerships, Jackson also said AutoNation would consider using cash to repurchase debt and its own shares.

AutoNation is the largest U.S. dealership chain by sales. The Fort Lauderdale, Florida-based company operates 264 dealerships in 15 states.

Toyota Motor Corp <7203.T>, Honda Motor Co Ltd <7267.T> and Ford Motor Co vehicles represent almost half of its new car sales taken together.

(Reporting by Kevin Krolicki; editing by Derek Caney and Andre Grenon)

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