(Corrects spelling of Coles CEO's last name in paragraph four)
* Wesfarmers lowest first-half profit in more than 10 years
* Coles earnings drop 14 pct, British hardware impairment drags
* Underlying net profit A$1.5 bln vs Morgan Stanley est. A$1.6 bln
* Wesfarmers shares up 3 pct, biggest gain in 2 yrs
By Tom Westbrook and Byron Kaye
SYDNEY, Feb 21 (Reuters) - Australian retail giant Wesfarmers Ltd said it saw signs of a recovery in its core grocery business after a price war with rival Woolworths Ltd, sending its shares sharply higher despite an 87 percent slump in first-half profit.
An expected $1 billion writedown on British hardware business Homebase, which dragged first-half profit to its lowest in more than a decade, was balanced by signs of a sales pickup at Australian No.2 supermarket chain Coles.
That suggests the company has weathered a decline in fresh produce prices and could be on the verge of snapping a more than year-long losing streak in market share against Woolworths, which reports on Friday.
"We're happy with the growth we're getting out of the business and we're happy more than anything with the rate of growth we're seeing in the last quarter," Coles CEO John Durkan said on an analyst call.
Wesfarmers said food and liquor sales, which account for about 55 percent of its overall sales, grew 0.9 percent in the six months to Dec. 31. The growth rate was higher in the second quarter, at 1.4 percent.
That was despite price deflation for food and liquor of 1.6 percent during the half, as a result of "lower fresh produce prices driven by seasonal factors", Wesfarmers said.
Wesfarmers shares closed up 3 percent, their biggest gain in two years, while the broader market was flat. The shares were however still below their last close before the company's Feb. 2 warning that it would take a roughly $1 billion writedown on Homebase.
"Many analysts have been bagging Coles and jumping on the Woolworths bandwagon so today's result was a reminder that Coles is turning around," said Daniel Mueller, a portfolio manager at Vertium Asset Management.
Including the Homebase writedown and several one-off items for food and liquor, Wesfarmers said net profit fell to A$212 million for the six-month period.
The Homebase investment, which is now under review, reported a A$165 million loss. The company said it would update the market on Homebase in June.
Elsewhere in the conglomerate, a buoyant coal price lifted industrials division earnings by 19.1 percent to A$449 million, and earnings rose in the domestic hardware, discount department store and office supplies businesses.
However, having agreed to sell its largest coal mine, Curragh, for A$700 million in December, the company will be even more reliant on Australia's competitive retail landscape, where sluggish wage growth has subdued consumer spending.
The company maintained its interim dividend at A$1.03 a share and expects to book an A$100 million post-tax gain on the sale of the Curragh mine. ($1 = 1.2690 Australian dollars) (Reporting by Byron Kaye and Tom Westbrook in Sydney; Additional reporting by Shashwat Pradhan in Bengaluru; Editing by Stephen Coates and Leslie Adler)