* Q1 net profit falls as costs rise across the board
* Margins tumble even though promotional activity abates
* Head of flagship business unit steps down
* Shares fall 4.5 pct (Recasts, adds CEO comments, details, analysts)
MOSCOW, April 26 (Reuters) - X5 Retail Group said it needed a fresh look at its flagship cut-price store business in a tough market environment after disagreements over strategy with the unit's head resulted in her departure.
Russia's biggest food retailer, X5 has been pressing ahead with the expansion of its low-cost Pyaterochka chain as an economic downturn hit households' incomes, denting consumer spending.
Such stores, which at X5 contribute around 80 percent of all sales, generates stronger revenues when promotional activity is high but that eats into profit, making strategy a delicate balancing act.
Pyaterochka General Director Olga Naumova, praised by analysts for helping X5 regain its leadership of the retail market, has left her post, X5 said on Wednesday.
Igor Shekhterman, X5 chief executive, said the decision had been taken "after many months of difficult discussions with Olga about the core strategic principles."
He said Pyaterochka needed "a fresh approach" in a more challenging market environment, characterised by increasing competition and weak demand.
"We need a fresh look at the format's CVP (customer value proposition)," Shekhterman said.
Shares in X5 tumbled on the day of Naumova's departure and extended losses on Thursday as X5 reported a 33 percent drop in its first-quarter net profit to 5.6 billion roubles ($89 million) due partly to higher costs of expanding the chain.
Adjusted earnings before interest, taxes, depreciation and amortisation (EBITDA) were 2 percent lower at 22 billion roubles on revenue up 20 percent, resulting in an EBITDA margin sliding to 6.3 percent from 7.7 percent a year ago.
In a trading update last week, X5 had said Pyaterochka curbed promotional activity in the first quarter, resulting in a weaker growth of its like-for-like sales and a decline in the number of transactions.
"The vicious circle of discounting and higher promo is ultimately proving to be a negative sum game for all players, and retailers' investment cases increasingly depend on how quickly grocers are expected to scale back promo activity and return to more rational competition," the Aton brokerage said.
X5's London-listed shares were down 4.5 percent at 1415 GMT at $27.7. ($1 = 62.8410 roubles) (Reporting by Maria Kiselyova Editing by Jason Neely/Keith Weir)