Since this basically transcodes the video to mp2vtwice, it'll look like crap.
Might try using h264 instead... actually scratch that, I tested h264 and it wont stretch?
I have the same problem, a video that's 720x480 buts wants to play at 4:3. The windows player can force it to 16:9, but streaming it at that (to appleTV) is strangely difficult. After some quick experiments, here's one roundabout way of fixing it (works in vlc 2.0.7): Use your own video's width and ...