File image of United Parcel Service aircraft loaded with air containers full of packages bound for their final destination at the UPS Worldport All Points International Hub
United Parcel Service aircraft are loaded with air containers full of packages bound for their final destination at the UPS Worldport All Points International Hub during the peak delivery day in Louisville, Kentucky, in this December 21, 2009 file image. REUTERS

United Parcel Service Inc. (NYSE: UPS) is expected to post third-quarter profits that match year-earlier results despite higher anticipated revenue as factories make fewer items for UPS to ship and customers choose cheaper delivery options amid weak economic conditions. The world’s biggest package-delivery company will also record a one-time charge as it restructures pension plans.

UPS, which reports earnings Tuesday before markets open, is likely to book a profit of $1.06 a share on revenue of $13.3 billion, based on the average estimate of analysts surveyed by Thomson Reuters. In the same period a year earlier, EPS was $1.06 on $13.17 billion in revenue.

Over the past three months, the consensus estimate has dropped from $1.20.

USP guided third-quarter expectations down during its second-quarter results announcement and stated that its results would be lower than the $1.06 posted in the same year-ago period.

For the year, the company expects earnings of $4.50 to $4.70 a share, down from a previous projection of $4.75 to $5 a share issued in January. This represents a 3 percent to 8 percent increase over 2011.

"As we look toward the second half of the year, customers are more concerned as greater uncertainty exists,” UPS said in July.

Economic growth around the globe has slowed. Output has declined in Japan, China and elsewhere in Asia. Several countries in Europe are in recession, and the U.S. is struggling with high unemployment and weak manufacturing growth.

“We expect UPS to be somewhat less successful in passing along rate increases until the U.S. and global economy shows more concrete signs of improvement,” S&P Capital IQ stock analyst Jim Corridore wrote in an Oct. 13 note.

The Atlanta-based shipping giant, considered an economic bellwether because of the number of products it ships and the number of countries in which it does business, projects the U.S. economy will expand 1 percent in the rest of the year.

UPS Chief Executive Officer Scott Davis said in July that the looming U.S. "fiscal cliff" -- the combination of spending cuts and tax increases scheduled to kick in early next year unless politicians reach a compromise -- already is crimping business investment and is likely to continue to do so.

“As we get closer to the fiscal cliff, there's just more uncertainty out there than ever, and it's hard for me to see how that's going to turn around until we get some policymaking done in Washington,” Davis said. “We have a three-, four-, five-year horizon. People cannot make decisions without that. So I think it's going to get tougher before it gets better.”

When UPS reports earnings results Tuesday, management will likely provide more color on the company’s €5.2 billion ($6.8 billion) bid for Dutch peer TNT Express NV (AMS: TNTE), which is currently facing tough scrutiny from European antitrust regulators. The potential merger, the biggest in UPS’s 105-year history, will reinforce UPS as the world’s No. 1 package delivery company.

Pension Restructure

The company announced in late August that it has reached an agreement with the New England Teamsters and Trucking Industry Pension Fund to establish a second pension-plan pool. The new structure is intended to make it more attractive for employees to join the fund, and allows UPS to freeze its liability in the original pool.

“This multi-employer pension fund is sharply underfunded (it is characterized as being in the red zone), and we believe that the withdrawal reduces future risk of an even greater liability related to future pensions for workers who were not UPS employees,” Thomas R. Wadewitz, transportation analyst at J.P. Morgan, wrote in an Aug. 24 note.

While the move bodes well for the future, UPS expects to record a charge of $896 million in the third quarter as the company restructures pension plans for around 10,200 employees. The one-time charge represents the current value of the $2.1 billion withdrawal liability from the original pool, which UPS will pay over the next 50 years.

High International Exposure

UPS, like other logistics heavyweights, has high international exposure, making it more vulnerable to the slowdown in world trade.

In 2011, UPS handled 2.4 million international shipments per day. Its international package delivery service accounted for 23 percent of total revenues last year.

International revenues have been hurt by a shift to shorter trade lanes (intra-Asia and intra-Europe) and away from the profitable long-haul trade lanes, such as Asia to the U.S. and Asia to Europe. Volumes to these trade lanes were down double-digits.

For the second half of this year, UPS anticipates daily export volume to grow at a slightly faster pace than what it was in the first half of the year. However, the company cautioned that this improvement is not indicative of economic expansion, but is more a result of beginning to lap last year's slowdown in Asia.

The company said it is planning another 10 percent reduction in its air capacity out of Asia after cutting the network by a similar amount in October 2011 because of steeper-than-expected declines in exports from the region.

"Clearly, things are weaker than we thought when we made plans for this year," Chief Financial Officer Kurt Kuehn said in a July 24 earnings conference call. The cuts to the Asian network are being made primarily by reducing flight frequencies, he added.

“We are taking our network down to beginning to get close to the point where we were at the low time in 2009,” Kuehn said. “We are fairly lean right now.”

Uncertainty At Home

Things aren’t looking much rosier at home.

While the international markets performed worse than expected, “the more material issue really has been the deceleration in the core domestic demand,” Kuehn said, referring to the recent trend that businesses of all sizes are more cautious thanks to the fiscal cliff and uncertainty surrounding the election.

According to Kuehn, average daily volume growth is expected to moderate. At the same time, customers are shying away from the more expensive ways to ship. In 2011, UPS handled 15.8 million domestic shipments per day.

“Although demand has remained at healthy levels in the U.S., it has come largely in the lower-priced ground segments,” Brandon R. Oglenski, analyst at Barclays Capital, wrote in a Sept. 13 note. “Growth has been driven by continued expansion of online e-commerce and direct retail shipments to consumers."

Compared to the higher-weight business-to-business standard air and ground shipments, e-commerce package growth is driving a shift to lower weight and lower yielding traffic mix at UPS.

Oglenski estimates the average package yield from SurePost -- a lower-priced product UPS offers to its current shippers as an alternate for higher-priced standard ground service -- is significantly below the average standard ground shipment.

SurePost involves UPS providing sorting and linehaul transport of packages with the U.S. Postal Service providing final mile delivery to consumers.

Q2 Recap

UPS undershot earnings expectations in July and cut its own full-year profit forecast, saying consumer confidence has been rattled by the European debt crisis and the looming "fiscal cliff."

Net income rose 2.2 percent to $1.15 a share, compared with $1.09 a share in the period a year earlier. Total revenue climbed 1.2 percent, to $13.3 billion.

Stock Performance

UPS generated more than $5 billion in free cash in 2011, after capital expenditures and pension payments, and analysts look for continued strong cash generation. “We believe the company is a strong generator of cash, and we favor its historical use of its funds to pay dividends and repurchase stock,” S&P Capital IQ Equity Analyst Jim Corridore wrote in an Oct. 13 note.

The company repurchased $870 million of shares in the first half of the year and is on track to repurchase $1.5 billion in fiscal 2012.

When taking into account share buybacks and dividends, UPS has a relatively high effective yield of 5.2 percent.

“We expect weak Asia airfreight demand and a soft U.S. economy to remain headwinds for UPS stock in the near term,” Wadewitz of J.P. Morgan said in a Sept. 28 note. “Nevertheless the medium term-story is attractive. We expect EPS accretion from the TNT deal and growth in B2C to remain meaningful drivers for UPS in the medium term.”

UPS’s major domestic competitors are FedEx Corporation (NYSE: FDX) and the U.S. Postal Service. UPS also competes with a variety of international operators, including Canada Post Corp., Purolator, DHL Express, Deutsche Post (and its subsidiary DHL), Royal Mail, Japan Post, India Post and many other regional, national postal services and air cargo handlers.

Shares of United Parcel Service Inc. (NYSE: UPS) closed up 32 cents, or 44 percent, to $73.61 apiece in Thursday’s trading. The stock is up less than 1 percent on the year.