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United Parcel Service, Inc. (UPS - Analyst Report) reported second quarter 2013 adjusted earnings per share of $1.13, in line with the Zacks Consensus Estimate and consistent with its own projection given last week. Earnings per share came in below $1.15 earned in the corresponding quarter last year. Earnings were primarily affected by a poor market scenario in freight forwarding services and lower profits from International Package.

Total revenue for the quarter grew 1.2% year over year to $13,507 million but fell short of the Zacks Consensus Estimate of $13,636 million. Growth in volumes and higher revenues from the U.S. Domestic Package segment aided revenue accretion.

Total operating profit dipped 2.7% year over year to $1,742 million. Operating margin also deteriorated 50 basis points (bps) year over year to 12.9%.

Revenue Segments

US Domestic Package revenues rose 2.3% year over year to $8,241 million in the reported quarter. Operating profit dropped 0.2% year over year to $1,132 million. Operating margin fell 40 bps year over year to 13.7%. The margin contraction was due to unfavorable customer and product mix followed by higher pension costs and difficult year-over-year comparisons for fuel surcharges.

Average daily volume increased 1.9% on increased online shopping. Revenue per piece improved 0.3% year over year driven by higher rates.

International Package revenues rose 1.6% year over year to $3,062 million. Operating profit fell 0.7% year over year to $451 million and operating margin contracted 40 bps to 14.7%. Average daily volume grew 5.0% year over year on strong international shipments in Europe and Asia. Revenue per piece fell 3.4% year over year.
    
Supply Chain and Freight segment revenues were down 3.2% year over year at $2,204 million. Operating profit plunged 21.3% year over year to $159 million. Operating margin contracted 170 bps year over year to 7.2%. The decline in profits and margin contraction is mainly due to pressure on the company’s freight forwarding business owing to lower demand across trans-Pacific business networks.

Liquidity    

UPS generated free cash flow of $2.5 billion and spent $990 million in the second quarter. The company also repurchased 21.8 million shares worth $1.8 billion and paid dividends of $1.1 billion.

Guidance

As guided on Jul 12, 2013 adjusted diluted earnings per share are likely to the range between $4.65 and $4.85. The projection represents year-over-year growth of 3% to 7%. In the second half of the year, the company expects earnings growth to accelerate, representing growth rate of 4% to 13%.

Our Analysis

Despite the challenging macroeconomic conditions, UPS has a strong hold within the industry with a focused approach towards expansion, various strategic measures, collaborations with other leading firms, a well-defined business model and constant technology upgrades.

Its integrated sales approach also promises growth given its industry-leading margins and financial strength. However, we remain concerned about the volatile economy condition that continues to restrict market demand. Further, rising pension headwinds also keep us on the sidelines.

UPS, which operates with the likes of FedEx Corporation (FDX - Analyst Report), Expeditors International of Washington Inc. (EXPD - Analyst Report) and Radiant Logistics, Inc. (RLGT - Snapshot Report) retains a Zacks Rank # 4 (Sell).

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