7/23/2010
By David Urani, Research Analyst

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UPS' strong second quarter earnings results came in strongly as the shipping giant delivered $12.2 billion of sales, beating the consensus by $200 million, while its net earnings of $0.84 per share blew past the $0.77 per share consensus. Net income was 71% higher than a year ago on a 13% increase in sales. After those results you'd think economic activity was resurging, but that wasn't quite the case. UPS is a masterfully managed company and that was on display in the second quarter.

On the top line, UPS' sales increase of 7.1% year over year was good, although volumes only increased by a modest 3.6%. A significant contributor to the top line growth was the Company's rate increase at the beginning of the year which increased base rates for both ground and air shipments by 4.9%. Even on the volume end, economic factors were not the whole story, as its flourishing international business partly reflects strategic moves by management to tap into new markets. Among those moves are a venture with Turkish shipper Unsped Paket Servisi and a newly opened hub in Shenzhen, China. Total international package volumes were 20.1% higher year over year, which was a strong enough result for investors to overlook the mere 1.2% growth domestically.

The bottom line is where UPS really made a big jump, with the Company raising its operating margin for the second quarter to 11.5% from 8.3% in the previous year and from 8.9% in the first quarter. Despite experiencing higher purchased transportation costs and fuel expenses during the quarter, various tweaks to the operating structure made for a huge improvement in the bottom line. The company has had a significant overcapacity throughout the recession as demand fell, and in the second quarter it was evident UPS succeeded in right-sizing its business for the current climate. In January, it announced layoffs of 1,800 management and administrative positions, which was a contributing factor in the decrease in compensation expense to 53.4% of revenue in the second quarter from 55.8% in the first quarter.

Aside from staff, UPS continues upon the path of innovation that has made it a worldwide shipping leader, with various initiatives to cut down on everyday operating costs. To start with, it recently finished a $1 billion expansion of its Worldport hub. Already a technical wonder, the improved hub can now process 37% more packages per hour with 51 additional miles of conveyor belts, giving it a total of 155 miles. It also launched its new Smart Pickup system in March. Smart Pickup is an automated system that synchronizes UPS and business clients to allow UPS vehicles to arrive to pick up packages only when they are ready to ship. The system is expected to cut 8 million driving miles and 793,000 gallons of fuel per year.

Certainly, the global economic climate is still very uncertain, and in terms of global shipping that could cause some volatility in volumes. However, UPS in showing how cutting edge leadership can make a difference in a difficult situation. In all aspects of its business, from pricing to international expansion, to saving a few gallons of gas here and there, UPS has improved its operations over the past year. When economic conditions do eventually return to normal, you can be sure that those initiatives are going to become increasingly evident and that's what makes UPS an attractive holding. 

David Urani
Wall Street Strategies