(UPS) UPS 2011 Forth Quarter Earnings

United Parcel Services (UPS), the world’s largest package delivery company, is slated to release its fourth quarter and fiscal 2011 earnings on January 31, before the opening bell. The current Zacks Consensus Estimates for the fourth quarter and fiscal 2011 are pegged at $1.26 and $4.25, respectively, representing substantial year-over-year increase of 16.23% and 19.25%.

Looking at surprises, UPS posted an average positive surprise of 2.04% in the trailing four quarters. Hence, we will not be surprised if the carrier beats expectations in fourth quarter 2011, attributable to operating leverage with improved pricing and strong volume, yield improvement in the U.S. Domestic Package division andthe ramp in share buybacks.

During the third quarter conference call, UPS reaffirmed its adjusted earnings guidance of $4.15 to $4.40 per share for fiscal 2011. The company expects to deliver healthy revenue and margin expansion, driving earnings per share above the previous peak levels. In addition, it expects to post record profits in 2011.

Last week, UPS changed its pension accounting method, which included booking of actuarial gains and losses for the year rather than amortizing them over time. This move is expected to result in a pre-tax charge of $827 million in fiscal 2011 and will dilute earnings per share by 51 cents and 41 cents in the fourth quarter and 2011, respectively.

Nevertheless, the new accounting system will boost adjusted earnings per share by 3 cents in the fourth quarter and 12 cents in 2011.

Third Quarter Flashback

Despite the weak exports from Asia and challenging economy, the company’s third quarter earnings surpassed the Zacks Consensus Estimate by a penny and improved substantially from the year-ago earnings.

Revenue also improved year over year but fell shy of the Zacks Consensus Estimate. US Domestic Package, and Supply Chain and Freight segments performed well during the quarter with increased operating margins. The margin expansion in the US Domestic Package was driven by higher yields, positive product mix and improved network efficiencies while the Freight business led to strong margins in the Supply Chain and Freight segment.

International Package, on the other hand, delivered lackluster performance due to lower trades to Asia-to-US lane, surging fuel price, unfavorable product mix and currency fluctuations and negatively impacted overall results.

Agreement of Analysts

Estimates reflect a positive bias for both the fourth quarter and fiscal 2011 over the last 30 days. 4 analysts out of 21 and 2 analysts out of 22 made upward revisions for the fourth quarter and fiscal 2011, respectively. None of the analysts moved in the opposite direction.

The analysts have raised their estimates based on the new accounting method, and expect continued healthy performance in the Supply Chain and Freight segment and improved margins in Domestic Package to fuel profitability further. In addition, International Package, which was the dampener in the third quarter, is expected to grow with improved Asian exports driven by solid holiday shipments, new product launches and low inventories.

Further, the analysts were impressed with UPS’s strong commitment to return value to its shareholders. The company started 2011 with an 11% hike in its quarterly dividend to 52 cents per share from 47 cents. With respect to buyback, UPS boosted its repurchase capacity by 35% to $2.7 billion in 2011 and expects to repurchase shares worth $8 billion between 2012 and 2014.

In 2010, UPS distributed $1.8 billion in dividends and repurchased $800 million shares. In the first nine months of 2011, dividend payments and share repurchases were $1.5 billion and $2.2 billion, respectively.

Magnitude — Consensus Estimate Trend

The magnitude of the fourth quarter estimate revisions remained unchanged at $1.26 over the last 7 days but was up by a penny over the last 30 days.

Similarly, the Zacks Consensus Estimate of $4.25 for fiscal 2011 remained static over the last 7 days but was up by a penny over the last 30 days.

Our Recommendation

We are encouraged by management’s increased confidence to deliver solid earnings growth in 2011 on volume growth, improved pricing, domestic margin expansion, freight recovery and accelerated free cash flow. Further, revenue and earnings growth projections coupled with the hike in shareholder returns inspire our optimism on the stock.

Although UPS is expected to generate record earnings per share in 2011, we remain cautious on sluggish U.S. economic growth, uncertainty surrounding Euro-zone debt crisis, surging fuel prices, unionized workforce and intense competition, particularly from FedEx Corporation (FDX) that could restrict the near-term upside potential.

We are currently maintaining our long-term Neutral recommendation on UPS. The stock retains a Zacks #3 Rank (Hold) for the short term (1-3 months).

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