On July 22, United Parcel Services (NYSE:UPS), the world’s largest package delivery company, declared its adjusted second-quarter 2010 earnings of 84 cents per share, which surpassed the Zacks Consensus Estimate of 77 cents. Earnings per share shot up 71.4% year over year from 49 cents in the year-ago quarter. Earnings were driven by higher package volume as well as strong revenue growth.

On a reported basis, earnings saw a whopping increase of 90.9% year over year in the second quarter. In the year-ago quarter, UPS considered a $48 million one-time after-tax charge for the re-measurement of certain foreign currency obligations.

Total revenue increased 13% year over year to $12.2 billion, reflecting consolidated volume growth of 4% and a 7% increase in total revenue per piece. Adjusted operating income spurred 56% year over year to $1.4 billion, reflecting an operating margin of 11.5%, up 320 basis points year over year. Growth in the international sector outpaced growth in domestic sector.

Revenue Segments

US Domestic Package revenue climbed 7.1% year over year to $7.3 billion. Operating profit surged 57% from the year-ago quarter to $748.0 million, resulting in an operating margin of 10.3%, up 330 bps year over year. This increase was driven by higher yields and improved efficiencies. Average daily volume upped more than 1% during the quarter. Revenue per piece improved 6% due to increases in base pricing and higher fuel surcharges.
 
International Package revenue leaped 23% year over year to $2.8 billion.  Operating profit increased 78% from the year-ago quarter to $521.0 million, resulting in an operating margin of 18.8%, up 580 bps year over year. The strong growth in major regions with Asia led to a 15% increase in export volume. Non-U.S. domestic volume increased 24%, driven by strong organic growth in core European countries and Canada.

Supply Chain & Freight segment revenue increased 20.6% year over year to $2.16 billion. Operating profit increased 5% year over year to $133.0 million, resulting in an operating margin of 6.1%, down 90 bps from the year-ago quarter. Although UPS Freight returned to profitability in the second quarter, the margin contracted due to capacity constraints in the global air freight market.

Outlook

Despite the slow recovery in the U.S. and a cautious outlook in Europe, United Parcel increased its outlook on higher ground and export volumes. The company now projects adjusted earnings growth of 45%–50% for 2010. United Parcel raised its earnings per share guidance to a range of $3.35–$3.45 from $3.05–$3.30 per share. The mid-point of $3.40 cents per share is well above the current Zacks Consensus Estimate of $3.27 per share.

Our Analysis

With signs of economic recovery, although at a slower pace, we believe the company will benefit on its broad product portfolio, continued momentum in its segments, economies of scale, and significant investments made on the domestic as well as international front. However, the large European exposure, a slowdown in global trade and lower operating leverage could limit the upside for the stock.

As the company completes many of its large investment projects (e.g., Worldport expansion), we expect it to generate significant free cash flow over the next several years. These projects are subsequently expected to generate significant shareholder value and greater price appreciation.

Based on improving tends and fundamentals, we are maintaining our Buy recommendation with Zacks #2 Rank for the short term (1-3 months). However, we are currently reiterating our long-term Neutral recommendation on United Parcel Services.

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