United Parcel Service (NYSE:UPS) will announce its third quarter earnings on coming Tuesday, October 23.^[1] The company has posted moderate growth in revenues and operating profit in the first-half of this year. Revenue was $26.5 billion, up 2.8% y-o-y, and operating profit was $3.4 billion, up 4.4% y-o-y, in the six months ended June 30, 2012.^[2] This growth has been driven by higher domestic U.S. delivery demand, partially offset by lower international delivery demand. In particular, the steep decline in export demand from Asia to Europe and the U.S. has impacted UPS’ earnings in 2012 so far.

In the third quarter these trends have persisted. As the U.S. economy has continued to grow at a moderate pace, this has provided growth to domestic U.S. delivery demand. The slowdown in Europe is expected to have impacted imports from Asia, resulting in a decline in export delivery demand from Asia. In addition, UPS’ planned 10% reduction in air capacity in Asia in Q3 should help the company margins.

On the whole, we anticipate UPS to post moderate growth in third quarter earnings driven by growth in domestic U.S. package delivery demand, partially offset by decline in international package delivery demand. We currently have a stock price estimate of $85.23 for the company, approximately 15% above its current market price.

See our complete analysis of UPS here

Domestic U.S. delivery demand to drive earnings growth

The U.S. economy has continued to expand at a moderate pace in the third quarter. This will allow for growth in the Domestic U.S. Delivery division of the company. Additionally, industrial production and retail sales, particularly online retail sales have continued to grow, and this will provide for growth in the small package delivery market in the U.S.. Thus, we anticipate the domestic U.S. delivery demand to drive earnings growth for UPS in the third quarter. In the six months ended June 30, 2012, revenues for UPS’ Domestic U.S. Delivery division have increased 5.1% y-o-y and operating profit has increased 13.4% y-o-y.^[2]

Also, the stable demand environment in the domestic U.S. delivery market has also allowed UPS to increase shipping rates. The average revenue per package for domestic U.S. operations has increased 1.1% y-o-y in the first-half of 2012.^[2]

International delivery demand to continue to decline

However, in the international markets, particularly in Europe economic growth has slowed. This slower economic growth has caused customers to shift from premium express services to low-end ground based services and deferred shipping. The economic slowdown has also caused a sharp decline in export demand from Asia to Europe and the U.S. In the six months ended June 30, 2012, total revenues for UPS’ international delivery division declined 1% y-o-y to $5.98 billion.^[2] The decline in demand also impacted the company’s yield from its international operations. Its average revenue per package for these operations declined 1.4% y-o-y in the first-half of the current year.^[2]

In the third quarter, we anticipate the trend to continue as the economic environment in Europe has not improved. However, the company’s planned 10% reduction in air capacity in Asia as export demand has waned and as customers have increasingly shifted to low-end services, will improve its operating margins.

All in all, UPS is expected to post moderate growth in its third quarter earnings driven by moderate rise in domestic U.S. delivery demand, partially offset by decline in international delivery demand.

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