Before the opening bell, United Parcel Services (UPS) reported fourth quarter adjusted earnings of $1.28 per share outpacing the Zacks Consensus Estimate of $1.26. Earnings per share of the world’s largest package delivery company grew a substantial 20.7% from $1.06 in the year-ago quarter.

Healthy US Domestic as well as International Packages and freight performances led to the earnings improvement in the quarter. On a GAAP basis, diluted earnings per share in the quarter were 74 cents, down 27.5% year over year from $1.02.

The adjusted earnings for the quarter exclude the negative impacts of $527 million related to after tax charges arising from the change in pension accounting method. 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.

Adjusted earnings for the full year were $4.35 compared to $3.48 a year ago. Adjusted earnings for 2011 exclude an after-tax impact of $507 million. On a GAAP basis, earnings improved 15.3% year over year to $3.84

Total revenue for the quarter grew 5.6% year over year to $14.2 billion but was shy of the Zacks Consensus Estimate of $14.4 billion. The year-over-year increase in revenue reflects consolidated volume growth of 3.6% and a 2.9% rise in revenue per piece. Adjusted operating income increased 17.3% year over year to $2.02 billion, reflecting an operating margin of 14.3%, up 140 basis points (bps) from 12.9% in the year-ago quarter.

For fiscal 2011, total revenue increased 7.2% year over year to $53.1 billion, representing consolidated volume growth of 1.8% and a 5.7% upside in revenue per piece. Adjusted operating income increased 20.1% year over year to $6.9 billion.

Revenue Segments

US Domestic Package revenue rose 7.3% year over year to $8.7 billion in the reported quarter. Adjusted operating profit leaped 30% from the year-ago quarter to $1.3 billion, resulting in a 260 bps expansion in operating margin to 15.2%.

The margin expansion was driven by higher yields, positive product mix and improved network efficiencies. Average daily volume increased 3.8% due to growth in online shopping. Revenue per piece improved 3.4% year over year driven by higher rates and fuel surcharges that offset lower package weight and changes in customers and products mix.

International Package revenue climbed 3.5% year over year to $3.2 billion. Adjusted operating profit fell 4.5% year over year to $505 million in the reported quarter and operating margin contracted to 16% from 17.4% in the year ago quarter. Lackluster margin performance was based on lower trades to Asia-to-US lane and currency fluctuations.

Average daily volume enhanced 2.6% year over year on a 4.5% growth in export average daily volumes. The upside in average daily volumes was on the back of more than 1 million shipments on an average daily basis for the first time ever in the Company’s record. Domestic average daily volumes inched up 1.3% year over year. Revenue per piece grew 2.0% from the year-ago quarter.

In the fourth quarter, the company introduced two new return services to 30 countries across Europe. UPS Returns Exchange and UPS Returns Pack and Collect products that enables reverse logistics solutions to on-line retailers.

Supply Chain and Freight segment revenue grew 2.1% to $2.3 billion and adjusted operating profit climbed 10.6% to $199 million from the year-ago quarter. Operating margin expanded 70 bps year over year to 8.5%, primarily attributable to strong growth in the Freight business.

During the fourth quarter, the company acquired Pieffe Group, an Italian pharmaceutical logistics company. The company expects the acquisition to be accretive to the global healthcare market businesses.

Liquidity

UPS generated free cash flow of $5 billion and spent $2 billion while pension contributions were $1.4 billion in fiscal 2011. The company repurchased 38.7 million shares for approximately $2.7 billion in 2011.

Guidance

Based on strong performance in the fourth quarter, UPS reiterated its adjusted earnings guidance of $4.75 to $5.00 per share for fiscal 2012. The mid-point ($4.87) is above the current Zacks Consensus Estimate of $4.80. Cash flow are expected to remain strong providing increased returns to shareholders

Our Analysis

We believe healthy performance in the Supply Chain and Freight segment, strong export volumes in International Package and improved margins in Domestic Package will fuel future profitability. Besides, UPS continues to enhance shareholders’ value in the form of higher dividends and share buybacks.

These factors are expected to boost profitability going forward. However, competitive threats, labor unionization, large European exposure and competitive threats, particularly from FedEx Corporation (FDX) keep us cautious on the stock.

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

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