By Lisa Baertlein
LOS ANGELES (Reuters) -United Parcel Service expects its newly won U.S. Postal Service (USPS) air cargo contract to be profitable in its first year and throughout the more than five-year deal, after rival FedEx (NYSE:FDX) struggled with the business, Chief Executive Carol Tome said on Tuesday.
Atlanta-based UPS will become the No. 1 USPS air cargo service provider on Sept. 30. It replaces FedEx, which was paid $1.75 billion in fiscal 2023 to provide Priority Mail and other speedy air services for the quasi-governmental agency.
FedEx held the contract for more than two decades, but recently struggled to squeeze out profits after the postal service shifted volume from planes to trucks in a bid to slash costs.
While some analysts and investors worry that UPS is sweeping up a money-losing business, the delivery firm said it can profit from the new deal because it has a unified network that lowers costs by reducing the distances postal service shipments travel.
"In contrast to traditional hub and spoke models, we don't have to run all of the air volume through our main air hub" in Louisville, Kentucky, Tome said.
That means short-distance USPS shipments can be moved locally or regionally. FedEx was built on a hub and spoke model.
The unified network at UPS makes it easier for the company to make money from the work, said Satish Jindel, an industry expert who helped found a company purchased by FedEx.
CEO Tome on an earnings call said the deal will be margin accretive and earnings per share accretive to UPS "beginning in year one and through the life of the contract."
The company reported better-than-expected quarterly profit on Tuesday as cost cuts offset still-soft demand for package delivery.
While the financial terms have not been disclosed, the contract promises to significantly increase the company's U.S. Postal Service business from $308 million in fiscal 2023.
UPS Chief Financial Officer Brian Newman told Reuters in a telephone interview that $1.5 billion is a "good placeholder" for revenue from the new contract.
Annual postal service payments to FedEx declined after peaking at $2.40 billion in fiscal 2020. That starved the daytime air operation that FedEx created for the business of the volume it needed to keep planes about 70% full and generating profit, analysts and postal service experts told Reuters.
UPS has "plenty of space on aircraft" for the additional volume and will hire fewer than 200 pilots, Tome said.
Switching shipments from planes to trucks saved $1 billion at the post office, which plans to cut another $2 billion from its transportation costs. That forecast suggests that even more of its volume could move to lower-margin ground services.
CFO Newman declined to say if UPS would handle postal business that is diverted from planes to trucks.
The company will update its guidance to reflect the new business after the second quarter, Tome said.
Some Wall Street analysts remained cautious. Pressure to quickly absorb the business, high service costs and other factors could weigh on UPS margins, Third Bridge analyst Anthony DeRuijter said.
Meanwhile, UPS is working closely with the postal service to onboard the business ahead of this year's busy holiday shipping season that stretches from Thanksgiving to Christmas, executives said.