UPS ( UPS) shares fell Monday after a report that the company is looking to cancel more than a billion dollars in aircraft orders with Airbus because of a switch in consumer preferences and the shipper's efforts to streamline operations. According to The Wall Street Journal, which cited sources close to the deal, the world's largest shipment company is in negotiations to cancel about $1.6 billion in orders for the A300-600 aircraft. Mary Anne Greczyn, a spokesperson for Airbus, a joint venture of EADS and BAE Systems ( BAESY.PK), confirmed that the company was talking with UPS and said "There haven't been any cancellations, and the contract had not been changed." Recently, UPS shares fell 75 cents, or 1.1%, to $69.88, while rival FedEx ( FDX) dipped 33 cents, or 0.5%, to $68.35. Terms of the contract are not available, but Howard Rubel, an analyst at Schwab Soundview Capital Markets, said in a research report "There is no question that UPS wants to walk away from this order" Rubel said that UPS may be able to cancel orders for planes if construction has yet to begin on them, adding that a UPS cancellation would likely be the end of the A300-600, since the shipping company is the A-300's biggest customer. "Should UPS walk, this would spell the end of the line for the A300-600, a line that we estimate was producing about nine planes per year out of a total line of 300 planes. There could be some adverse financial impact on EADS as a consequence of this," said Rubel. "It is possible Airbus would like UPS to buy the A380." Over the last three years, customers have moved away from more expensive air shipments to ground shipments, and analysts say this has forced UPS to adjust its fleet planning, especially for domestic operations. A recent report from Morgan Stanley said that demand for air express grew 2% year over year in January, down from the 7% year-over-year growth seen during December.
And while international air shipments are a growing and lucrative part of UPS' business mix, with revenue up 17% year over year in the fourth quarter, the A300-600s are not used on trans-Atlantic or trans-Pacific routes. "What you're seeing in the marketplace is a secular shift of air products being moved on the ground," said Mark Davis, analyst at FTN Midwest Research. "This is not a surprise. UPS is the best operator out there in terms of operating its network, and if this is something they're looking at doing, it could be an opportunity to drive greater efficiencies. We view it as positive." (FTN Midwest has no banking relationships with the companies it covers.) Indeed, the renegotiation of the Airbus contract is part of UPS' $600 million initiative to make its network more efficient, using software to pick the cheapest and quickest routes in shipping packages. UPS expects to save $600 million a year with the new program. At the core of these efficiency efforts is Volcano, UPS' system for optimizing air shipments out of Worldport, the company's massive package sorting hub in Louisville, Ky. According to a report in InformationWeek, by using Volcano to decide how to best use its fleet, UPS only leased one plane to handle the peak Christmas period, saving the company millions. Ultimately, Davis said that UPS will be successful in renegotiating some kind of a deal with Airbus. If the contract is extremely firm, then UPS may be allowed to defer aircraft or apply the value of the contract to other Airbus models. "Obviously, UPS is a major flagship customer for Airbus, and they tend to get favorable terms and can negotiate," he said, adding that a deal won't have a major impact on earnings. "If they're canceling orders, there may be some minor impact in terms of penalties, but if you're not bringing in aircraft, there are savings in other areas."