By Nick Carey

CHICAGO (Reuters) - United Parcel Service on Tuesday reported an in-line profit that was hit by fuel costs and a weak U.S. economy, but the package delivery company's shares rose more than 3 percent as analysts said it was performing well despite multiple challenges.

UPS, considered a bellwether of U.S. economic health like its main rival FedEx Corp , said it expected the second half of the year to generate "modestly better results" than in the first half.

"In the short term, UPS faces tremendous headwinds in terms of profits thanks to fuel and the U.S. economy, but they are managing through it pretty well," said David Sandell, a portfolio manager at New York-based Leeb Capital Management, which manages assets of around $170 million. Leeb sold off its UPS shares last year but monitors the stock closely.

Sandell said UPS shares represent good value long term and when asked if it was time to invest in them, he said: "It's getting close to that point."

Fuel prices moving forward will play a crucial role in the recovery prospects of both the U.S. economy and UPS, he added.

Atlanta-based UPS reported quarterly net income of $873 million, or 85 cents per share, compared with $1.10 billion, or $1.04, a year earlier.

Analysts had on average expected earnings per share for the quarter of 85 cents, according to Reuters Estimates.

"Slow U.S. economic activity and fuel price increases hit us and our customers during the quarter," Chief Financial Officer Kurt Kuehn said in a statement.

UPS reported revenue for the quarter of $13.0 billion, up 6.7 percent from the $12.2 billion it reported for the second quarter of 2007. Analysts had expected revenue for the quarter of $12.8 billion.

Revenue at the company's domestic U.S. package service rose to $7.7 billion from $7.6 billion, but the average daily package volume dipped to 13.1 million from 13.2 million. UPS said it had seen a "more pronounced" shift by customers to lower-cost services from its premium products.

The company said revenue at its international segment rose to $2.95 billion from $2.5 billion, but added that results were negatively impacted by fuel costs and declining U.S. import volumes.

"We continue to favor UPS as a great 2009 and beyond story that is well positioned to begin to expand its core Domestic Package margins for years to come," Edward Wolfe of Wolfe Research wrote in a note for clients. "There is nothing in UPS report to change our view and we continue to recommend buying UPS aggressively at current levels."

For the full year, UPS said it expects earnings per share from $2.50 to $3.70. Analysts have predicted earnings per share for 2008 of $3.61.

UPS said that would translate to a range of $1.78 to &1.98 per share for the second half of the year compared with a first-half performance of $1.72.

On a conference call with analysts, UPS Chief Executive Scott Davis said the company was "making good progress" toward concluding a 10-year agreement with Deutsche Post express unit DHL to haul packages by air for DHL within the United States, and between the United States, Canada and Mexico. DHL and UPS said during the second quarter that they were working toward a 10-year deal.

DHL has struggled to become profitable in the U.S. market, which is dominated by UPS and FedEx.

In a research note for clients, Robert W. Baird analyst Jon Langenfeld wrote that heading into 2009, UPS would benefit from the DHL agreement, its new contract with the Teamsters union and accretion from its share buyback program. But fuel prices remain a major concern.

"Elevated fuel prices could permanently destroy demand in favor of lower priced and less profitably deferred and ground services" Langenfeld wrote. "With limited visibility to fuel prices and the current industry demand destruction from the elevated surcharges, we believe the stock warrants a Neutral rating."

In early trading on the New York Stock Exchange, UPS shares rose $1.99, or 3.3 percent, to $61.45.

(Editing by Maureen Bavdek)

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