Two iconic American companies are in process of restructuring after operationally underperforming, but which is the better buy right now: General Electric (GE -0.33%) or Coca-Cola (KO -0.80%)? The answer may largely come down to what each company's management is doing to generate value for shareholders.
General Electric's negative exposure to the coronavirus pandemic is obvious -- GE Aviation, with its aircraft engines and aftermarket parts, provides the largest portion of its earnings. But the ways that it's impacting Coca-Cola are also deep, if less obvious.
The beverage company relies heavily on what management calls the away-from-home market -- in other words, restaurants, hospitality and leisure destinations, etc. In fact, the away-from-home sales channels provide around half of Coca-Cola's global revenue. In the third quarter, with away-from-home volume down by a mid-teens percentage, the company's revenue and operating income fell 9% and 8%, respectively.
The declines in 2020 are masking the results of Coca-Cola management's ongoing restructuring initiatives.
In a nutshell, CEO James Quincey is engaged in refocusing the business on growing its stronger brands and significantly improve marketing efficiency. The company recently announced it would be eliminating about 200 brands from its portfolio -- about half of its total. In addition, Coca-Cola's 17 global business units will be reorganized into nine operating units. The intent of that move is to speed up decision-making at the company.
It's all aimed at improving profitability and free cash flow. The latter metric will be particularly important to income investors as the company has been struggling to cover its dividends with free cash flow lately.
As counter-intuitive as it may sound, GE actually has a number of things in common with Coca-Cola. The industrial company also began 2020 in the midst of a significant restructuring that management had undertaken in order to improve profitability and free cash flow.
CEO Larry Culp is overseeing a restructuring of GE's power and renewable energy segments. The near-term goal is for them to start generating cash flow in 2021 and 2022 respectively. In the longer term, the aim is to pull those segments' margins up to the levels of their peers, such as Vestas and Siemens Gamesa in renewable energy, and Siemens Energy in power.
In the meantime, the healthcare segment can be relied upon to provide $1 billion-plus in annual free cash flow and solid growth. And, before the pandemic hit, GE Aviation was expected to generate at least $4.4 billion in free cash flow in 2020.
Unfortunately, the realities of this year have held back those aspirations and significantly reduced GE Aviation's earnings. It's going to be at least a couple of years before GE gets back to generating FCF at anywhere close to a level that would justify its $85 billion market cap.
As such, investors should think of GE is as a company with two stories. The first is a tale of growth opportunities based on the restructuring of its power and renewable energy businesses. The second, parallel narrative will involve the long, slow recovery story of GE Aviation. In order for investors to have confidence that the latter story will have a happy ending, the plot will have to include wide-scale distribution of effective coronavirus vaccines. Fortunately, recent events in the healthcare world strongly suggest that the questions on that front are now matters of when, not if.
Finally, turning to the issue of valuation, it's interesting that the two companies trade at similar price-to-FCF multiples.
General Electric or Coca-Cola?
There's nothing to stop an investor from buying both of these stocks, but of the two, General Electric looks like the more attractive option today. Provided that the coronavirus pandemic can be beaten, GE will have greater opportunities to increase its earnings and cash flow than Coca-Cola.
Both stocks should do well in a post-pandemic world, but GE Aviation has a substantial opportunity to embark on a multiyear recovery, and there are already signs that its power and renewable energy units are on track to increase their margins. Moreover, GE has clear targets to aim for based on the margins achieved by its peers. Coca-Cola is somewhat in uncharted territory, and its valuation looks expensive given its long-term prospects.
GE's recovery will take years, but if you are looking for a stock to buy and hold for the long term, it looks to have more upside potential than Coca-Cola right now.