The novel coronavirus (COVID-19) pandemic is forcing many companies to suspend their buybacks and dividends to conserve cash. As a result, many dividend stocks are losing their luster in this brutal bear market.

One such stock is Western Digital (NASDAQ:WDC), which spent 291% of its free cash flow (FCF) on its dividend over the past 12 months. That lofty cash dividend payout ratio initially seems unsustainable, so will this hard disk drive manufacturer and data storage company be forced to reduce its forward yield of 4.6% in the near future?

Four open and overturned HDDs on top of other HDDs.

Image source: Getty Images.

Passing a cyclical trough

Western Digital's revenue and earnings declined over the past year as it struggled with two main headwinds. First, its flash memory and solid-state drive (SSD) business struggled as a supply glut crushed market prices. Second, demand for its platter-based hard disk drives (HDDs) fell as PC manufacturers and data center customers faced longer upgrade cycles.

Growth (YOY)

Q2 2019

Q3 2019

Q4 2019

Q1 2020

Q2 2020

Revenue

(21%)

(27%)

(29%)

(20%)

0%

Non-GAAP EPS

(63%)

(95%)

(95%)

(89%)

(57%)

YOY = Year-over-year. Source: WD quarterly reports.

However, Western Digital's revenue growth stabilized last quarter as flash memory prices gradually improved. Those prices should continue rising as memory chipmakers produce fewer chips and demand from the PC and data center markets (which both benefit from people working from home and accessing cloud-based services) rises.

PC makers will likely buy more HDDs to serve remote workers, and data center customers should buy more drives as they deal with higher storage and bandwidth requirements through the pandemic.

Micron (NASDAQ:MU) confirmed those trends in its recent second-quarter earnings report. The memory chipmaker declared it was already seeing supply shortages in the data center market, and expected to sell more chips to PC manufacturers as employees worked from home and students enrolled in virtual classes. In short, demand for Western Digital's memory chips and disk drives could continue rising throughout the crisis.

At the end of January, WD expected its third-quarter revenue to rise 12%-17% annually, with more than five-fold growth in its non-GAAP earnings. Western Digital didn't reduce that guidance after the outbreak intensified in March. Western Digital's rival Seagate (NASDAQ:STX) also previously stated that it didn't expect a "material financial impact" from COVID-19 in its March quarter.

Is Western Digital financially sound?

Western Digital's dividend looked dangerously unsustainable last year as its dividend payments overwhelmed its free cash flow. However, that ratio improved significantly in the first half of 2020 as the aforementioned tailwinds kicked in:

Millions USD

Q2 2019

Q3 2019

Q4 2019

Q1 2020

Q2 2020

Free cash flow

$24

($110)

($179)

$294

$377

Dividends paid

($144)

($146)

($146)

($147)

($149)

YOY = Year-over-year. Source: WD quarterly reports.

Western Digital's guidance for the third quarter indicates its cash dividend payout ratio could drop below 100% on a trailing 12-month basis by the end of the year.

Western Digital ended last quarter with $3.14 billion in cash and equivalents. That's more than enough cash to cover the $286 million in current maturities on its long-term debt of $9.55 billion and to fund its dividend if its FCF dries up again.

Western Digital also hasn't repurchased any shares over the past year, which frees up more cash for other purposes. During last quarter's conference call, CFO Robert Eulau declared that Western Digital's "first priority is to reinvest in the business to maximize long-term shareholder value. After that, paying our dividend and reducing our debt are the next priorities."

Is Western Digital a safe dividend stock?

Western Digital's dividend looks stable, but it hasn't raised its payout since 2015. Seagate, which generates most of its revenue from the less capital-intensive HDD market instead of the volatile SSD market, raised its dividend for the first time since 2015 last year.

Western Digital's cyclical recovery seems well-insulated from the COVID-19 headwinds, but investors should still be wary of supply chain disruptions or postponed upgrades at smaller data center customers. These unpredictable headwinds could still cause Western Digital to miss its own expectations or lower its guidance, so investors should wait for its third-quarter report in early May before scooping up this stock for its dividend.