Western Digital declares a quarterly dividend
On February 14, NAND (negative AND) chipmaker Western Digital (WDC) declared a quarterly dividend of $0.50, sending the stock up 0.5% in the after-hours trading session. Even though WDC has declared a quarterly dividend of $0.50 since 2015, this time it is different. On January 14, Evercore ISI analyst C.J. Muse downgraded the stock, raising doubts about the sustainability of its $2 annual dividend. This downgrade sent the stock down ~6% in the first half of the trading session.
In his note to clients, C.J. Muse stated that declining NAND prices have been reducing Western Digital’s profit margins and FCF (free cash flow). Moreover, its long-term debt of $10.9 billion and cash reserve of $4.6 billion could harm its ability to pay a dividend if FCF continues to fall. He expects fiscal 2019 FCF per share to fall to $2.35, which means it will spend 85% of its FCF on dividend payments.
There are several factors that support WDC’s ability to pay a dividend, but in the worst case scenario, the company could face difficulty paying dividends.
A scenario where WDC cannot sustain dividend payments
In fiscal 2018, WDC spent ~$600 million on dividend payments. The company has maintained its FCF above $1 billion since 2012. For WDC to stop paying dividends, its annual FCF has to fall below $700 million, down 67% from its current TTM (trailing 12 months) FCF of $2.14 billion.
However, NAND chipmakers like Samsung (SSNLF) and Micron (MU) have reduced their capital spending to reduce oversupply and boost NAND prices. Moreover, WDC expects NAND demand to pick up in fiscal 2020.
If WDC’s FCF falls to a level where it cannot pay a dividend, its share price will likely plummet. If WDC’s FCF per share falls to $2.35 as predicted by C.J. Muse, its stock price would fall to $28.2, assuming the stock trades at its highest price-to-FCF of 12.0x.
Thus, WDC’s dividend announcement reassures investors that the company still has the ability to maintain its $2 annual dividend.
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