Will Woodside Petroleum Limited launch a share buyback?

Pressure is mounting for Woodside Petroleum Limited (ASX:WPL) to abandon its takeover bid for Oil Search Limited (ASX:OSH) and to undertake a capital return instead. Here's why…

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What is the best way for Woodside Petroleum Limited (ASX: WPL) to boost earnings growth by up to 15%?

It isn't by winning the takeover for Oil Search Limited (ASX: OSH), according to Credit Suisse.

If anything, the broker is urging Woodside to abandon its quest to buy over the Papua New Guinea-focused gas producer because Woodside shareholders will be better off if the oil & gas major used the cash to buy back its own shares.

Credit Suisse estimates that Woodside's earnings per share (EPS) would increase between 11% and 15% for the rest of the decade if Woodside were to purchase $2.5 billion of its shares using debt at $29.50, which is above its current share price.

The fact that Woodside's share price is hovering around a 10-year low and its ability to borrow cheaply at around 2.5% thanks to record low interest rates make the strategy immediately earnings accretive. The same may not be true if it were to buy Oil Search given that it probably will have to lift its original offer if it hopes to win over Oil Search's shareholders.

Shares in Woodside jumped 1.1% to $29.38 during lunch time trade, while Oil Search tumbled 1.4% to $7.45 despite the overnight jump in the oil price.

An off-market buyback would be appealing to shareholders because it gives the company a chance to distribute more of its $US2 billion ($2.9 billion) or so in franking credits.

While the debt-funded buyback will push Woodside's gearing to 30% in the current financial year, the company should easily be able to pay this down to around 22% in two years, according to the broker.

A stock buyback might be good in the short-term for earnings but it will leave Woodside stuck with a fundamental problem that has driven it to lob a bid for Oil Search in the first place – the lack of growth options.

Woodside is cashed up but needs to buy or build new projects to replenish reserves.

However, a share buyback is likely to give its stock a much needed boost – in theory at least – and that means it will be in a much better position down the track to undertake another all-scrip bid (and not necessarily for Oil Search).

I am a shareholder of both companies and I am not keen on the merger of the two. A buyback would certainly be a better option in my view.

But Woodside isn't the only one trying to find a growth path. Debt-laden Santos Ltd (ASX: STO) is in need of cash and is looking to sell assets to bolster its balance sheet. Woodside might find a better deal from Santos' divestment program.

Motley Fool contributor Brendon Lau owns shares of Oil Search Limited and Woodside Petroleum Ltd.. Follow me on Twitter - https://twitter.com/brenlau Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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