2 takeover targets set to beat the FTSE 100 in 2017

These two stocks could outperform the FTSE 100 (INDEXFTSE:UKX) this year.

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A number of stocks in the FTSE 100 could become ripe for takeover this year, as the conditions that make acquisitions more likely seem to be gradually presenting themselves. For example, sterling has weakened and this has made UK shares cheaper to buy for foreign investors.

Although Brexit creates a degree of uncertainty, the UK looks set to retain a loose monetary policy, which should boost its economic performance. And with many UK-listed shares being international companies, their performance may not suffer even if Brexit causes a slowdown in economic growth. With that in mind, here are two companies that could become takeover targets this year.

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Sector consolidation

The tobacco industry could experience further consolidation, which may make Imperial Brands (LSE: IMB) a takeover target. In recent months, British American Tobacco has decided to purchase the remaining part of US peer Reynolds that it does not already own. This should create a dominant tobacco company, which could have cost and product development advantages over rivals.

Therefore, the purchase of Imperial Brands by a sector peer would not be a major surprise. It has a sound growth strategy and exposure to some of the fastest-growing tobacco markets in the world. It also has a sound balance sheet, while its shares have a price-to-earnings (P/E) ratio of just 14. This suggests they offer a wide margin of safety, given their forecast growth rate of earnings, which is in the high single-digits over the next couple of years.

Imperial Brands also has the second biggest-selling e-cigarette in the US. This could hold significant appeal for a rival which is looking to diversify its operations. So, given sterling’s weakness and Imperial Brands’ growing profitability, it could be a realistic takeover target.

A steady income stock

In recent years, the utility sector has become an increasingly attractive place to invest. Part of the reason for this is the steady and resilient income opportunity that is on offer. Now that inflation is moving higher not just in the UK but potentially across the globe, Severn Trent (LSE: SVT) may become an increasingly attractive acquisition target.

The company currently yields 3.5%, which is slightly below the FTSE 100’s yield. However, Severn Trent’s dividend payments are likely to be more robust than those of the wider index, and should rise by close to 3% per annum. This should keep their gain ahead of inflation, which may make them attractive to a company that’s concerned about a higher rate of inflation and the greater uncertainty present in the global economy in 2017.

While Severn Trent currently has a relatively high P/E ratio of 22, its long-term average is around 19. This indicates that its shares may not be particularly overvalued – especially when their bid potential, income appeal and defensive characteristics are taken into account. Therefore, even if a bid is not forthcoming, they may yet beat the FTSE 100 during the course of the year.

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Peter Stephens owns shares of British American Tobacco and Imperial Brands. The Motley Fool UK has recommended Imperial Brands. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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