U.K. Stocks Under Pressure as Pound Strength Hits Cost of Selling Abroad

The relentless strength of sterling is biting into some U.K. stocks.

A rebounding U.K. economy this year has heightened expectations that the Bank of England will be the first major central bank to raise interest rates, boosting the pound relative to other currencies.

That is good news for Britain's summertime holidaymakers. But companies including luxury retailer Burberry Group PLC, advertising heavy-hitter WPP PLC and Associated British Foods PLC have all said in their recent earnings releases that sterling's upward march is increasing the cost of their products and services abroad, leaving a sizable dent in their revenues. Analysts and investors say the perky pound is becoming a drag for many of the country's stocks.

"Relative to euro-zone companies, U.K. exporters could clearly be hit by the currency, and that is something that makes us quite cautious on the U.K. market as a whole," said Emmanuel Cau, an equity strategist at J.P. Morgan Chase & Co. in London.

According to strategists at Goldman Sachs, about 80% of FTSE 100-company sales are generated outside of the U.K., making them particularly vulnerable to exchange-rate movements. That dependence on overseas income has contributed to the FTSE 100 index lagging other markets in Europe. Since the start of the year, the FTSE has lost 0.22%, while Europe's Stoxx 600 index, for example, has gained 3.25%.

Sterling has defied many expectations for a drop and climbed by 4% against the dollar so far this year. It now stands at more than $1.71, its highest point in nearly six years. It has also cranked higher against the euro, hitting two-year highs.

Burberry's Chief Financial Officer Carol Fairweather last week warned that if exchange rates remain where they are, full-year retail profit would be reduced by GBP55 million ($94 million), a hit that is GBP15 million more than a previous estimate in May.

Associated British Foods PLC also last week said the strength of sterling had a negative impact on sales, particularly in its overseas grocery and ingredients businesses. Total group sales fell 3% in the 16 weeks to June 21. If currency fluctuations were stripped out, sales would have climbed 3% over the same period, the company said.

And at the end of June, WPP Chief Executive Officer Martin Sorrell said that reported revenue for the first five months of the year was up by just 1.2% at GBP4.43 billion, held back by the strength of the pound.

J.P. Morgan's Mr. Cau reckons the number of U.K. firms reporting weaker sales on the back of a stronger pound will likely increase over the next few weeks as more companies file their quarterly earnings reports.

Unfortunately for them, the pound shows no sign of turning.

"Right now the market is pricing in the first interest rate rise probably about November or December time; if we suddenly see some very strong data coming through in the U.K., we could see those expectations brought forward and that could lift sterling even further," said Azad Zangana, European economist at Schroders in London, an asset manager.

Mr. Zangana said his firm has cut its exposure to FTSE 100 companies to underweight in the past month or so because of the stronger pound.

Other investors say that while they don't avoid export-focused companies, they look for U.K. firms that are able to prosper even in a strong pound environment because they both produce and sell their goods overseas.

"These tend to be the more global companies, which are listed in the U.K.," said Simon Brazier, head of U.K. equities at Threadneedle Investments, citing Unilever PLC as an example.

Write to Ben Edwards at [e-mail]