Lululemon Athletica (LULU -0.48%) and Levi Strauss (LEVI -2.27%) both saw their stocks hit record highs during the bullish stampede toward growth stocks in 2021. However, both stocks tumbled over the past year as investors fretted over the impact of inflation on apparel sales.

As of this writing, shares of Lululemon and Levi Strauss trade 24% and 50%, respectively, below their all-time highs. Should investors buy either of these out-of-favor apparel stocks as a contrarian play? 

Four friends are showered with cash as they shop.

Image source: Getty Images.

Lululemon is still a high-growth apparel retailer

Lululemon's revenue rose 30% to $8.1 billion in fiscal 2022 (which ended this January), compared to its post-pandemic growth of 42% in fiscal 2021. That growth was driven by the expansion of its direct-to-consumer (DTC) channel, which includes its e-commerce platform and brick-and-mortar stores; its international division; and its men's business.

However, its adjusted gross margin still declined 150 basis points to 56.2% in fiscal 2022 as it grappled with higher supply chain costs, currency headwinds, and increased markdowns. Nevertheless, its adjusted earnings per share (EPS) -- which were buoyed by nearly $444 million in buybacks throughout the year -- still increased 29%.

Last April, Lululemon launched a new "Power of Three x2" plan to double its digital revenue, double its men's revenue, and quadruple its international revenue from fiscal 2021 to fiscal 2026. Those three goals were identical to the ones it introduced in its first five-year "Power of Three" growth plan in April 2018. Lululemon crossed all of those milestones ahead of schedule, even as it endured store closures during the pandemic, and it says it's still on track to achieve its new "Power of Three x2" goals. That rosy outlook implies its revenue will grow at an average rate of 15% through 2026.

Analysts expect Lululemon's revenue and adjusted EPS to grow 16% and 15%, respectively, in fiscal 2023. The bulls believe Lululemon's dominance of the high-end yoga apparel and athleisure market, its robust digital sales, and customer loyalty to its brand, which it repeatedly reinforces with free yoga classes and community events, will continue to drive its long-term growth. At 26 times forward earnings, Lululemon also looks more reasonably valued than it did in 2021.

Levi Strauss faces tougher near-term challenges

Levi Strauss' revenue only rose 7% to $6.2 billion in fiscal 2022 (which ended last November), representing a significant slowdown from its 29% growth in fiscal 2021. Its adjusted gross margin fell 30 basis points to 57.6%, mainly due to currency headwinds, the suspension of its business in Russia, and markdowns, but its adjusted EPS -- which was supported by $176 million in buybacks throughout the year -- grew 2%.

Levi Strauss also unveiled a new long-term growth plan last June, which aims to grow its annual revenue by 6% to 8% organically through 2027. It plans to do that by tripling its annual e-commerce sales and expanding its DTC segment to 55% of its top line, compared to 42% of its revenue in fiscal 2022. That outlook implies it could generate up to $10 billion in revenue in fiscal 2027. It also expects its adjusted earnings before interest and taxes (EBIT) margin to rise from 11.6% in fiscal 2022 to 15% in fiscal 2027 as it expands its higher-margin brands and streamlines its business.

But for fiscal 2023, it expects its revenue to only rise 1.5% to 3%, mainly due to currency headwinds and the loss of its Russian sales, as its adjusted EPS drops 7% to 13%. Analysts expect its revenue to rise 2% as its adjusted earnings dip 11%.

Levi's brand is still synonymous with jeans, but it didn't even crack the top five clothing brands for U.S. teens, according to Piper Sandler's latest semi-annual survey. Nike, which competes against Levi's and Lululemon in the activewear market, ranked first, followed by American Eagle Outfitters and Lululemon. That lack of youth appeal could erode the relevance of Levi's brand and curb its long-term growth. But at 14 times forward earnings, Levi still looks cheap relative to its peers.

The winner: Lululemon

Levi Strauss' low valuation and decent forward dividend yield of 2.7% might limit its downside potential, but there simply aren't enough compelling reasons to buy the stock when so many other blue-chip dividend stocks are still on sale.

Lululemon doesn't pay a dividend, but it's still one of the market's fastest-growing apparel brands, and its bright long-term outlook suggests it will continue to generate double-digit sales growth for the foreseeable future. Therefore, I believe Lululemon's stock is worth buying before a new bull market starts -- but I'm less optimistic about Levi Strauss' prospects.