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Lululemon and Gildan: the yin and yang of investing

In this economy, which kind of clothing company would you want in your portfolio. Lululemon and Gildan -- two very different companies -- both report their earnings this week.

LAURA LEYSHON/For The Globe and Mail/laura leyshon/The Globe and Mail

Canadian clothing companies Lululemon Athletica Inc. and Gildan Activewear are a study in contrasts. The first is a premium consumer brand, the second a global, low-cost manufacturer.

Lululemon offers a brand steeped in the ideals of a virtuous and healthy lifestyle. Gildan sells retailers blank and private-label active wear and underwear.

But both companies will face a similar challenge on Thursday when they are due to report their quarterly results. While each is expected to post robust year-over-year sales growth of about 37 per cent, they will each need to reassure investors about the future.

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Gildan has been suffering from sluggish sales recently and has responded by stepping up the discounts it offers to U.S. wholesalers, according to Claude Proulx, an analyst with BMO Nesbitt Burns Inc. He says the company has decided to pass on the savings it is enjoying from the recent decline in cotton price in an effort to gain market share and to keep its manufacturing plants running at full capacity. He estimates that the net effect will be a 4 per cent decline in Gildan's prices for next year, which will hurt profits in the first half of fiscal 2012.

While shareholders may be upset by this new course of events, things will improve by the middle of the year. Earnings growth should turn "strongly positive" as the company benefits from the lower cotton prices and higher volumes, Mr. Proulx wrote in a report. He has an "outperform" rating on the shares and a price target of $33.75 (U.S.).

Lululemon, meanwhile, must keep expectations high enough to support the lofty value of the shares, which trade at 43 times earnings. In September, management reported a 77 per cent surge in second-quarter profit, but it miffed investors by toning down guidance a notch. The shares are down 25 per cent since then.

For its latest quarter, Lululemon is forecasted to deliver profit growth of 37 per cent. In contrast, the Street thinks that Gildan will report that profit shrank by 16 per cent.

Generally, investors see far more desirability in Lululemon, giving it a valuation more than double that of Gildan, despite the fact that Gildan books $2 of revenue for every $1 by Lululemon. But sentiment swings the other way among analysts. Seventy per cent of those following Gildan rate it a buy, compared with just 36 per cent for Lululemon.

BMO analyst John Morris says business remains strong for Lululemon and the company is pursuing several avenues for new growth, including expanding online sales, exploring international expansion and widening its product lines to including more running wear and new categories, such as cycling and dance apparel.

The retailer has also been doing a better job recently of getting the right sizes and amount of inventory into stores. But at the end of the day, investor expectations are just too high, Mr. Morris says. He rates the shares "market perform" and has a $54 target on them, down from $60 just prior to the release of second-quarter results.

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For investors looking at these two stocks, the question is one of style. At a time of growing economic concerns, do they favour a retailer built on a brand that is highly valued for its intangible attributes? Or do they prefer a dividend-paying manufacturer that boasts low-cost factories and a diverse group of retail customers?

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