Bain Capital’s Brookside Capital Dumped Apple Inc. (AAPL) and Bought These Stocks

At the end of September, Apple Inc. (NASDAQ:AAPL) was the largest holding by market value in Brookside Capital’s portfolio. However, by the end of the fourth quarter of 2012 the hedge fund (which is part of the larger Bain Capital alternative investments group) had sold all of its Apple Inc. (NASDAQ:AAPL) shares, according to our database of 13F filings. We track 13Fs from hedge funds and other notable investors as part of our work researching investment strategies; we have found that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year (learn more about our small cap strategy) and believe that more techniques are possible as well.

Apple Inc. (NASDAQ:AAPL)

However, we also keep track of major changes in hedge fund sentiment, and one of these took place between October and December of last year with regards to Apple Inc. (NASDAQ:AAPL). With a number of hedge funds selling shares, it lost its place as the most popular stock among hedge funds to American International Group Inc (NYSE:AIG). Find more stocks hedge funds loved. We have been investigating some of the funds which sold out of Apple, including Brookside, to see what they were buying instead. Read on for our look at two positions the fund increased last quarter or see the full list of stocks Bain’s equity hedge fund reported owning.

The new top pick in the portfolio, fueled by an increase of almost 300% in the size of Brookside’s position, was Express Scripts Holding Company (NASDAQ:ESRX). The $48 billion market cap pharmacy benefit management services company was embroiled in a dispute with pharmacy Walgreen Company (NYSE:WAG) for part of last year, damaging its business. Revenue and earnings have returned nicely, however, and Express Scripts actually made our list of the most popular healthcare stocks among hedge funds as of the end of December (check out more of hedge funds’ healthcare picks). While the trailing earnings multiple is 38, that includes a substantial period when earnings were depressed because of the Walgreen’s issue. In the fourth quarter of 2012 the company reported $1.05 in earnings per share; if we annualize that figure we get a P/E multiple of only 14, with some potential for further growth as the U.S. population ages and consumes more prescription drugs.

Bain’s third largest holding was in a stock which it had not owned any of at the beginning of October: $14 billion market cap auto parts store AutoZone, Inc. (NYSE:AZO). Since Autozone sells replacement parts, it does not have much exposure to the overall economy as demonstrated by its beta of 0.2. The stability of its business is also keeping growth low- in its most recent quarter, revenue was up only 3% and net income up only 6% compared to the same period in the previous fiscal year. The trailing earnings multiple of 16 looks a bit high considering that recent financial performance, and even with analyst expectations of bottom-line growth for the next two years the forward P/E is 13. As long as growth remains as slow as it is, it is challenging to see Autozone has being that much undervalued.

Of course Apple isn’t exactly expensive itself- in fact it trades at a discount to either stock at 10 times trailing earnings- but concerns have developed over the company’s future with investors currently pricing in a decline in earnings. We think that Apple is still at least a candidate for value status, and think it offers better prospects on that front than Autozone. Express Scripts does look intriguing seeing as its current earnings run rate puts it in value territory with likely some remaining upside to come, and we would be interested in taking a closer look at that company.

Disclosure: I own no shares of any stocks mentioned in this article.