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BHP raises the white flag

Incoming CEO of BHP Billiton (ASX: BHP) Mr Andrew Mackenzie has wasted no time in taking the axe to numerous projects that are no longer feasible in a post-resource price boom world.

In a speech to be delivered at the Bank of America Merrill Lynch Global Metals, Mining & Steel Conference, Mackenzie effectively raised the flag of expansion stating:

“… capital and exploration expenditure for the 2014 financial year will decline significantly, to approximately US$18 billion, and the rate of spend is expected to decline substantially thereafter. By reducing our annual spend and increasing internal competition for capital, we expect to maximise returns from incremental investment, while delivering a substantial increase in the Group’s free cash flow.”

Mackenzie also highlighted during the presentation that US$1.9 billion in annualised cost saving was delivered in the first half of the financial year. It looks like BHP has resigned itself to lower commodity prices as the focus shifts to expanding margins and increasing returns.

There is little doubt that miner Rio Tinto (ASX: RIO) is undergoing a similar adjustment within its business, as the new management team looks for any way to increase productivity and reign in expenditure.

Of course this doesn’t bode well for a whole host of mining service stocks including Boart Longyear (ASX: BLY) and Ausenco (ASX: AAX). Not only will firms be fighting over a diminishing pie of work, they will also be dealing with a potential structural change as major miners such as BHP and Rio revert to an own and operate model. With the tight labour and equipment supply issues soon to be a thing of the past it may make a lot more sense to bring mining services in-house again, rather that outsourcing to contractors as has been necessitated over the past decade.

Foolish takeaway

While the stock market is far from perfectly efficient, a lot of the time it does get it right. The prices and yields on offer across the mining and mining services sectors might look enticing to a value investor but now as much as ever is a time to be especially careful of value traps.

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More reading

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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