What: Shares of BHP Billiton Limited (ASX: BHP) plunged to their lowest level since July 2013 yesterday. The fall occurred despite the miner declaring its plans to cut costs in its Western Australian Iron Ore (WAIO) division by 25%, as well as its intention to increase production by a further 28%. The shares fell as low as $32.68, which reflects a 17.8% decline since late August.
So What: Although lower costs and greater production would normally be seen as a good thing, investors are clearly questioning whether it is a sensible move considering the strong headwinds facing the industry.
While Chinese demand for the steelmaking ingredient is waning, the world's largest miners are ramping up production in an attempt to grow economies of scale and force smaller miners from the market. When combined, these two behaviours have acted to deflate the commodity's price which has already fallen more than 40% this year.
A move to increase production could certainly help strengthen the miner's long-term ambitions to become the world's cheapest producer – even ahead of Rio Tinto Limited (ASX: RIO). However, if the future for iron ore isn't as strong as CEO Andrew Mackenzie perceives it to be, such a strategy could also prove damaging for the company.
If all goes according to plan, BHP will maintain a cash cost less than US$20 per tonne (before transport and royalty costs) as well as annual production of 290 million tonnes (Mt) by 2017 – up from the current 225Mt.
Now What: The market's reaction to BHP's announcement yesterday highlights just how touchy the industry is currently. Two months ago, the same news could have acted to drive the share price much higher, but now reality seems to be sinking in with investors becoming more cautious of the outlook for the sector.
While I stand by my judgement that BHP is the best way for investors to gain exposure to the industry (thanks to its high level of diversification), I would personally be avoiding the sector altogether for now. Aside from anything else, there are far better opportunities presenting themselves without the same level of risk facing the miners.
