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By Damion Rallis, Senior Research Associate

As Australian mining company BHP Billiton Limited (BHP) faces uncertainty following reports this week of labor unrest in eastern Australia, several other recent news events combine to cast shadow on the company's short- and long-term prospects. In fact, the company has been in the news recently for its testy back-and-forth with the government of Papua New Guinea over an immigration ban. In short, with only two weeks of 2013 behind us, the company's share price is already off 4% while one leading analyst has already downgraded BHP to underperform.

While the mining industry has slumped over the past few years (see our September 2012 report on mining company Lonmin: "Nothing to Cheer about at Lonmin"), 2013 begins with a certain amount of optimism: " The miners are feeling a bit more optimistic as 2013 approaches. While there are few firm numbers to back it up, anecdotal evidence suggests that cost inflation in the mining sector is beginning to slow down and come under control." Is BHP Billiton poised to take advantage of rising commodity prices or is there simply too much white noise that will continue to keep the company bogged down?

Currently, while BHP's "C" rating for ESG reflects moderate risk, its AGR Rating-a measure of corporate integrity based on metrics of reported financial results and corporate behavior-is "Aggressive." Furthermore, GMI Ratings' Litigation Risk model has been showing warning signs for BHP for several rating periods. The company's score is 12 (on a scale from 1 to 100), meaning "Moderate Risk." This places BHP in the 12th percentile of all companies in Asia-Pacific, indicating higher shareholder class action litigation risk than 88% of all rated companies in this region.

One of the most significant factors in BHP's overall "C" rating is its social-component rating of "F". According to our events system, in 2010, after a miner was killed at Leinster's Perseverance underground mine, Western Australian Mines and Petroleum Minister Norman Moore met with BHP Billiton executives to voice "deep concern" over the "continuing" safety problems at the company's Leinster operations. Two months later, Industrial Relations Court Magistrate Michael Ardlie found the company guilty of failing to provide and maintain a safe work system and instructions. BHP Billiton had pleaded guilty to breaching workplace safety laws and had also issued a public apology, recognizing the extreme grief Mr. Rigg's death had on his family and friends. Scott Rigg's death could have been prevented if a safety checklist had been followed, a court has found.

In BHP's 2010 Sustainability Report, the company asserted that "effective health and safety performance is critical to the wellbeing of our people and to the success of our business" and that the company "will only be truly successful when [it] can guarantee every employee and contractor will go home safely to their families at the end of every day." Despite the establishment of a "Zero fatalities" safety target, there were five fatalities in 2010, two fatalities in 2011, and three more fatalities in 2012. Furthermore, other safety targets were missed as well, such as a 50% reduction in total recordable injury frequency at sites in both 2011 and 2012. The company's 2012 annual report tasks the board's Sustainability Committee with establishing "clear links between remuneration and HSEC [health, safety, environment and community] performance." Consequently, 15% of the named executive officers' short-term bonus consists of HSE targets. Despite the fact that BHP failed to achieve both safety-related targets for 2012 (including three fatalities) and missing on 5 of 11 total HSEC targets, the Remuneration Committee (with advice from the Sustainability Committee) judged 2012 results to be "marginally above expectations."

As an aside, the explanation of the assessment of HSEC targets is rather unclear; at 249 words, I had to read the assessment at least two times before I could even determine whether executives received this portion of their short-term bonus or not. Despite this lack of clarity (a trait seen throughout the company's Remuneration Report), BHP ironically wants to amend suggested Australian executive pay disclosure laws since they will "confuse investors." BHP prefers a single figure for each director rather than the government's proposal of multiple sets of figures. Perhaps the devil is in the details and BHP has a lot to hide?

Other concerns weighing heavily on the company's F-rated social policies include evidence uncovered by the company concerning possible violations of applicable anti-corruption laws involving interactions with government officials in Cambodia. Despite this poor recent track record, BHP criticized the government of Papua New Guinea (PNG) over an immigration ban which led to the resignation of the Chairman at the Ok Tedi Mining Limited. Ok Tedi is controlled by the PNG Sustainable Development Program, a $1.4 billion charitable trust set up by BHP after it completed its withdrawal from the business in 2002 instead of facing the possibility of legal liabilities amounting to billions of dollars due to environmental damage. Despite its borderline unethical withdrawal from the Ok Tedi mine in 2002, BHP apparently feels no remorse as it "took aim at PNG Prime Minister Peter O'Neill, accusing the leader of improper dealings in the granting of exploration licences." PNG Prime Minister Peter O'Neill retorted quickly, accusing BHP of having a "colonial era attitude in its dealings with the nation."

In yet another dispute, supervisors at one of BHP's coal mines in eastern Australia are planning to strike this week over an ongoing pay dispute involving base pay and overtime hours. This is the second strike in the past few months, after workers picketed for two weeks at BHP's nearby Appin coal mine. Not only are labor concerns a direct threat to the company's bottom line and community relations, but the fact that the mines will continue to operate throughout the strike suggests that the company is less than serious about safety concerns. Despite a BHP spokesman's reassurances that "safety is the over-riding priority," common sense would suggest that operating a mine without the expertise of 32 supervisors would be anything but safe.

While it is possible that some of the aforementioned risks could be overlooked during good times, the results of recent operations at BHP Billiton have been anything but good. According to its annual report, for the fiscal year ended June 30, 2012, the company has seen drastic reductions across the board:

Moreover, other 2012 financial lowlights include the company's $1.8 billion impairment charge from its US Fayetteville gas asset along with multiple other impairment charges that include a $342 million charge for the August 2012 suspension of the company's $20 billion Olympic Dam expansion project that was scrapped amid fears of the impact of a slowing global economy. The shelving of the dam project garnered countless unflattering headlines and criticism from the Australian government, which was relying on the project to generate thousands of jobs. Lastly, it was just this week that Bank of America Merrill Lynch downgraded BHP to "underperform," calling BHP's stock "expensive and over-owned."

Aside from some muted optimism that the mining industry is due for a 2013 rebound (albeit without any actual evidence thus far), there is very little to be optimistic about BHP Billiton's near- and long-term prospects. Even if the company improves marginally due to an industry-wide uptick, its recent total shareholder results versus its peers would suggest that BHP will continue to soundly underperform versus its peers.

But with everything else going on, including a number of public spats involving two separate federal governments and slowly spreading labor issues, now might not be the time to trust the Australian miner.

Disclaimer: GMI Ratings is an independent provider of research and ratings on environmental, social, governance (ESG) and accounting-related risks affecting the performance of public companies. GMI Ratings is a registered investment adviser and is therefore subject to certain reporting requirements. Specifically, per our ethics policy, our analysts are precluded from engaging in any transactions involving any companies we follow. Our ratings and supporting research are intended to provide investors with an effective summary of ESG and forensic accounting factors that can and do impact issuer risk. They are not, however, intended for stand-alone use and should not be considered as simple Buy, Sell or Hold recommendations. We encourage investment professionals to regard these ratings as a specialized, proprietary input to be used in combination with existing fundamental analysis or other approaches and to help comply with the UN-PRI (United Nations Principles of Responsible Investing) and similar standards.

Source: Governance Concerns At BHP Billiton