1. RISK FACTORS

Significant risk factors in the operation of the sugar business of the
company, which may have affect on the return on investment by the
shareholders, can be summarized as follows.

1.  Risk factors in Raw Material Sourcing – Sugarcane

  The company’s business is to run factories to produce sugar which use
  sugarcane as raw material. The company has also invested in other
  related projects, which use by products and wastes generated from the
  sugar manufacturing process, to create added value, such as an ethanol
  manufacturing project which uses molasses, a by-product from sugar
  manufacturing, a biocompost fertilizer manufacturing project which
  uses both filter cake, a waste from the sugar manufacturing process,
  and waste water from the ethanol manufacturing process, as raw
  materials and a power generating project which uses bagasse, a waste
  from the sugar plant, as raw material fuel and source of energy to
  generate electric power. Once these projects are completed, the
  results of the company will be directly dependent on the quantity of
  sugarcane available, which is the important raw material for the whole
  chain. Other factors remaining unchanged, those years when the company
  has lower amount of sugarcane for crushing, the quantities of products
  are lower and the sales realization is lower. Conversely, those years
  when the company has more quantity of sugarcane for crushing, the
  quantities and sales volumes of the company’s products are higher.
  Therefore, the quantity of sugarcane available for crushing is the
  most important factor affecting the operations of the company.

  There are two main reasons that cause fluctuations in the quantity of
  sugarcane, viz. (1) changes in the acreage under sugarcane cultivation
  and (2) changes in the yields of sugarcane.

  (1) Changes in the acreage under sugarcane cultivation

  Due to the fact that major sugar factories in Thailand do not have
  their own plantations, they have to depend on farmers who farm the
  land that they own and bring the sugarcane to the crushing mills
  according to a sale-purchase agreement (Contract Farming) with the
  sugar factories. Therefore, the area under sugarcane plantation
  depends on the price agreed for the cane and whether it is worthwhile
  for the farmers to grow sugarcane compared to other agricultural crops
  such as cassava (tapioca). Promotional policies of the Government, as
  well as by the sugar mills, also play an important role.

  (2) Changes in the yields of sugarcane

  The plantation of sugarcane in Thailand depends on soil fertility and
  climatic conditions. This results in the annual yields of sugarcane
  per area to fluctuate depending on the climate and irrigation system
  at different locations. Generally, sugarcane crop has a 10 – 14 month
  gestation period. Hence, if the soil and climate conditions in a
  particular year are good, then the quantity of sugarcane during the
  following year is more, giving better yields per area. However, if
  there are drought conditions in any year, then it results in lower
  yields of sugarcane in the following year.

  Table 1.1 : Thailand sugar cane crushed in the past 10 years

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  Source : Office of the cane and sugar board, Thailand

  Table 1.2 : Area (1,000 Rai) for sugar cane plantation in the past 10
  years

  []

  Source : สำนักงานเศรษฐกิจการเกษตร

  When the quantity of sugarcane crushed reduces, the effect on the
  company is that the quantity of sugar produced goes down, the unit
  cost, especially the fixed cost, goes up, the profit per unit reduces
  and the company’s overall profit is reduced. In addition, in those
  years when the sugarcane crushed is low, there is increased
  competition among sugar mills to purchase the sugarcane produced in
  the neighborhood in order to protect their crushing quantities. All
  the sugar mills have to vie by paying more than the established
  sharing system price of sugarcane which increases the overall raw
  material cost for the company. However, since Thailand is one of the
  world’s leading sugar exporters and is the leading sugar supplier to
  the Asian region, the lower crushing quantities in Thailand results in
  lower quantities available for export with consequent increase in
  export prices. Such increase in the export price of sugar helps reduce
  the impact of lower crushing quantities and the resulting increase in
  costs.

  The company has also taken other steps to assure the sustained supply
  of sugarcane. The company offers assistance to sugarcane farmers such
  as loans for planting sugarcane crop, support in procuring inputs for
  farming, providing irrigation systems, introducing technology to
  increase yields and efficiency in cultivation and reducing the
  influence of middle men in sugarcane sale purchase deals. The
  company’s objective in granting such assistance is to establish better
  well being of the farmers. The company has always adopted a slogan
  “Farmer Prosperous, Factory Successful” which promotes good
  relationship with the farmers and considers them as integral part of
  process of reducing raw material risks for the company.

2.  Risk from Fluctuating Sugar Prices in the World Market

  While considering sugar trade in world markets, it can be said that
  sugar has high price fluctuations when compared with other
  agricultural produce. The world sugar prices depend on several
  factors, such as demand and supply of consuming and producing
  countries, exporters and importers, traders and profiteers, soil
  fertility and climatic conditions in the respective countries,
  promotional policies and export and import incentives for the sugar
  industry by governments, including those of developed countries. At
  present, the sugar price is also interrelated to the oil price, since
  both sugarcane and molasses can be used to produce alcohol, also
  called ethanol, which is blended with gasoline for use in cars as
  fuel. All the above factors cause high fluctuations in world sugar
  prices. Chart 3.3 and Chart 3.4 show the historical price of NYBOT,
  Raw Sugar #11 in the past 10 years and the historical price of LIFFE,
  Refined sugar #5 in the past 10 years. (under Topic 3, Business
  Operation of Each Product Line – File: KSLEF.DOC)

  Generally, sugar companies in Thailand are bound to meet the domestic
  demand first. The balance sugar can be exported. Every year, the
  Office of the Cane and Sugar Board estimates the quantity of domestic
  demand for sugar, called Quota A, and apportions this quantity to all
  the sugar mills based on their respective sugar production. The ratio
  of domestic sales to exports of all sugar mills is therefore quite
  similar, usually in the range of 30:70 to 40:60 depending on the
  sugarcane available for crushing all over the country. The sales of
  the sugar industry fluctuate according to world sugar prices in the 60
  – 70 % range. Other factors remaining unchanged, those years when the
  world sugar price drops, the export value will be lower. Higher world
  sugar prices result in increased export sales values. In any case,
  generally, the sugar prices depend on the amount of sugar that can be
  produced. If the sugar prices are high, it is perceived that world
  sugar production is low and if the world sugar price is low, then it
  is perceived that the world sugar production is high. Therefore, in
  those years when the world sugar prices drop considerably, the
  quantity of sugar sold is more and this helps in reducing the impact
  of fluctuating world sugar prices.

  As regards the company, since it is involved only in the sugar and
  molasses business, the fluctuations in the world sugar price has an
  influence in the company’s operations. The company has, however,
  invested in other related industries such as the project to
  manufacture ethanol, the project to manufacture biocompost fertilizer
  and the project to produce electric power which in future will reduce
  the impact of world sugar prices on the business and permit operating
  in businesses where the impact of price is less pronounced.

3.  Risk from Government Policy

  The sugarcane and sugar industry in Thailand is under the supervision
  and control of the Office of the Cane and Sugar Board under the Cane
  and Sugar Act 1984. The Board regulates the amount of sugar produced
  by a quota system (Quota A for sugar sales within the country, Quota B
  and C for sugar exports), controls on the price at which sugar is sold
  within the country, regulates on the ratio of distribution of revenue
  from the sugar business between the farmers and sugar factories, with
  the revenues sharing in the ratio of 70:30, controls on the entry of
  new players in the business etc. It is evident that the rules and
  regulations enacted by the Cane and Sugar Board have an impact on the
  production costs and the operations of the company. For Example, the
  distribution of revenues in 70:30 ratio determines the sugarcane price
  which the sugar mills must pay to the farmers. In case, changes in the
  domestic sugar prices or changes in regulation of entire sugar
  industry, it will have a definite impact on the operations of the
  company.

  Other overall Government policies also have an impact on the company’s
  business. The policy to promote the production of ethanol has grown
  the ethanol market and has positive impact on the cane and sugar
  industry because ethanol can be produced directly from cane and also
  from molasses. The policy to promote the planting of oil palm trees or
  price guarantees for cassava have negative impact on the company since
  the area under sugar cultivation will reduce and farmers will switch
  to growing alternative crops with better returns.

  The company has considered the importance of government policies in
  charting its business strategy. The company’s cane and sugar factories
  have cooperated with three sugar mill associations and associations of
  sugarcane farmers to enable the government to better understand the
  important issues concerning the cane and sugar industry. The industry
  is a precursor to the food and processed food industries and is now
  becoming involved directly with the energy and fuel industry
  (ethanol). Additionally, ethanol is a pure alcohol that can be used as
  a basic starting point to produce other chemicals such as acetic acid,
  ethyl acetate etc. Exports of sugar are different from other
  industries in that they bring in foreign exchange into the country
  almost fully since there is no outflow of foreign exchange due to any
  imports. Sugarcane is an agricultural produce every part of which can
  be put to effective use. Hence, sugarcane can be considered as an
  important agricultural crop in Thailand. Communication, explanation
  and understanding with the government will reduce the risk of
  government policy on the sugarcane and sugar business.

4.  Risk of Bad Debts Arising from Credit Given to Farmers (Advance
    Credit)

  In the running of a sugar mill, the factories extend loans or other
  kinds of financial support to sugarcane farmers as working capital to
  plant sugarcane crop, or what is called “sugarcane credit”, thereby
  reserving the sugarcane for crushing. After the sugarcane crop is
  ready for harvesting and the sugar mills are ready to start crushing
  the cane, the farmers harvest the cane and send it to the sugar mills
  and receive payment for the value of the cane supplied after the loans
  advanced and other financial support given is deducted. The risks that
  are generated from such sugarcane credit can come from reduced
  production in any year due to drought conditions, losses from crop
  disease and pestilence, farmers refusing to send the cane to the sugar
  mills etc. Such liabilities, arising from sugarcane credit, can
  adversely affect the company’s operations requiring higher amounts of
  provisioning for bad debts.

  The company would like to mention that regarding the above risk
  factors, it has made positive developments in the sugarcane system.
  The company has bought a satellite monitoring system (Global
  Positioning System – GPS) to survey the sugarcane plantation areas,
  which helps in reducing the problems of ownership of sugarcane fields.
  The system is also used to plan for sourcing more sugarcane. The
  company also encourages farmers to deposit assets as collateral for
  the loans advanced. All this has resulted in the company having a very
  low bad debt situation at present and the major debts are adequately
  covered with pledged assets.

5.  Risk associated with the success of the 3 new projects

  During the month of February 2005, the company increased its number of
  shares by offering ordinary shares to the general public and by
  listing the company in the Stock Exchange of Thailand. One of the
  purposes of this listing was to raise funds to finance the three new
  projects in related fields viz. the ethanol factory project, the
  biocompost fertilizer production project and the electricity
  generation project. These projects will be completed and ready to
  commence operation during 2005 – 2006.

  Risks associated with the above projects are that they are in the
  early stages and it is not possible to predict now whether they will
  be successful or not. The risks from each project are analyzed below.

  Ethanol Manufacturing Project

  At present, the construction of the factory is completed and
  production is expected to commence in December 2005. Since the sugar
  mills are expected to start crushing cane from 10 December 2005, it is
  expected that sales of ethanol to customers will commence in January
  2006. The factory has a capacity of 150,000 litres/day of ethanol,
  will use sugarcane juice and molasses as raw material and has an
  investment budget of Baht 350 million, which is expected to be met.
  The risks in this project are the price at which ethanol will be sold,
  since a clear picture of the price structure still does not exist, the
  production costs which are mainly the high investment costs and the
  highly fluctuating raw material costs, the sourcing of raw materials
  in sufficient quantities to meet the installed capacity, operating the
  plant efficiently and lastly, the government policy which created the
  ethanol industry in the first place. Presently the various risks have
  started to reduce, whether it is the clarity in the government policy
  or cooperation from the oil companies who are promoting the increased
  use of ethanol blended gasoline, called gasohol. As far as the project
  is concerned, the selling price of ethanol should be correlated to the
  cost of production entirely from molasses or from cassava or should be
  linked to the price of importing ethanol from other countries.

  On the subject of raw material availability and its fluctuating price,
  the entire company is a sugar producer and owner of both raw materials
  viz. sugarcane juice and molasses which can therefore reduce, to an
  extent, the risks associated with molasses price and the availability
  of adequate quantities of molasses.

  Biocompost Fertilizer Manufacturing Project

  As of now, the company expects to commission this plant during January
  – February 2006 since it has to wait for wastes from the sugar mill
  and from the ethanol factory and expects to commence sales of
  biocompost fertilizer to customers by April 2006. The factory has a
  capacity to produce 100,000 tons of biocompost fertilizer per year
  using filter cake from the sugar factory and waste water from the
  ethanol factory as raw materials. The project has an investment budget
  of Baht 120 million but is expected to cost only about Baht 80
  million. The risk factors associated with this project are the price
  at which the biocompost fertilizer can be sold, the quantity that can
  be produced and the limitations in the raw materials which are wastes
  of the sugar mill and ethanol plant.

  The company has carefully considered these risks and has already
  decided that the selling price during the initial period will be lower
  than the prevailing market price, as a market entry measure, and as an
  act of promotion, assistance and support to the sugarcane farmers
  supplying to the company.

  Power Generation Project

  At present, the company expects to be able to start running the
  machinery and sell the electricity generated by November 2006 as
  planned. The factory has a capacity of 30 MW and has a contract
  agreement to sell 20 MW of electricity to the Electricity Generating
  Authority of Thailand. The availability of adequate quantity of fuel
  (bagasse) for generating electricity is a risk factor associated with
  this project. The company has studied this situation and decided that
  the power plant has a suitable size and is at a level that, in case
  the sugar mill cannot supply the required quantity of bagasse, the
  company can source other fuels to supplement the requirement.

  Another risk associated with this project is related to the possible
  delay in project implementation. This will cause a delay in income
  revenues and will cause payment of fines to the Electricity Generating
  Authority of Thailand as per the agreed terms and conditions of sale.
  As at present, the implementation of this project is proceeding as per
  planned schedule and in case there is a delay in the project due to
  reasons attributable to the project contractor, then the expenses to
  the company arising from the delay can be claimed from the contractor
  according to the terms already incorporated in the turn key contract.

6.  Exchange Rate Risk

  The company exports about 60-70% of the sugar produced and hence, is
  exposed to the risk of fluctuating foreign exchange rates. However,
  the company operates under the 70:30 revenue sharing scheme, which
  hedges the risk from exchange rate variations since, lower revenues
  due to lower exchange rates cause the sugarcane price to be lower
  under this scheme. This means that sales revenues and major raw
  material cost of the company are directly linked to the exchange rate
  (Natural Hedge).

7.  Risk of having major shareholders controlling the votes of at the
    Shareholders’ meeting

  The Chinthammit and his company hold more than 60% of total paid up
  share capital of the company. Therefore, the Chinthammit Group and his
  company can control all the proceedings of the shareholders meetings
  whether it is the appointment of Directors or whether it is to seek
  approvals on other matters that require majority votes, except for
  special agendas which, by law or by the articles of association of the
  company, require 75% vote in shareholders’ meetings. Therefore, it is
  difficult for other shareholders to collect enough votes to
  investigate or counterbalance the issues raised by the majority
  shareholders.

  However, for the company's transparency and power balancing, the
  company has appointed three independent audit committee members for
  checking the operations of the company and also, out of the eighteen
  directors of the company, eleven are not Chinthammit; thus, power
  balancing for operation in the company is reasonable. In addition, the
  company also has also set up an independent internal control team
  which reports directly to the audit committee.