2. 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. 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 plantation
  which may depend on the price agreed for the cane and whether it is
  worthwhile for the farmers to grow sugarcane compared to other
  agricultural crops as well as the promotional policies of the
  Government and (2) changes in the yield of sugarcane (ton(s) of cane
  per rai) which may occur due to climate change conditions, such as
  drought and flood, caused by global warming.

  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 per unit, 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 sugar cane locating in
  the neighborhood area. Therefore, in order to protect their crushing
  quantities, sugar mills have to vie by paying more than the price,
  established by revenue sharing system. This increases the overall raw
  material cost for the company.

  Thailand is one of the world’s leading sugar exporters and is the
  leading sugar supplier to the Asian region. Decreased amounts of cane
  crushed in Thailand result in lower sugar quantities available for
  exportation. Export prices, consequently, increase. Such increase
  relieves the impact of decreased quantities of cane crushed and burden
  of increased costs. The company, furthermore, values stability of
  sugarcane supplies. To ensure the sustained supplies, 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 sales and purchase deals. All the assistance is provided for
  the farmers in an attempt to help them improve their lives.

2.  Risk from Fluctuating Sugar Prices in the World Market

  While considering sugar trade in the world markets, it can be said
  that sugar has high price fluctuations when compared with other
  agricultural products. The world sugar prices depend on several
  factors, such as demand and supply of countries that are producers,
  consumers, exporters and importers. Traders’ speculations are in
  relation to climatic conditions facilitating cultivation in each of
  the respective countries. Government policies on promoting,
  interfering, exporting and importing sugar, particularly in developed
  countries also determine pricing in the industry. At present, sugar
  prices are also interrelated to oil prices. Both sugarcane and
  molasses can be used to produce a type of alcohol called ethanol.
  Ethanol can be blended with gasoline to produce fuel. All the above
  factors cause high fluctuations in the world sugar prices.

  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 allocates this Quota 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. However, regarding on the cost of production, the cane
  price is the major cost, calculated by the formula based on the
  revenue sharing system 70 : 30. This means that when the sugar price
  has decreased 100%, the farmer should get the 70% impact in term of
  lower sugar cane price and the sugar factory should get 30% impact.

  During the past few years, the world sugar price was very volatile. It
  can be seen from the difference between low price at 11 cents/lb and
  high price at 35 cents/lb. With severe price fluctuations, if the
  company were not able to establish a selling price that was higher
  than the price level for setting cane prices, the corporate operating
  results would have been severely affected. To prevent the risk posed
  by sugar price volatility in the world market, the company entered
  into a sugar futures contract with a financial institution. The risk
  hedging procedure would allow the company to minimize the dependency
  of its profitability on the risk posed by sugar price volatility.
  However, this could affect profit and loss account recording, and
  there was a risk that the amount hedged through the sugar futures
  contract could exceed the actual volume of sugar exported. This
  oversold condition could result in a loss. For details, refer to topic
  12. Other Related Information: Risk Hedging Procedure Against Sugar
  Price Volatility in the World Market.

  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 ethanol production
  project, the bio-fertilizer project and the power plant project 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 domestic sales, Quota B and C for sugar
  exports), controls the domestic price, regulates on the ratio of
  distribution of revenue from the sugar business between the farmers
  and sugar mills, with the revenues sharing in the ratio of 70:30,
  controls on the entry of new players in the sugar 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 revenues sharing system 70:30 ratio
  determines the sugar cane 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. For example, the decision to promote the renewable energy,
  such as ethanol, has secured the domestic sale volume. 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 cane
  plantation will reduce and farmers will switch to growing alternative
  crops with better returns.

  The company realizes the importance of governement policies in shaping
  directions of cane and sugar industry. Hence, it has collaborated with
  three sugar mill associations and associations of sugarcane farmers to
  enhance the government’s understanding of the cane and sugar industry
  and its significance. The industry is a precursor of the food and
  processed food industries. Ethanol derived from sugar production can
  be used as fuel energy. Ethanol is a pure alcohol that can also be
  used as a starting point for production of other chemicals. Exporting
  sugar brings in foreign income and almost does not require import
  costs and expenses. This differentiates the sugar industry from other
  industries.

  Sugarcane is Thailand’s important economic crop in which every part of
  it can be utilized. Communication, explanation and understanding
  between the government and the sugar industry can reduce the risk
  potentially posed by government policies affecting directions of
  sugarcane and sugar insdustries.

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.

  However, by track record, level of bad debt is low because the company
  not only concerns the above risk factors but also improves in the
  sugarcane credit 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 low bad debt situation at present and the major debts
  are adequately covered with pledged assets.

1.5) Risks of Investing in Corporate Ventures

  The company has undertaken 4 projects during the past 4 years which
  are sugarcane plantation and sugar mill projects in Laos, sugarcane
  plantation and sugar mill plantation in Cambodia, the renewable energy
  project in Boploy and the latest project sugar mill and power plant in
  Loei province. The projects in Laos and Cambodia are in progress of
  expanding the planted area s to feed crushing capacity the company has
  invested in. Since the renewable energy project in Boploy is a
  large-scale project, investment has been divided into 2 phases.
  Construction of the first phase was completed and has operated
  commercially in 2011. For the second phase, it will be completed and
  expected to operate commercially in 2012.

  There are risks involving in the projects, as some of them are in
  progress of expanding planted areas, one has just started operation
  for the first year and one has just invested. At this point, it is
  still difficult to determine whether the projects will be successful
  or not. The risks are explained as follows:

  Sugarcane Plantation and Sugar Mill Projects in Laos and Cambodia

  Major risks of the projects may be primarily posed by political risks
  and government policies in Laos and Cambodia. In Laos, the risk the
  enterprise is facing involves the land concession policy in which
  locals’ parcels of lands and boundaries of the land under the
  concession are unclearly defined. Negotiations between the company and
  locals take time. Furthermore, the government policy regarding the
  sugar mill encouraging locals to grow sugarcane for sugar production
  and tax may also be risk factors. In Cambodia, the political risk is
  relatively high, especially border and political disputes between
  Thailand and Cambodia. The Cambodian tax policy may also be
  problematic for the project operations. However, the project is a
  joint venture between Thailand and Taiwan. The Cambodian government
  fully supports the project as it benefits community development,
  generates income for locals, and creates employment opportunities for
  local workers and farmers. The operations of the project bring in
  development to local communities in Cambodia.

  Apart from the political and government policy risk factors, the
  projects may run the risk of a shortage of skilled laborers. Sugar
  cane plantation is a relatively new industry in both countries. There
  have been shortages of plantation skills and local laborers. Resources
  in transporting sugar cane to the mill for crushing are still limited.
  Climate change conditions, for instance, drought and flood, may also
  affect the timing for planting sugarcane. Destruction of crops by
  cattle and control by government were causing delays for the projects.
  The company has adopted a new system that allows those matters to be
  managed more effectively. Specialists from Thailand have been brought
  in to improve sugarcane seeding and plantation methods to suit local
  conditions. The company has also brought in machinery and more
  contractors from Thailand and is leasing plantation areas to farmers
  in order to alleviate the management problem.

  Renewable Energy in Boploy, Kanchanaburi Province

  The project includes relocation and expansion of the sugar mill,
  currently in Tamaka District to Boploy District, along with
  development of sugar-by product businesses- ethanol, fertilizer and
  power plant businesses. The project is still in progress and requires
  ongoing investment. A primary risk comes from the need for adequate
  supply of raw materials for crushing. To reduce this risk, the
  investment for this project is divided into 2 phases. This ensures
  that the production capacity closely corresponds with the local
  promotional plan for cane plantation. Construction of the first phase
  consists of sugar mill with capacity of 14,000 tons cane/day, power
  plant with capacity of 45 MW and ethanol plant with capacity of
  200,000 liters/day. However, in 2011, only sugar mill and power plant
  in the first phase have operated commercially while ethanol plant and
  fertilizer plant were testing run and expected to operate commercially
  in 2012. For the second phase consists of sugar mill with capacity of
  14,000 tons cane/day, power plant with capacity of 45 MW were
  completed and expected to operate commercially in 2012 as well. (Some
  of the remaining investment in sugar mill, 4,000 tons cane/day will be
  invested later after there is adequate supply of cane). Other risks
  are operational risks, such as other types of licensing, construction
  and machinery installation time frames, manufacturing technology which
  is relatively modern, labor and potential skill shortage risks that
  could affect machinery operations, financing for investing and working
  capital, etc. In the first year of operation, the company had fixed
  the problem and learns from the mistakes to reduce the risks that may
  occur in the following year.

  Sugar Mill and Power Plant Project in Loei Province

  This project is investment in the fifth sugar mill of the company
  which consists of sugar mill with capacity of 16,000 tons cane/day,
  power plant with capacity of 40 MW in Loei province. A primary risk
  comes from the need for adequate supply of raw materials for crushing.
  To reduce this risk, the company promotes nearby cane farmers to
  expanding planted areas which is consistent with construction plan.
  The project is currently under construction, the primary risks during
  construction such as other types of licensing, machinery purchasing,
  delivery and installation in time frame. The project is expected to
  operate commercially in 2014.

  The other risks after commercial operation would be sourcing cane
  supply to feed the sugar mill, fluctuation of world sugar price,
  change in regulations, etc.

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 7 independent committee members and 4 out of 7
  independent committees are audit committee for checking the operations
  of the company. Moreover, out of the 21 directors of the company, 14
  are not Chinthammit members; 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.

8.  Risk from the World's Economic and Financial Situations

  The US and EU financial crises caused by credit problems have spread
  widely to other regions, affecting liquidity and economic systems
  around the world. As the mentioned issues have been affecting
  economies worldwide, there is no guarantee that these issues and
  similar circumstances in the future will not affect sugar businesses,
  demand for sugar, and/or the world's sugar prices. The lack of
  liquidity among financial institutions may also affect the Group's
  sources of loans and financing costs.

  KSL has implemented its financial policies well. Its D/E has been at
  an appropriate level. The company has maintained good relationships
  with all the banks that are long-term corporate business partners. All
  the corporate businesses will be handled carefully in order to
  minimize the future probable effect of the world's financial and
  economic conditions on the company.