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 factories to purchase the sugar cane locating
  in the neighborhood area. Therefore, in order to protect their
  crushing quantities, sugar factories 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 factories based on their respective sugar production. The ratio
  of domestic sales to exports of all sugar factories 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 average future price around 10-12 cents/lb surged
  to be around 17-20 cents/lb and was volatile especially in 2010-2011
  it used to be trade at more than 30 cent/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 factories, 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 factories 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 factories 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 factory, 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 factories are ready to start
  crushing the cane, the farmers harvest the cane and send it to the
  sugar factories 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 factories 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 2 projects during the past 2 years which
  are investment in sugar factory and power plant in Loei province and
  investment in power plant capacity expansion and crushing efficiency
  enhancement of sugar factory in Khon Kaen province.

  There are risks involving in the projects, as some of them are in
  progress of construction and pre-construction. At this point, it is
  still difficult to determine whether the projects will be successful
  or not. The risks are explained as follows:

Investment in Sugar Factory and Power Plant in Loei province

  This project is approved by cabinet to split some idle capacity of
  Khon Kaen Sugar Industry PCL to invest in the new sugar factory and
  also expand into capacity of 24,000 tons cane / day in Loei province.
  The Board of Directors meeting on May 9, 2010 has approved to invest
  in sugar factory and power plant in Loei province. The total
  investment value is approximately THB 3,800 million. The project
  consists of one sugar factory with capacity of 16,000 tons cane / day
  and one power plant with capacity of 40 Megawatt which are expected to
  operate commercially in 2013. Currently the project is under
  construction and still has risk of sourcing cane supply. However the
  company has promoted farmers around the factory in some period of time
  before project start.

  Investment in Power Plant Capacity Expansion and Crushing Efficiency
  Enhancement of Sugar Factory in Khon Kaen province

  The Board of Directors meeting on November 9, 2012, has approved the
  Company to make an investment in power plant capacity expansion by
  investing in 35 Megawatt capacity from its existing 30 Megawatt
  capacity; which is 65 Megawatt in total and efficiency enhancement of
  sugar factory by enhancing 8,000 tons cane / day capacity from its
  existing 27,000 Tons cane / day capacity. The total investment value
  is approximately THB 3,360 million which is expected to be finish in
  2014. The project costs a lot of investment budget and still has some
  funding concern. However the company has partially solved funding
  concern by using internal cash flow and retained earnings of Khon Kaen
  Sugar Industry PCL to fund the project. The other risks that may arise
  are construction risk and pre-construction risk since the project is
  in process of environmental impact assessment (EIA).

6.  Exchange Rate Risk

  The company exports about 60-70% of the sugar produced and hence, it
  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 for checking the
  operations of the company. 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.

9.  Risk from Laos & Cambodia Projects

  The projects in both countries are the initiative of offshore sugar
  business which the company is granted the concession area for cane
  plantation from the government and permitted to construct sugar
  factories. But land condition in concession area has low quality, lack
  of technology for huge plantation, lack of infrastructure and human
  resources therefore the projects take longer time for develop than the
  first plan. Consequently the productions still not reach break-even
  point and in 2012 both projects had loss. However the company has seen
  and solved various problems throughout the time. The company hired
  consultants to develop not only planting technology but also
  management system to control budget. Moreover the company provides
  loan to local farmers and suppliers to expand more plantation. After
  continuously developing infrastructures and land condition in the
  past, the projects show improvement.