Goldman sees this part of the energy sector outperforming, with more than 20% total return for these stocks

Published Tue, Oct 26 20212:51 PM EDTUpdated Tue, Oct 26 20214:02 PM EDT

Exploration and production companies report earnings this week and, after a blistering rally year to date for the energy sector , Goldman Sachs believes more gains are ahead for certain upstream names. The firm compiled a list of stocks that have total return potential above 20% looking forward, with Pioneer Natural Resources among the names on the list. On Monday, the SPDR Oil & Gas Exploration & Production Fund , which tracks the space, hit its highest level since June 2019. The fund is up about 89% for the year. The broader energy sector, by comparison, is up roughly 56% for 2021. With earnings reports on deck, Goldman Sachs said several key themes will be top of mind for investors. Free cash flow figures will be closely watched amid the recovery from the pandemic and as commodity prices rally. Analysts led by Neil Mehta said they expect "further [free cash flow] inflection in 4Q" should oil and gas prices climb even higher. Ongoing capital discipline will also be key after companies slashed spending in an effort to shore up balance sheets. Finally, investors will be watching for commentary around companies' capital return plans. "We expect producers to reiterate their commitment to capital discipline growth, and see upside to capital returns given favorable commodity prices," the firm summarized. Mehta pointed to Pioneer Natural Resources and Hess as two stocks that have lagged their peers and look attractive going forward. The two companies have returned nearly 70% this year. Texas-based Pioneer is on Goldman's conviction list. "We believe shares are not reflecting credit for PXD's strong asset quality and deep inventory of undeveloped locations, which can allow for improving FCF/dividend as hedges roll-off," the firm said. "PXD shares also offer attractive cash returns to equity holders in the near-term," the firm added. Goldman has a 12-month price target of $237 per share on the stock, which is 23% above where shares closed Monday. Including the company's dividend yield, the firm sees Pioneer's total return potential standing at 33%. When it comes to Hess, Goldman said the stock isn't fully reflecting the company's opportunity in Guyana. Mehta expects the company to grow its cash flow per share to $30 by 2030 from $10 in 2021. The firm's $118 per share target is roughly 33% above where the stock closed Monday, with total return potential at 34%. The jump in oil and gas prices has boosted shares of energy companies. West Texas Intermediate crude , the U.S. oil benchmark, has gained more than 70% this year and hit a seven-year high above $85 per barrel Monday. Natural gas has eased off its recent high, but is still up about 130% this year. Occidental is another name that makes Goldman's list. The firm sees the company's total return potential at 22%. "We continue to believe the company remains on track to generate attractive FCF especially at our bullish commodity price outlook which can allow for above-consensus debt reduction," Goldman said. For Diamondback Energy , Goldman sees 21% total return ahead. Mehta said Diamondback is attractive due to its disciplined production growth and shareholder payout policy. He estimates that 50% of the company's free cash flow will go toward growing the company's dividend, buying back stock and a variable dividend. "The company has shown strong production and capex execution this year, and we see this being maintained in 3Q," the firm said. Shares of Occidental and Diamondback are up 105% and 130% this year, respectively. —CNBC's Michael Bloom contributed reporting.

A new oil well head waits to be fracked at a Hess site near Williston, N.D.

Andrew Cullen | Reuters

The firm compiled a list of stocks that have total return potential above 20% looking forward, with Pioneer Natural Resources among the names on the list.