It’s been a great summer for the oil and gas drillers. The Energy Select Sector SPDR (NYSE: XLE) is up 7 percent over the last three months, in line with the rallying S&P 500.

And that understates how well energy producers have performed, because the XLE is dominated by the large-cap integrated oil majors with growth challenges and the drag of shrinking downstream margins.

The broader based SPDR S&P Oil Gas Exploration & Production ETF (NYSE: XOP), which consists mostly of midcap and small-cap producers, has been among the market rally’s leaders, advancing  more than 12 percent in three months and 10 percent in just the last five weeks.

A wide variety of energy stocks have benefited: the leading producers of both oil and gas from the new shale basins as well as smaller players manifesting even faster growth, speculative lottery tickets and overleveraged behemoths that have turned to cost-cutting and restructuring for salvation.

Many have been designated Best Buys in our portfolios and have been living up to that label.

The momentum should continue in the energy space, bolstered by high crude prices and the likelihood of a further recovery in natural gas. But we think the time has come to look beyond some of the speculative names that have moved first and fastest to a couple of conservative, prudently managed companies that have not yet received their due, but could do so in the near future.

The recent gains have made their assets look even more undervalued, and their under-leveraged balance sheets offer plenty of potential to speed up growth. Both companies produce primarily natural gas and so are well positioned to profit from the rising global demand for this relatively cheap fuel, but are also investing in promising new oil fields.

We’re adding Devon Energy (NYSE: DVN) and WPX Energy (NYSE: WPX) to our Growth Portfolio.

Devon is by far the larger of the two. The fourth-largest US natural gas producer has a market capitalization of $24 billion, and 71 drilling rigs scouring pay dirt from the Canadian oil sands to the shale beneath Oklahoma and Texas.

Oil accounted for not quite a quarter of the past quarter’s average daily production, and more than half of those barrels were bitumen from the Canadian oil sands sold at a hefty discount to benchmark crudes.

More encouragingly, US crude production from unconventional resources is set to grow 40 percent this year, paced the blossoming production and growing acreage positions in the Permian Basin in Texas and the Woodford Shale and Mississippi Lime plays centered on Oklahoma. These basins are getting the lion’s share of incremental capital spending these days, and offer Devon great growth potential.

But growth at any cost has not been management’s style, and while the conservative culture has denied Devon the windfalls earned by EOG Resources (NYSE: EOG), it’s also spared it the near-death experience and the ensuing cost-cutting still roiling Chesapeake (NYSE: CHK).

In the four years through 2012, Devon realized nearly $12 billion in asset sales and joint venture proceeds, including the 2010 divestiture of international and offshore operations that recently led TV personality Jim Cramer to lump the stock with other “perpetual losers” as a “walking poison pill.”

But all those sales, in conjunction with strong cash flow, were enough to bankroll investments in the resource plays just starting to bear fruit without running up Devon’s debt.  Capital spending is now running only modestly above cash flow from operations, and Devon is still managing to sell its odds and ends at higher cash flow multiples than is currently accorded to the entire company, including its unconventional US jewels.

Meanwhile, the company recently repatriated $2 billion from those years-ago oversea sales at a bargain 5 percent income tax rate to pay down debt, and may be able to bring home as much at a similar rate in the near future.

Another catalyst will be the imminent filing of a prospectus for the planned initial offering of Devon midstream assets newly organized into a master limited partnership and likely to be revalued at the much higher multiples accorded to MLPs.

It’s also important to understand that, at current prices, the growth rate in crude production, and especially US crude production matters disproportionately to a driller’s bottom line. For instance, while crude accounted for just under a quarter of Devon’s recent production, it delivered just over half of the company’s revenue. So the ability to grow crude production now while prices are high is paramount, and Devon has a lot of financial dry powder as well as attractive prospects on which to expend it.

The experienced management team’s determination to grow shareholder returns rather than production makes it likely those investments will be prudent.

Source: Company presentation

Shares are up 15 percent since the end of the second quarter but are still down a third from their 2011 peak.  And the current Enterprise Value/Ebitda multiple of 6 doesn’t do justice to Devon’s opportunities for profitable growth. There’s also potential for growth in the current 1.5 dividend yield. Buy DVN below $67.

WPX is at first glance even more of an ugly duckling, with a market cap of just $3.8 billion and homely 5 percent revenue growth. It did post an operating gain in the most recent quarter, a first in its brief history as an independent company.

But that’s not why billionaire hedge fund manager David Einhorn of Greenlight Capital amassed a $50 million stake in WPX during the second quarter, and not why WPX was presented by respected value investor Guy Gottfield at the Value Investing Congress in Las Vegas in May. And it’s not why T. Rowe Price has accumulated a stake of nearly 10 percent.

These shrewd investors are probably attracted to the fact that WPX remains priced at less than three quarters of its book value, a notable industry anomaly. As Gottfried explained in his presentation, WPX likely suffers from the fact that it was an unwanted gas-focused production unit spun off by Williams Companies (WMB) in early 2012, just as gas prices were nearing their nadir.

Crude accounted for not quite 8 percent of recent production by volume (but nearly 30 percent of revenue), and as with Devon this is where WPX is deploying its capital. In it case, its most promising resource play is the Middle Bakken formation within the Williston Basin in North Dakota, where WPX is growing production 30 percent year-over-year. Very recently, WPX has also drilled some very promising wells in the Gallup Sandstone formation in New Mexico.


Source: company presentation

The bulk of WPX’s natural gas is pumped from the Piceance Basin in western Colorado, where WPX is the dominant and lowest-cost producer. Piceance is rich in value-added natural gas liquids, and WPX has recently managed to halt a decline in that basin’s production. WPX also has a promising position in the Marcellus Shale straddling Pennsylvania and West Virginia. It divested assets in the Barnett and Arkoma basins at prices that, Gottfried calculates, imply an upside of 50 to 75 percent for the shares from current levels.

This low valuation may not be immediately apparent from the company’s earnings, because WPX uses a success accounting method that does not capitalize general and administrative expenses the way it’s done by many competitors. But it’s evident in the discount to book value and the stock action, with shares already up 27 percent year-to-date. There is likely much more to come, despite naysayers like the Goldman Sachs analyst who’s just rated the stock a Sell.

We think WPX is a buy on the asset breakup value alone, and a strong buy given its opportunities in the Bakken, Piceance and Marcellus. The divestiture of majority-owned Latin American assets may provide a near-term catalyst. Buy WPX below $22.