UPDATE 3-American Eagle's weak Q2 view drags down shares

* Q1 adj EPS $0.17 vs est $0.17

* Q1 revenue $659.5 mln vs est $656.3 mln

* Sees Q2 earnings below Street

* Shares down 14 pct (Recasts; Adds analyst comments, updates share movement)

By Nivedita Bhattacharjee

BANGALORE, May 26 (Reuters) - Teen retailer American Eagle Outfitters (AEO.N) forecast a second quarter that fell way below estimates as it sees spotty consumer demand ahead of the back-to-school season, sending its shares down 14 percent on Wednesday.

The company, which has been losing market share to lower priced rivals like Aeropostale Inc (ARO.N) and privately held Forever 21, saw inconsistent store traffic levels, and was hurt as it did not balance inventory and discounts well.

During the quarter, total merchandise inventory for the company, that has leaned heavily on denims to attract girls, was $326 million, an increase of $47 million.

Wall Street Strategies analyst Brian Sozzi said the rising inventory would probably mean that the company would have to discount more, putting margins under pressure.

However, American Eagle was planning to cut down inventory in the second half of the year, as it looks to manage pricing and units better, it said on a conference call with analysts.

PRICEY IMAGE

Most top U.S. retail chains reported weaker-than-expected April same-store sales, in what may be a pointer that Wall Street's hopes for a consumer rebound have gotten ahead of the actual pace of recovery.

"While the economy has seen a slow uptick, we are seeing women shopping more for themselves after some pent-up demand, we have still not seen that in the teen space. Teens are still underemployed," said Sapna Shah, principal at research and consulting firm Retail Eye Partners.

Shah said teens, with limited pocket money, would rather spend on entertainment like movies and eating out than buy clothes, and when they do, they want "incredible value for money."

Their perception of American Eagle, which has traditionally not been among the more affordable retailers, also works against the company, Shah said.

Earlier in the month, rival Aeropostale beat quarterly forecasts, and said summer specials like knit tops and shorts were seeing strong demand at its stores.

In contrast, for American Eagle, knit tops have been a problem area, and the company said it is working on getting more designs and a faster turnaround for the category.

WEAKNESS AHEAD

For the second quarter, American Eagle forecast a loss of 1 cent a share to a profit of 3 cents a share, below analysts estimates of a profit of 21 cents a share, according to Thomson Reuters I/B/E/S,

The second-quarter view reflects "margin pressure related to weaker business trends early in the quarter," the company, which owns the American Eagle, aerie and 77kids by American Eagle brands, said.

American Eagle's net profit in the first quarter ended May 1 was $10.9 million, or 5 cents per share, from $22 million, or 11 cents per share, a year earlier.

Excluding costs associated with the exit from its profit-losing Martin + Osa chain earlier this year, the company earned 17 cents a share, in line with analysts average estimates of 17 cents a share.

Revenue rose 8 percent to $659.5 million. Analysts were looking at revenue of $656.3 million.

Shares of the Pittsburgh-based company were down 14 percent at $13.24 Wednesday, making them the biggest percentage loser on the New York Stock Exchange. (Reporting by Nivedita Bhattacharjee in Bangalore; Editing by Aradhana Aravindan)