Ok, now on to the novel of a post in answer to the OP:
Italy has several major hurdles to overcome if it's going to be a viable military power. It can fair fairly well but will never achieve German-level success without serious ASB. Best case is, yes, stay out of the war as long as possible and maybe jump on the Allied bandwagon when the writing is on the wall.
First, as stated earlier by others, economically it's in a hard spot. Its industry is newborn and ranks far behind its European neighbors in output and potential output. It has no natural resources to exploit. It does not have enough agricultural potential to feed its population. It is because of this utterly and completely dependent on imports and sea trade. It is therefore very vulnerable to blockades. The fact that Britain controls both Gibraltar and Suez and has influence in Turkey means the RN can choke off the Med pretty much at will. OTL during the entire course of the war Italy produced fewer tanks, planes, trucks, etc. than Britain in a half year and the US in a month.
The Empire made this position worse, not better. All the colonies were money-losing operations. Ethiopia alone cost four times the annual Italian GDP to maintain. Libyan Oil is the only moneymaker, and, as I stated before, any serious exploitation will have to be after the war.
Strategically, it's in a bad position. As a peninsula it's major cities are vulnerable to sea power, and where it's located geographically its major industrial cities are vulnerable to air raids from any of its neighbors.
Culturally and politically it's divided. Mussie's true genius was political in his ability to play off the myriad factions that fought for influence in the nation, including but far from limited to: the Agrari (big landowners), the industrialists, the royal/noble families, the Church, the Army, the Navy, regional/parochial interests, and factions within the hodge-podge Fascist party (Nationalists, semi-socialists, syndicalists, unionists, reactionaries, radicals, centralists, decentralists, various blocs and cabals, the local Ras', the Militia, the party hierarchy, individual generals and party gerarchi, etc.). Getting the nation to steer in one direction is difficult to say the least.
One result of this lack of direction resulted in the haphazard implementation of Corporative bureaucracies that, rather than create the theoretical streamlined, clockwork organizations simply created tangles of redundant and inefficient bureaucracies.
The military was as much a bluff as anything else. The numbers were limited and the capabilities inflated to appear formidable. Balbo was responsible for a lot of this as his transatlantic flights made headlines, but aircraft production never got above a few hundred a year. Also, all three branches lacked any unified strategic doctrine. The army, navy, and AF all battled for limited funds and all developed independent strategic doctrines in isolation. Ironically each had a (subservient) place for the other two services, which they never really coordinated with the other ones (ex. the Navy's Med strategy relied on undefined "assistance" from the AF, who didn't really develop viable anti-ship capabilities until mid-war). Also, all the services were internally without cohesive direction. The army was divided between Infantry-Artillery conservatives and Mechanized-Motorized (incl. tanks) progressives, the navy had the typical battleship/air power divide, and the AF waffled between Douhetist strategic bombers and Mecozzian tactical support.
Command/control wise they are in
very poor shape: the old Savoy elites that dominated the army were at best stuck in 1917...many seemed stuck in 1817! Mussie's need for control and personal security meant that promotion was based more on loyalty to him than on merit. Also, the Land of Marconi desperately lacked radios.
The Ethiopian and Spanish wars also taught the wrong lessons, making them believe that their outdated biplanes and tankettes were actually sufficient, which combat against modern forces proved horribly wrong.
Politically later on, the ineptitude and inefficiency had reached critical mass. By the late 30s Mussie was living in a bubble. He was, at heart, a self-doubting and paranoid man whose bluster and bravado was as much a facade and bluff as the "might" of the Fascist Nation. After the victory in Ethiopia he became so popular (practically a demigod) he started to believe his own hype. He surrounded himself by sycophants and yes men. He used blackmail and threats to pacify his gerarchi, seeing each and every one of them as a threat. Balbo was the only one who got away with public criticism of Mussie and the nation due to his own popularity and his indispensability (he was one of the few actually making things work at some level).
What Italy did have in its favor:
The myth of Italian cowardice and personal ineptitude is utterly false. Individual Italian soldiers, sailors, and airmen were actually very brave and skilled and fought well at an individual and squad level. The British commanders spoke well of Italian bravery in Africa despite the futility of it all. The NCOs and junior officers were skilled and disciplined and individual units fared well man-for-man. It was piss-poor strategy and command doctrine that sacrificed many in pointless and ill-planned battles.
Italian "Special Forces" were possibly the world's best at the time. Italian Frogmen proved very dangerous to Allied shipping and taught the Allies a thing or two after the war (lessons taken to heart by by the SeALs). Italian Alpini (mountain troops) and Bersaglieri (rangers/snipers) fought with distinction on all fronts, including in Russia.
Italian Artillery was good and performed well, even with the technological inferiorities of many designs.
Italian late-war aircraft were very good and their pilots the match of any peers. There just never were enough of either to come close to attrition rates.
So, later war means:
More time to build up their forces, more time to develop better weapons, time to observe and learn from the active combatants, and opportunity to jump on the Allied bandwagon late in the war, hoping for easy spoils.
If they opt for a "parallel war" option (not allied to Germany, not at war with the Allies, merely opportunistically attacking smaller neighbors (Yugo, Greece, etc.)), they have some hope of limited gains if they move carefully and with proper preparation, but face possible post-War (diplomatic, economic) retributions if they don't have some diplomatic justifications to placate the allies.
However:
They still suffer from the same command/control issues and lack of inter-service cohesion. Observation of the war alone may not do much to change this, particularly since OTL the high command showed a chronic inability to notice any shortcomings and a chronic ability to assume best-case for their forces. Only hard-learned lessons in combat will expose this, and honestly they have a very small window for that learning curve before they run out of weapons and supplies.
The Axis, regardless of when they enter the war, is going to be the doom of Italy. Unless your 20's POD drastically realigns who is fighting when and where, any OTL sort of situation will doom the Axis and with it Italy.
Mussie is unlikely to do the "right things" without a serious change in personality. He may avoid joining the war in 1940, but he WILL get his nation involved in
some war sometime soon. It's central to his being and his desires, which OTL almost always overwrote any caution or proper planning. Best case is late Allied, but more likely is the parallel war scenario. And if he acts as impulsively as OTL he'll face a bigger quagmire in the Balkans than he expects, such as OTL's Greek debacle.